MSRB Regulatory Updates

October 2, 2014 | Bond Dealers of America National Fixed Income Conference

Michael L. Post, Deputy General CounselSharon Zackula, Associate General Counsel

Municipal Securities Rulemaking Board

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• MSRB Fiscal Year 2015 Strategic Priorities

• Rules for Municipal Advisors

• Rules for Dealers

Presentation Outline

MSRB Fiscal Year 2015 Strategic Priorities

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Prioritizing Future Initiatives

• MSRB request for comment on its strategic priorities was released on September 8, 2014

– Municipal Advisor Regulation

– Municipal Entity Protection

– Market Efficiency

– Price Transparency

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Prioritizing Future Initiatives

Rules for Municipal Advisors

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Advancing Municipal Advisor Regulation

• MSRB is developing a comprehensive regulatory framework that includes:

– Development of rules governing the professional conduct of municipal advisors

– Establishment of a professional qualifications program that ensures municipal advisors are qualified in their duties

– Extensive education and outreach to municipal advisors on duties and obligations

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Overview of Municipal Advisor Rulemaking

• MSRB rulemaking for municipal advisors

– Core standards of conduct rule (MSRB Draft Rule G-42)

– Supervision and compliance obligations (MSRB Draft Rule G-44)

– Professional qualifications for municipal advisors (MSRB Draft Rule G-3)

– Pay-to-play rule (Draft Amendments to MSRB Rule G-37)

– Gifts and gratuities(Draft Amendments to MSRB Rule G-20)

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Scope of Draft Rule G-44

• Reasonably designed supervisory system

– Written supervisory procedures

– Designation of a one or more municipal advisor principals responsible for supervision

• Compliance processes

– Review, test and modify compliance policies and written supervisory procedures

• Designation of a single chief compliance officer

– CCO may be a principal of the firm or a non-employee of the firm

• CEO must certify annually that compliance processes in place (to be implemented 18 months after SEC approval)

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Written Supervisory Procedures

• A municipal advisor’s written supervisory procedures must take into consideration at least the following:

– Firm’s size

– Firm’s organizational structure

– Nature and scope of municipal advisory activities

– Number of offices

– Disciplinary and legal history of associated persons

– Likelihood that associated persons may be engaged in relevant outside business activities

– Any indicators of irregularities or misconduct

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Compliance Processes

• Municipal advisors must implement processes to establish, maintain, review, test and modify written compliance policies and supervisory procedures

• Municipal advisors must conduct, at least annually, a review of the compliance policies and supervisory procedures

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Designation of Municipal Advisor Principal

• Municipal advisors must designate one or more municipal advisor principals to be responsible for supervision

– The MSRB intends to file amendments to its professional qualifications rule, Rule G-3, to establish the municipal advisor principal classification

– Initially, principal would be required to pass municipal advisor representative qualification examination, when adopted

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Designation of Municipal Advisor Principal (continued)

• Supervisory principals must have sufficient knowledge, experience and training to understand and discharge their responsibilities

• Supervisory principals must have authority to: – Carry out the supervision for which they are responsible

– Implement the established written supervisory procedures and take any other action necessary to fulfill their responsibilities

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Professional Qualifications: Overview of Amendments to MSRB Rule G-3

• Draft amendments to MSRB Rule G-3:

– Add standards for municipal advisors

– Create two new registration classifications

– Require municipal advisors to take and pass a professional qualification exam

– Eliminate the apprenticeship requirement for dealers and include no such requirement for municipal advisors

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Professional Qualifications:Two New Registration Classifications

• Municipal advisor representative:

– a natural person who is an associated person of a municipal advisor who engages in municipal advisor activities on the firm’s behalf (other than a person whose functions are solely clerical or ministerial)

• Municipal advisor principal:

– a natural person who is an associated person of a municipal advisor who is directly engaged in the management, direction or supervision of the municipal advisory activities of the municipal advisor

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Professional Qualifications: Representative Qualification Exam

• Draft amendments to MSRB Rule G-3 require each municipal advisor representative to take and pass a qualification exam

– No grandfathering

– At a later date, the MSRB will consider a qualification exam for municipal advisor principals

– Individuals who do not pass the exam would generally be permitted to re-take the exam after 30 days

– One-year time period from the effective date of the qualification exam to pass the exam

– Exam expected during 2015

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Status of Draft Rule G-42

• Initial Request for Comment published on January 9, 2014

• Draft Rule G-42 was revised based on comments received and a second Request for Comment was published on July 23, 2014

• MSRB anticipates rule filing with SEC in Fall 2014

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Scope of Initial Draft Rule G-42

• Duties and responsibilities of a non-solicitor municipal advisor engaging in municipal advisory activities – Standards of conduct

– Disclosure of conflicts of interest

– Documentation of the relationship

– Recommendations

– Principal transactions

– Prohibitions related to compensation, fees and the retention of business

• Duties created by the Initial Draft Rule are in addition to fiduciary duties under state or other laws

• Duties of solicitors will be addressed in a separate rulemaking initiative

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Revised Draft Rule G-42:Standards of Conduct

• Revised Draft Rule G-42 (a) has not been modified and continues to follow Dodd-Frank Act in deeming a municipal advisor to owe a fiduciary duty only to its municipal entity clients

• Revised Draft Rule retains the duty of care as the standard of conduct that would apply to municipal advisors whose clients are obligated persons

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– Disclosure of legal or disciplinary events that are material to the client’s evaluation or disclosed on the Form MA or Forms MA-I filed with the SEC and where the forms can be electronically accessed

– Date of the last material change to a legal or disciplinary event disclosure on any Form MA or Form MA-I filed with the SEC

– Disclosure of material conflicts of interest arising from compensation only when compensation is contingent on the size or closing of a transaction

Revised Draft Rule G-42: Disclosure of Conflicts and Other Information

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Revised Draft Rule G-42: Disclosure of Conflicts and Other Information (continued)

– Advisor must affirmatively disclose that it has “no known” material conflicts of interest based on the exercise of reasonable diligence rather than a more categorical statement

– No requirement to disclose information on professional liability insurance

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Revised Draft Rule G-42:Documentation of the Relationship

• Revised Draft Rule G-42 simplifies documentation:

– Documentation of compensation only to include form and basis of direct and indirect compensation

– No longer required to document reasonably expected amount of compensation

– No longer required to detail specific undertakings if requested by the client with respect to the preparation and finalization of the official statement, if the municipal advisory activities relate to a new issue or reoffering

– Documentation of the advisory relationship must be amended and supplemented only if there are material changes or additions

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Principal Transactions

• Revised Draft Rule G-42(e)(ii) clarifies and narrows the scope of the proposed prohibition of principal transactions:

– Municipal advisor and its affiliates are prohibited from “engaging in a principal transaction” directly related to the same municipal transaction or municipal financial product as to which the municipal advisor is providing advice

– No specific prohibition or disclosure and consent requirement in the Revised Draft Rule for a municipal advisor to an obligated person client

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Principal Transactions (continued)

• Revised Draft Rule G-42(f)(ii) provides a definition of the term “engaging in a principal transaction”:

“When acting as a principal for one’s own account, selling to or purchasing from the municipal entity client any security or entering into any derivative, guaranteed investment contract, or other similar financial product with the municipal entity client.”

Extension of MSRB Rule G-37 to

Municipal Advisors

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The Purpose of Rule G-37 Amendments

• Existing MSRB Rule G-37 (1994) addresses “pay to play” practices, seeks to eliminate quid pro quo corruption or the appearance of quid pro quo, and has separate and mutually reinforcing requirements that apply to dealers

• Draft amendments would extend Rule G-37 to municipal advisors to address “play to play” practices

• Draft amendments cover all municipal advisors, including municipal advisors that solicit business on behalf of third-parties (municipal advisor third-party solicitors)

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Recent Action

• MSRB Notice 2014-15: “Draft Amendments to MSRB Rule G-37 to Extend Its Provisions to Municipal Advisors”

– Published August 18, 2014

• Comment period ended October 1, 2014

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Scope of Draft Amendments to Rule G-37• Establish limitations on business activities of municipal

advisors that are triggered by the making of certain political contributions

• Establish limitations on municipal advisors on solicitation and coordination of political contributions to officials of issuers or political parties of states, localities if seeking to do business there

• Require disclosure and recordkeeping by municipal advisors of specified political contributions

• Define “municipal advisor professional” (“MAP”)

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Cross Bans on Business for Dealer-Municipal Advisors

• To address the possibility or appearance of quid pro quo corruption, draft amended Rule G-37 would subject a firm that is a dealer-municipal advisor to a “cross-ban,” but one that is appropriately limited in scope:

– Ban on both municipal securities business and municipal advisory business when a contribution is made to an official that has both dealer and municipal advisor selection influence

– Ban on only the type of business that the official to whom the contribution was made has the ability to influence where that influence is more limited

– In the instances above, triggering contribution can be made by the dealer-municipal advisor, an MFP, an MAP, or a PAC controlled by the dealer-municipal advisor or an MFP or MAP of the dealer-municipal advisor

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Excluded Contributions

• De Minimis Contributions: MAPs, like MFPs, may contribute up to $250 per election to an official for whom the MAP is entitled to vote

• Exceptions to “Two-Year Look-Back” (contribution review period): If a person becomes an MAP solely

– Because she solicits municipal advisory business, the ban is triggered only if the MAP (i) in her pre-MAP status, contributed to official of a municipal entity and (ii) subsequently, as a MAP, solicits business from the same municipal entity

– Because she is a supervisor or executive, the ban is triggered only as to business in connection with officials the MAP made contributions to within 6 months of becoming an MAP

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Next Steps

• Review the comment letters filed in response to MSRB Notice 2014-15

• Consider possible revisions to the draft proposal in response to the comments, if appropriate

• Obtain Board approval to file a proposed rule change with the

SEC

Rules for Dealers

Best-ExecutionMSRB Rule G-18

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Evolution of Proposed Best-Execution Rule

• Evolution

– Discussion of best-execution in SEC filing for MSRB Rule G-43 (Broker’s Brokers) (March 26, 2012)

– SEC Report on the Municipal Securities Market (July 31, 2012)

– MSRB Notice 2013-16: Best-Execution Concept Proposal (August 6, 2013)

– MSRB Notice 2014-02: Request for Comment on Draft Best-Execution Rule (February 19, 2014)

– Rule Filing SR-MSRB-2014-07: Filing of Proposed Best- Execution Rule (August 20, 2014)

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Overview of Proposed Rule G-18: Best-Execution

• Dealers must use reasonable diligence to obtain the most favorable terms available to their customers under prevailing market conditions:

– Guidance on reasonable diligence

– Provisions specific to broker’s brokers and customer instructions

– Exception for municipal fund securities (Section 529 plan securities) and transactions for sophisticated municipal market professionals (SMMPs)

– Requires written policies and procedures and periodic review of these policies and procedures

• Generally consistent with FINRA Rule 5310 on Best-Execution, but tailored to the characteristics of the municipal securities market

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Best-Execution Obligation

• In any municipal security transaction with a customer or a customer of another dealer, dealers must use reasonable diligence to ascertain the best market for the security

• The dealer must then buy or sell in that market so that the price to the customer is as favorable as possible under prevailing market conditions

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“Market” Defined

• A “market” encompasses a variety of different venues, including (but not limited to):

– Broker’s brokers

– Alternative trading systems or platforms

– Other counterparties, including a dealer itself acting as a principal

• The term should be construed broadly

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Reasonable Diligence

• Factors used to determine whether a dealer has used “reasonable diligence” include:– character of the market for the security

– size and type of transaction

– number of markets checked

– information reviewed to determine the current market for the security or similar securities

– accessibility of quotations

– terms and conditions of the customer’s inquiry or order

• Factors generally conform to the factors in FINRA Rule 5310 (Exception: Information reviewed to determine the current market for the security or similar securities is not found in FINRA Rule 5310)

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Reasonable Diligence (continued)

• Failure to obtain the most favorable price does not necessarily mean that a dealer failed to use reasonable diligence

• A dealer’s failure to maintain adequate resources is not an excuse for executing away from the best available market

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Customer Instructions

• Dealers are not required to make a best-execution determination that would supersede a customer’s unsolicited specific instruction regarding the execution of the transaction

– Required to process the transaction in a reasonably timely manner and in accordance with the terms of the customer’s bid or offer

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Interpositioning

• Dealers must not interject a third party, such as a broker’s broker, between themselves and the best market for a security if the use of that party would be inconsistent with the dealer’s best-execution obligation

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Timing

• Dealers must make every effort to execute customer transactions promptly, taking into account prevailing market conditions

– In certain market conditions, a dealer may need more time to use reasonable diligence to ascertain the best market for the security

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Principal and Agency Transactions

• Proposed Rule G-18 applies to both principal and agency transactions

• Best-execution obligations are distinct from those regarding the fairness and reasonableness of commissions, markups or markdowns governed by MSRB Rule G-30

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Sophisticated Municipal Market Professionals (SMMPs)

• Proposed amendments to Rule G-48 (Transactions with SMMPs) provide that dealers do not have best-execution obligations with respect to transactions with SMMP customers

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Proposed Amendments to MSRB Rule D-15

• Proposed amendments to Rule D-15 help ensure that the exemption for dealers from the best-execution obligation for transactions with SMMPs would only apply to appropriate customers, and to provide for a uniform approach

• Three additional elements for the required SMMP customer affirmation:

– Aligned with elimination of a dealer’s best-execution obligation: customer would be required to affirm that it is exercising independent judgment in evaluating the quality of execution of the customer’s transactions by the dealer

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Proposed Amendments to MSRB Rule D-15 (continued)

– Aligned with elimination of a dealer’s obligation to ensure fair and reasonable pricing in a specified subset of transactions with SMMPs: customer would be required to affirm that it is exercising independent judgment in evaluating the transaction price in that subset of transactions

– Aligned with reduction of a dealer’s obligation to make time-of-trade disclosure under Rule G-47: customer would be required to affirm that it has timely access to “material information” available publicly from “established industry sources”

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Required Dealer Policies and Procedures

• Specific requirements to establish policies and procedures and to review such procedures at least annually:

– Must have written policies and procedures, including those that address how best-execution determinations will be made for securities with limited pricing information or quotations

– Document compliance with its policies and procedures

– Periodically review dealer’s policies and procedures, including procedures for determining the best available market for retail customer transactions (i.e., to assess if the policies and procedures are reasonably designed to achieve best execution, taking into account, changes in market structure, new entrants, availability of additional pre-trade and post-trade data, and availability of new technologies)

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Executing Brokers

• Dealers are only obligated to provide best-execution to customer orders received from other dealers when the order is routed to the dealer for handling and execution

– The best-execution obligation does not apply to a dealer when another dealer is simply executing a customer transaction against that dealer’s quote

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Next Steps

• Review comments filed in response to SEC publication of SR-MSRB-2014-07

– SEC comment period closed on September 29, 2014

• File a Response to Comments and any amendments, as appropriate

MSRB Regulatory Updates

October 2, 2014 | Bond Dealers of America National Fixed Income Conference