Notice2022-09960
Self-Regulatory Organizations; Municipal Securities Rulemaking Board; Notice of Filing of a Proposed Rule Change Consisting of Amendments to MSRB Rule G-19 Regarding Regulation Best Interest for Certain Municipal Securities Activities of Bank Dealers and MSRB Rule G-48 Regarding Quantitative Suitability for Institutional Sophisticated Municipal Market Professionals
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
May 10, 2022
Issuing agencies
Securities and Exchange Commission
Full Text
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<title>Federal Register, Volume 87 Issue 90 (Tuesday, May 10, 2022)</title>
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[Federal Register Volume 87, Number 90 (Tuesday, May 10, 2022)]
[Notices]
[Pages 28084-28097]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-09960]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-94850; File No. SR-MSRB-2022-02]
Self-Regulatory Organizations; Municipal Securities Rulemaking
Board; Notice of Filing of a Proposed Rule Change Consisting of
Amendments to MSRB Rule G-19 Regarding Regulation Best Interest for
Certain Municipal Securities Activities of Bank Dealers and MSRB Rule
G-48 Regarding Quantitative Suitability for Institutional Sophisticated
Municipal Market Professionals
May 4, 2022.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'' or ``Exchange Act'') \1\ and Rule 19b-4 thereunder,\2\ notice
is hereby given that on April 29, 2022, the Municipal Securities
Rulemaking Board (``MSRB or ``Board'') filed with the Securities and
Exchange Commission (``SEC'' or ``Commission'') the proposed rule
change as described in Items I, II, and III below, which Items have
been prepared by the MSRB. The Commission is publishing this notice to
solicit comments on the proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The MSRB filed with the Commission a proposed rule change
consisting of amendments to: (i) MSRB Rule G-19, on suitability of
recommendations and transactions, and (ii) MSRB Rule G-48, on
transactions with sophisticated municipal market professionals
(``SMMPs'') \3\ (collectively, the ``proposed rule change''). The
proposed rule change would align MSRB Rule G-19 to the Commission's
Rule 15l-1 under the Exchange Act (``Regulation Best Interest'') \4\
for certain municipal securities activities of bank dealers \5\ (the
``Best Interest Amendments''). In addition, the proposed rule change
would amend MSRB Rule G-48 to modify the quantitative suitability
obligation of brokers, dealers, and municipal securities dealers
(collectively, ``dealers'' and, individually, each a ``dealer'') by
eliminating the quantitative suitability obligation for recommendations
in circumstances where a dealer does not have actual control or de
facto control over the account of an Institutional SMMP (the
``Institutional SMMP Amendment'').\6\
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\3\ Under MSRB Rule D-15, on the term sophisticated municipal
market professional, ``[t]he term `sophisticated municipal market
professional' or `SMMP' is generally defined by three essential
requirements: the nature of the customer; a determination of
sophistication by the broker, dealer or municipal securities dealer
[ ]; and an affirmation by the customer; as specified [therein].''
See MSRB Rule D-15. See also related discussion under Background and
Purpose of the Institutional SMMP Amendment--Background on MSRB Rule
D-15 and SMMP Affirmation Requirements near note 37 infra.
\4\ 17 CFR 240.15l-1; see also Exchange Act Release No. 86031
(June 5, 2019), 84 FR 33318 (July 12, 2019) (File No. S7-07-18)
(``Regulation Best Interest Adopting Release'').
\5\ Consistent with MSRB Rule D-8, on the term bank dealer, the
term ``bank dealer'' as used herein means ``a municipal securities
dealer which is a bank or a separately identifiable department or
division of a bank as defined in rule G-1 of the Board.'' Such
references in this proposed rule shall be collectively to ``Bank
Dealers'' or individually to a ``Bank Dealer.'' See also MSRB Rule
D-11, on the term associated persons (indicating that the term bank
dealer as used in MSRB rules shall generally refer to the associated
persons of a bank dealer unless the context otherwise requires or a
rule of the Board otherwise specifically provides).
\6\ The term ``Institutional SMMP'' is used here as defined
below under the discussion Background and Purpose of the
Institutional SMMP Amendment. The Institutional SMMP definition used
herein would not encompass any natural person customers who qualify
as ``retail customers'' under the definitions of Regulation Best
Interest, such as certain natural persons with significant total
assets, who might otherwise meet the status requirements of an SMMP.
See note 20 infra and related discussion under Background and
Purpose of the Institutional SMMP Amendment.
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Subject to Commission approval, the respective compliance dates for
the amendments to MSRB rules included in the proposed rule change will
be announced in a regulatory notice published by the MSRB on its
website within 30 days of the publication of the Commission's approval
order in the Federal Register. Such compliance date for the Best
Interest Amendments will be no earlier than one year from the MSRB's
publication of the regulatory notice announcing it.\7\ Such compliance
date for the Institutional SMMP Amendment will be no earlier than 30
days from the MSRB's publication of the regulatory notice announcing
it.
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\7\ This one-year minimum timeframe is roughly equivalent to the
timeframe provided by the Commission when it adopted Regulation Best
Interest. See Regulation Best Interest Adopting Release, 84 FR at
33318, 33400 (setting an effective date of September 10, 2019 and a
compliance date of June 30, 2020).
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The text of the proposed rule change is available on the MSRB's
website at <a href="http://www.msrb.org/Rules-and-Interpretations/SEC-Filings/2022-Filings.aspx">www.msrb.org/Rules-and-Interpretations/SEC-Filings/2022-Filings.aspx</a>, at the MSRB's principal office, and at the Commission's
Public Reference Room.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the MSRB included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The MSRB has prepared summaries, set forth in Sections
A, B, and C below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
The proposed rule change consists of the Best Interest Amendments
to MSRB Rule G-19 and the proposed Institutional SMMP Amendment to MSRB
Rule G-48 for the respective purposes further described below.
Background and Purpose of the Best Interest Amendments
The proposed Best Interest Amendments would amend MSRB Rule G-19 to
extend the obligations of Regulation Best Interest to Bank Dealers when
making recommendations to retail customers of municipal securities
transactions or investment strategies involving municipal securities
(collectively, ``retail municipal recommendations'' and, individually,
each a ``retail municipal recommendation''). The Best Interest
Amendments are intended to improve investor protection in the municipal
securities market by ensuring that retail customers are afforded
investor protections under Regulation Best Interest, regardless of
whether a retail municipal recommendation received by a retail customer
is made by a Broker-Dealer or a Bank Dealer.\8\
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\8\ The term ``Broker-Dealer'' is used here as defined below
under the following discussion Background on the Commission's
Regulation Best Interest.
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[[Page 28085]]
Background on the Commission's Regulation Best Interest
On June 5, 2019, the SEC adopted Regulation Best Interest, which
established a new standard of conduct for broker-dealers, and the
natural persons who are associated persons of such broker-dealers
(collectively, ``Broker-Dealers'' and, individually, each a ``Broker-
Dealer''), when making a recommendation to a retail customer of any
securities transaction or investment strategy involving securities.\9\
As defined in Regulation Best Interest, the term ``retail customer''
generally refers to any natural person, or the legal representative of
such person, who receives and uses a recommendation from a Broker-
Dealer primarily for personal, family, or household purposes.\10\
Regulation Best Interest enhanced the Broker-Dealer standard of conduct
beyond existing suitability obligations, such as those required by MSRB
Rule G-19, on suitability, for such retail customers and aligned the
applicable standard of conduct with the reasonable expectations of
retail customers.\11\ In this regard, Regulation Best Interest imposes
the following ``general obligation'' on Broker-Dealers, stating a
broker, dealer, or a natural person who is an associated person of a
broker or dealer, when making a recommendation of any securities
transaction or investment strategy involving securities (including
account recommendations) to a retail customer, shall act in the best
interest of the retail customer at the time the recommendation is made,
without placing the financial or other interest of the broker, dealer,
or natural person who is an associated person of a broker or dealer
making the recommendation ahead of the interest of the retail
customer.\12\
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\9\ See, generally, Regulation Best Interest Adopting Release
(citation at note 4 supra). In response, on May 1, 2020, the MSRB
filed a proposed rule change with the Commission to harmonize
Regulation Best Interest with certain MSRB rules applicable to
related municipal securities activities of Broker-Dealers. See
Exchange Act Release No. 88828 (May 6, 2020), 85 FR 28082, File No.
SR-MSRB-2020-02 (hereinafter, the ``Broker-Dealer Harmonization
Filing''), available at <a href="https://msrb.org/-/media/Files/SEC-Filings/2020/MSRB-2020-02-Notice.ashx">https://msrb.org/-/media/Files/SEC-Filings/2020/MSRB-2020-02-Notice.ashx</a>?. The Commission approved these
proposed amendments on June 25, 2020. See Exchange Act Release No.
89154 (June 25, 2020), 85 FR 39613 (July 1, 2020), File No. SR-MSRB-
2020-02, available at <a href="https://msrb.org/-/media/Files/SEC-Filings/2020/MSRB-2020-02-Federal-Register.ashx">https://msrb.org/-/media/Files/SEC-Filings/2020/MSRB-2020-02-Federal-Register.ashx</a>?.
\10\ 17 CFR 240.15l-1(b)(1) (``Retail customer means a natural
person, or the legal representative of such natural person, who (i)
[r]eceives a recommendation of any securities transaction or
investment strategy involving securities from a broker, dealer, or a
natural person who is an associated person of a broker or dealer;
and (ii) [u]ses the recommendation primarily for personal, family,
or household purposes.'') For discussion of what it means for a
retail customer to ``use'' a recommendation, see the SEC staff's
Frequently Asked Questions on Regulation Best Interest, available at
<a href="https://www.sec.gov/tm/faq-regulation-best-interest">https://www.sec.gov/tm/faq-regulation-best-interest</a>.
\11\ Regulation Best Interest Adopting Release, 84 FR at 33319.
\12\ 17 CFR 240.15l-1(a)(1). Regulation Best Interest provides
that this general obligation is satisfied only if a Broker-Dealer
complies with four component obligations: (i) An obligation to make
certain prescribed disclosures, before or at the time of the
recommendation, about the recommendation and the relationship
between the retail customer and the Broker-Dealer (the ``Disclosure
Obligation'') (see 17 CFR 240.15l-1(a)(2)(i)); (ii) an obligation to
exercise reasonable diligence, care, and skill in making a
recommendation (the ``Care Obligation'') (see 17 CFR 240.15l-
1(a)(2)(ii)); (iii) an obligation to establish, maintain, and
enforce written policies and procedures reasonably designed to
address conflicts of interest (the ``Conflict-of-Interest
Obligation'') (see 17 CFR 240.15l-1(a)(2)(iii)); and (iv) an
obligation to establish, maintain, and enforce written policies and
procedures reasonably designed to achieve compliance with Regulation
Best Interest (the ``Compliance Obligation'') (see 17 CFR 240.15l-
1(a)(2)(iv)).
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Discussion of Regulation Best Interest's Current Applicability to Bank
Dealers
By its terms, Regulation Best Interest does not apply to retail
municipal recommendations made by Bank Dealers, because Bank Dealers in
exempted securities have an exception from Broker-Dealer status under
the Act and Regulation Best Interest applies only to Broker-Dealers. As
a result, Bank Dealers presently are not required to comply with
Regulation Best Interest and, therefore, retail investors may not
benefit from its enhanced standard of conduct when receiving
recommendations from Bank Dealers.\13\
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\13\ See Broker-Dealer Harmonization Filing, 85 FR at 28083, n.
5 (discussing how Bank Dealers are not subject to Regulation Best
Interest by the terms of the SEC's rules and indicating the Board's
intent to issue a request for comment regarding extending the
requirements of Regulation Best Interest to Bank Dealers). Notably,
all Bank Dealer recommendations, including retail municipal
recommendations, are presently subject to the longstanding
suitability obligations provided by MSRB rules, including MSRB Rule
G-19 and, when applicable, MSRB Rule G-48.
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Application of Regulation Best Interest to Bank Dealers
The proposed Best Interest Amendments would amend MSRB Rule G-19 to
require a Bank Dealer to comply with Regulation Best Interest to the
same extent as if it were a Broker-Dealer when making a retail
municipal recommendation. Consequently, a Bank Dealer would have to act
in the best interest of the retail customer at the time a retail
municipal recommendation is made, without placing the financial or
other interests of the Bank Dealer ahead of the interest of the retail
customer. Correspondingly, the Bank Dealer would have to comply with
the Commission's component obligations of Regulation Best Interest to
the same extent as if it were a Broker-Dealer, including Regulation
Best Interest's Disclosure Obligation,\14\ Care Obligation,\15\
Conflict-of-Interest Obligation,\16\ and Compliance Obligation.\17\
Under the proposed Best Interest Amendments, the component obligations
of Regulation Best Interest would apply to those municipal securities
activities associated with a retail municipal recommendation within the
overall context of a Bank Dealer business model. The MSRB believes that
any SEC guidance with respect to the understanding and application of
Regulation Best Interest would be equally applicable to Bank Dealers.
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\14\ 17 CFR 240.15l-1(a)(2)(i).
\15\ 17 CFR 240.15l-1(a)(2)(ii).
\16\ 17 CFR 240.15l-1(a)(2)(iii).
\17\ 17 CFR 240.15l-1(a)(2)(iv).
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Application of the Disclosure Obligation to Bank Dealers
Consistent with Regulation Best Interest's Disclosure Obligation,
the proposed Best Interest Amendments would require a Bank Dealer,
prior to or at the time of the retail municipal recommendation, to
provide to its retail customer, in writing, full and fair disclosure
of: (a) All material facts relating to the scope and terms of the
relationship with the retail customer, including: (i) That the Bank
Dealer is acting as a municipal securities dealer with respect to the
retail municipal recommendation; (ii) The material fees and costs that
apply to the retail customer's transactions, holdings, and accounts;
and (iii) The type and scope of services provided to the retail
customer, including any material limitations on the securities or
investment strategies involving securities that may be recommended to
the retail customer; \18\ and (b) All material facts relating to
conflicts of interest that are associated with the retail municipal
recommendation.
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\18\ For example, if the applicable legal charter of a Bank
Dealer only permits a Bank Dealer to conduct municipal securities
activities or, in fact, a Bank Dealer's business model is limited to
municipal securities activities, then the Bank Dealer generally
would be required to accurately disclose the fact that it only
engages in transactions involving municipal securities and,
therefore, will only make recommendations to a retail customer
regarding transactions involving municipal securities. See also note
19 infra (discussing the Compliance Obligation pursuant to the Best
Interest Amendments for Bank Dealers who do not engage in any retail
municipal recommendations).
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[[Page 28086]]
Application of the Care Obligation to Bank Dealers
Consistent with Regulation Best Interest's Care Obligation, the
proposed Best Interest Amendments would require a Bank Dealer to
exercise reasonable diligence, care, and skill to: (a) Understand the
potential risks, rewards, and costs associated with any retail
municipal recommendation, and have a reasonable basis to believe that a
retail municipal recommendation could be in the best interest of at
least some retail customers; (b) Have a reasonable basis to believe
that the retail municipal recommendation is in the best interest of a
particular retail customer, based on that retail customer's investment
profile and the potential risks, rewards, and costs associated with the
recommendation, and does not place the financial or other interest of
the Bank Dealer ahead of the interest of the retail customer; (c) Have
a reasonable basis to believe that a series of retail municipal
recommendations, even if in the retail customer's best interest when
viewed in isolation, is not excessive and is in the retail customer's
best interest when taken together in light of the retail customer's
investment profile and does not place the financial or other interest
of the Bank Dealer ahead of the interest of the retail customer.
Application of the Conflict-of-Interest Obligation to Bank Dealers
Consistent with Regulation Best Interest's Conflict-of-Interest
Obligation, the proposed Best Interest Amendments would require a Bank
Dealer to establish, maintain, and enforce written policies and
procedures reasonably designed to: (a) Identify and at a minimum
disclose, in accordance with its Disclosure Obligation, or eliminate,
all conflicts of interest associated with such retail municipal
recommendations; (b) Identify and mitigate any conflicts of interest
associated with such retail municipal recommendations that create an
incentive for a natural person who is an associated person of the Bank
Dealer to place the interests of the Bank Dealer or such associated
person ahead of the interest of the retail customer; (c)(i) Identify
and disclose any material limitations placed on the securities or
investment strategies involving securities that may be recommended to a
retail customer and any conflicts of interest associated with such
limitations, in accordance with its Disclosure Obligation, and (ii)
Prevent such limitations and associated conflicts of interest from
causing the Bank Dealer to make retail municipal recommendations that
place the interest of the Bank Dealer ahead of the interest of the
retail customer; and (d) Identify and eliminate any sales contests,
sales quotas, bonuses, and non-cash compensation that are based on the
sales of specific municipal securities or specific types of municipal
securities within a limited period of time.
Application of the Compliance Obligation to Bank Dealers
Consistent with Regulation Best Interest's Compliance Obligation,
the proposed Best Interest Amendments would require a Bank Dealer to
establish, maintain, and enforce written policies and procedures
reasonably designed to achieve compliance with Regulation Best
Interest.\19\
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\19\ If a Bank Dealer's business model is such that it and its
associated persons are not permitted to make any retail municipal
recommendations, then a Bank Dealer may opt not to establish
policies and procedures outlining the affirmative regulatory
obligations pursuant to the Disclosure Obligation, Care Obligation,
and Conflict of Interest Obligation. However, it would be prudent
for a Bank Dealer to have policies and procedures that make clear
that, prior to permitting the making of any such retail municipal
recommendations, the Bank Dealer would need to establish policies
and procedures reasonably designed to ensure compliance with the
Best Interest Amendments to MSRB Rule G-19.
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Purpose and Intent of the Best Interest Amendments
The MSRB is proposing the Best Interest Amendments to MSRB Rule G-
19 for purposes of enhancing the standard of investor protection in the
municipal securities market and enhancing fairness and efficiency in
the municipal securities market by promoting regulatory parity among
Bank Dealers and Broker-Dealers. Specific to enhancing the standard of
investor protection, the MSRB believes that all retail customers
receiving a retail municipal recommendation should benefit from the
enhanced investor protections afforded by Regulation Best Interest,
regardless of whether such a retail customer is a customer of a Broker-
Dealer or a Bank Dealer. Currently, retail customers of Bank Dealers
are not afforded the protections of Regulation Best Interest when
receiving a retail municipal recommendation from a Bank Dealer. The
proposed Best Interest Amendments would require a Bank Dealer to comply
with the enhanced standard of conduct required by Regulation Best
Interest and, thereby, improve overall investor protection in the
municipal securities market.
Specific to promoting regulatory parity, the MSRB believes that the
proposed Best Interest Amendments would establish a uniform regulatory
standard in the municipal securities market by requiring the same
standard of conduct for Bank Dealers and Broker-Dealers when making
retail municipal recommendations. This uniform standard would enhance
the fairness and efficiency of the municipal securities market by
ensuring Bank Dealers have regulatory obligations and burdens when
engaging in retail municipal recommendations that are equivalent to the
regulatory obligations and burdens of Broker-Dealers when engaging in
the same municipal securities activities. This uniformity would better
ensure that Bank Dealers do not have a competitive advantage in the
municipal securities market by operation of a less burdensome
regulatory standard of conduct and, thereby, mitigate the potential for
regulatory arbitrage.
Background and Purpose of the Institutional SMMP Amendment
The proposed Institutional SMMP Amendment would amend MSRB Rule G-
48 to modify the current obligation to perform a quantitative
suitability analysis for recommendations where the dealer does not have
actual control or de facto control over the account of an SMMP who is
not a retail customer under Regulation Best Interest (collectively,
``Institutional SMMPs'' and, individually, each an ``Institutional
SMMP'').\20\
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\20\ See supra note 10 for the applicable definition of ``retail
customer'' and related citation. Any customer meeting such
definition of retail customer pursuant to Regulation Best Interest
would not be considered an Institutional SMMP for the purposes of
the proposed Institutional SMMP Amendment and its modification to
MSRB Rule G-48. For purposes of MSRB rules, such a customer meeting
the definition of a ``retail customer'' would receive the
protections afforded by Regulation Best Interest.
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Similar to the reduced customer-specific suitability obligations
currently afforded to Institutional SMMPs under MSRB Rule G-48(c), the
MSRB believes that dealers transacting with Institutional SMMPs should
have similarly reduced quantitative-suitability obligations in
instances where the dealer does not have actual control or de facto
control over the account of an Institutional SMMP. This modification
would effectively revert the quantitative suitability standard for
Institutional SMMPs back to the longstanding standard that was in place
under MSRB rules prior to June 30, 2020.\21\ The proposed Institutional
[[Page 28087]]
SMMP Amendment is intended to improve the efficiency of the municipal
securities market without eroding investor protection by aligning the
compliance burden associated with certain recommendations made by
dealers to the reasonable expectations and capabilities of
Institutional SMMPs--who by their nature are more sophisticated, non-
natural-person customers and must affirmatively indicate their capacity
to (i) exercise independent judgment and (ii) access material
information.\22\
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\21\ See Broker-Dealer Harmonization Filing, 85 FR at 28082, n.
4. The MSRB notes that it has had a long held prohibition against
``churning,'' and the MSRB formally ``recast'' this prohibition as
quantitative suitability through an amendment to MSRB Rule G-19
approved by the SEC in 2014. See Exchange Act Release No. 71665
(Mar. 7, 2014), 79 FR 2432 (Mar. 13, 2014), File No. SR-MSRB-2013-07
(discussing the then-existing MSRB prohibition on churning and a
proposed rule change to recast this prohibition using the phrase
``quantitative suitability''), available at http://www.msrb.org/~/
media/Files/SEC-Filings/2013/MSRB-2013-07-Fed-Reg-
Approval.ashx?la=en&hash=AEDA0B5509630E25473E9F6F3A3F9C34.
\22\ See MSRB Rule G-48(c). See also related discussion infra
under Background and Purpose of the Institutional SMMP Amendment--
Background on MSRB Rule D-15 and SMMP Affirmation Requirements.
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Background on MSRB Rule G-19's Quantitative Suitability Requirements
MSRB Rule G-19 sets the MSRB's baseline investor protection
standards regarding the suitability of recommendations made by dealers
to their customers of purchases, sales, or exchanges of municipal
securities that are not subject to Regulation Best Interest. Among
other requirements, Supplementary Material .05 of MSRB Rule G-19
enumerates three components of a dealer's suitability analysis when
recommending a transaction or investment strategy involving a municipal
security or municipal securities to a non-retail customer (i.e., a
recommendation that is not subject to Regulation Best Interest).\23\ As
further defined in the text of the rule, MSRB Rule G-19 provides that a
dealer's suitability obligation is composed of (i) reasonable-basis
suitability, (ii) customer-specific suitability, and (iii) quantitative
suitability. Most relevant to the proposed Institutional SMMP Amendment
of this proposed rule change, quantitative suitability requires a
dealer to have a reasonable basis for believing that a series of
recommended transactions, even if suitable when viewed in isolation,
are not excessive and unsuitable for the customer when taken together
in light of the customer's investment profile, as delineated in MSRB
Rule G-19.\24\ No single test defines excessive activity, but factors
such as the turnover rate, the cost-equity ratio, and the use of in-
and-out trading in a customer's account may provide a basis for a
finding that a dealer has violated the quantitative suitability
obligation.\25\
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\23\ See the Broker-Dealer Harmonization Filing, 85 FR at 28084.
The Broker-Dealer Harmonization Filing amended MSRB Rule G-19 to
provide that the rule does not apply to recommendations subject to
Regulation Best Interest.
\24\ MSRB Rule G-19, Supplementary Material .05(c).
\25\ Id.
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Pursuant to the amendments effectuated by the Broker-Dealer
Harmonization Filing, discussed above and effective as of June 30,
2020, the quantitative suitability obligation of MSRB Rule G-19 no
longer incorporates an element of control in relation to a customer's
account.\26\As a result, dealers are currently obligated to conduct a
quantitative suitability analysis under MSRB Rule G-19 when making
recommendations to Institutional SMMPs, even in instances where the
dealer does not have actual control or de facto control over the
account. The obligation applies notwithstanding the fact that
Institutional SMMPs self-identify under MSRB Rule G-48 and MSRB Rule D-
15 as having the willingness and requisite investment sophistication
to, for example, independently evaluate the recommendations of a dealer
and the quality of a dealer's execution, as further discussed
below.\27\
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\26\ In other words, as of June 30, 2020, if the obligations of
MSRB Rule G-19 attach to a dealer's recommendation, then the
investor protections regarding quantitative suitability apply
regardless of whether the dealer making the recommendation exercises
any actual control or de facto control over the customer's account.
The Broker-Dealer Harmonization Filing amended this language of
Supplementary Material .05(c) to eliminate such control
requirements, effectively extending the requirements of quantitative
suitability to any customer account. See Broker-Dealer Harmonization
Filing, 85 FR at 28084. June 30, 2020 was the compliance date for
the amendments enacted by the Broker-Dealer Harmonization Filing.
See Broker-Dealer Harmonization Filing, 85 FR at 28082, n. 4.
Pursuant to the Broker-Dealer Harmonization Filing, the MSRB also
notes that this quantitative suitability obligation applies
uniformly to any dealer (i.e., the same regulatory obligations apply
to both Broker-Dealers and Bank Dealers).
\27\ See MSRB Rule D-15(c) (requiring Institutional SMMPs to
``affirmatively indicate,'' among other things, that it is
exercising independent judgment in evaluating (A) the
recommendations of the dealer and (B) the quality of execution of
the customer's transactions by the dealer).
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Background on MSRB Rule G-48 and Modified Regulatory Obligations
MSRB Rule G-48 provides for modified dealer regulatory obligations
under MSRB rules when dealing with certain customers that meet the
definition of a Sophisticated Municipal Market Participant \28\ (i.e.,
an SMMP). More specifically, when transacting with an SMMP customer,
Rule G-48 modifies aspects of a dealer's baseline regulatory
obligations in terms of: (i) Time of trade disclosures,\29\ (ii)
transaction pricing,\30\ (iii) bona fide quotations,\31\ (iv) best
execution,\32\ and (vi) suitability.\33\ The modified regulatory
obligations afforded to SMMPs under MSRB rules are intended to account
for the distinct capabilities of certain sophisticated, non-retail
customers and the varied types of dealer-customer relationships
occurring in the municipal securities market.\34\
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\28\ See discussion under Background and Purpose of the
Institutional SMMP Amendment--Background on MSRB Rule D-15 and SMMP
Affirmation Requirements near note 37 infra (discussing the
definition of Sophisticated Municipal Market Participant under MSRB
Rule D-15).
\29\ MSRB Rule G-48(a) (``The broker, dealer, or municipal
securities dealer shall not have any obligation under Rule G-47 to
ensure disclosure of material information that is reasonably
accessible to the market.'')
\30\ MSRB Rule G-48(b).
\31\ MSRB Rule G-48(d) (``The broker, dealer, or municipal
securities dealer disseminating an SMMP's `quotation' as defined in
Rule G-13, which is labeled as such, shall apply the same standards
regarding quotations described in Rule G-13(b) as if such quotations
were made by another broker, dealer, or municipal securities
dealer.'')
\32\ MSRB Rule G-48(e) (``The broker, dealer, or municipal
securities dealer shall not have any obligation under Rule G-18 to
use reasonable diligence to ascertain the best market for the
subject security and buy or sell in that market so that the
resultant price to the SMMP is as favorable as possible under
prevailing market conditions.'')
\33\ MSRB Rule G-48(c).
\34\ See, e.g., Exchange Act Release No. 67064 (May 25, 2012),
77 FR 32704 (June 1, 2012), File No. SR-MSRB-2012-05 (May 25, 2012)
(approving an MSRB proposed rule change to relax certain
qualifications for a dealer to afford a customer SMMP status in
light of market developments regarding the increased availability of
municipal securities market information and the desire of certain
institutional customers to access alternative trading systems).
---------------------------------------------------------------------------
Most relevant to the proposed Institutional SMMP Amendment, Rule G-
48(c) currently modifies the suitability requirements of MSRB Rule G-19
by eliminating the requirement for dealers to conduct a customer-
specific suitability analysis for recommendations made to an
Institutional SMMP.\35\ The operative provision of MSRB Rule G-48
provides that, ``[w]hen making a recommendation subject to Rule G-19
and not Regulation Best Interest, Rule 15l-1 under the Act, a broker,
dealer, or municipal securities dealer shall not have any obligation
under Rule G-19 to perform a customer-specific suitability analysis.''
\36\ This
[[Page 28088]]
relaxed customer-specific suitability obligation is generally aligned
with the ``independent judgment'' affirmations a customer seeking SMMP
status makes under MSRB Rule D-15. The proposed Institutional SMMP
Amendment would likewise relax the quantitative suitability obligation
for similar reasons, as further described in the following
sections.\37\
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\35\ Id. The amendments to MSRB Rule G-48 enacted by the Broker-
Dealer Harmonization Filing carved out recommendations to customers
that are subject to Regulation Best Interest from the rule's
modified standards. See Broker-Dealer Harmonization Filing, 85 FR at
28084-85.
\36\ MSRB Rule G-48(c).
\37\ See Exchange Act Release No. 71665 (Mar. 7, 2014), 79 FR
14321 (Mar. 13, 2014), File No. SR-MSRB-2013-07 (Sept. 17, 2013)
(codifying the relaxed customer-specific suitability obligation for
recommendations made to SMMPs in MSRB Rule G-48 and the actual
control or de facto control requirement, thereafter eliminated in
2020 as described herein, for the applicability of quantitative
suitability to recommendations made to customers in MSRB Rule G-19).
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Background on MSRB Rule D-15 and SMMP Affirmation Requirements
MSRB Rule G-48 incorporates the definition of SMMP under MSRB Rule
D-15 for purposes of defining which customers do (or do not) qualify as
an SMMP for purposes of Rule G-48 and, therefore, MSRB Rule D-15
establishes the scope of potential customers who might qualify for MSRB
Rule G-48's modified obligations. The SMMP definition of MSRB Rule D-15
enumerates three definitional components, which separately address: (i)
The minimum qualifying traits and characteristics of an SMMP customer;
\38\ (ii) that a dealer must develop a reasonable basis for determining
whether a customer has the requisite level of expertise and
sophistication to be deemed an SMMP customer (the ``SMMP Reasonable
Basis Determination''); \39\ and (iii) what affirmations a customer
must communicate to the dealer regarding its own investment judgment
and access to information in order to be appropriately deemed an SMMP
customer (the ``SMMP Customer Affirmations'').\40\ In terms of the SMMP
Customer Affirmations, MSRB Rule D-15(c) provides that the customer
must affirmatively indicate to the dealer that (i) it is exercising
independent judgment in evaluating the recommendations of the dealer;
the quality of execution of the customer's transactions by the dealer;
and the transaction price for non-recommended secondary market agency
transactions as to which the dealer's services have been explicitly
limited to providing anonymity, communication, order matching and/or
clearance functions and the dealer does not exercise discretion as to
how or when the transactions are executed; \41\ and (ii) it has timely
access to material information that is available publicly through
established industry sources as defined in MSRB Rule G-47(b)(i) and
MSRB Rule G-47(b)(ii) (i.e., ``material information'' from
``established industry sources,'' such as EMMA website information and
rating agency reports).\42\
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\38\ MSRB Rule D-15(a). A customer is only eligible to be
treated as an SMMP if the customer is: (i) A bank, savings and loan
association, insurance company, or registered investment company,
(ii) a registered investment advisor, or (iii) a person or entity
with total assets of at least $50 million.
\39\ MSRB Rule D-15(b). A customer is only eligible to be
treated as an SMMP if the dealer has developed a reasonable basis to
believe that the customer is capable of evaluating investment risks
and market value independently, both in general and with regard to
particular transactions and investment strategies in municipal
securities. In addition, Supplementary Material .01 of MSRB Rule D-
15 states that, as part of the reasonable-basis analysis, the dealer
should consider the amount and type of municipal securities owned or
under management by the customer.
\40\ MSRB Rule D-15(c).
\41\ See MSRB Rule D-15(c)(1) (``The customer must affirmatively
indicate that it: (1) is exercising independent judgment in
evaluating: (A) the recommendations of the dealer; (B) the quality
of execution of the customer's transactions by the dealer; and (C)
the transaction price for non-recommended secondary market agency
transactions as to which (i) the dealer's services have been
explicitly limited to providing anonymity, communication, order
matching and/or clearance functions and (ii) the dealer does not
exercise discretion as to how or when the transactions are executed
. . .'').
\42\ See MSRB Rule D-15(c)(2) (``The customer must affirmatively
indicate that it . . . (2) has timely access to material information
that is available publicly through established industry sources as
defined in Rule G-47(b)(i) and (ii).'')
---------------------------------------------------------------------------
Thus, an institutional customer who self-identifies as an SMMP has
freely affirmed to a dealer its willingness to be treated as a
sophisticated customer with the capacity and resources to exercise its
own independent judgment. In this way, the SMMP Customer Affirmations
are designed to ensure that any customer treated as an SMMP has
affirmatively and knowingly provided the grounds on which a dealer may
afford such SMMP customer lesser protections under certain MSRB rules.
As an additional investor protection safeguard beyond the requirement
for SMMP Customer Affirmations, the SMMP Reasonable Basis Determination
also requires a dealer to have a reasonable basis to believe that an
SMMP customer is capable of evaluating investment risks and market
value independently, both in general and with regard to particular
transactions and investment strategies in municipal securities.\43\ In
this way, the SMMP Reasonable Basis Determination further ensures that
an Institutional SMMP does in fact possess a more sophisticated
understanding of the municipal securities market. Importantly, the
proposed Institutional SMMP Amendment would not alter the SMMP Customer
Affirmations, the SMMP Reasonable Basis Determination, nor any of the
other definitional elements of MSRB Rule D-15.
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\43\ See MSRB Rule D-15(b) and Rule D-15 Supplementary Material
.01.
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Purpose and Intent of the Institutional SMMP Amendment to MSRB Rule G-
48
The proposed Institutional SMMP Amendment would amend MSRB Rule G-
48 to modify the quantitative suitability obligations of dealers when
effecting transactions for their Institutional SMMPs. The proposed
Institutional SMMP Amendment would require a dealer to conduct a
quantitative suitability analysis only in situations where the dealer
has actual control or de facto control over an Institutional SMMP's
account.\44\ As stated above, the proposed amendments to MSRB Rule G-48
would narrowly reinstate the scope of suitability protections afforded
to Institutional SMMPs in effect prior to the amendments effectuated by
the Broker-Dealer Harmonization Filing and so should be a familiar
regulatory concept to dealers and Institutional SMMPs alike.\45\ More
importantly, because each Institutional SMMP must self-identify as an
SMMP by making the SMMP Customer Affirmations, as well as must fulfill
the requirements associated with a dealer's SMMP Reasonable Basis
Determination, the MSRB believes that the proposed Institutional SMMP
Amendment will ease a regulatory burden on dealers that effectively
replicates the sort of analysis an Institutional SMMP is willing and
capable of performing itself. As a result, the proposed Institutional
SMMP Amendment would align the compliance burden associated with
certain recommendations made by dealers to the reasonable expectations
and capabilities of Institutional SMMPs.
---------------------------------------------------------------------------
\44\ Where a dealer exercises actual control or de facto control
over an Institutional SMMP's account, the dealer would still be
required to perform a quantitative suitability analysis in
accordance with Supplementary Material .05 of MSRB Rule G-19.
Relatedly, if an Institutional SMMP limitedly provides its customer
affirmation on a trade-by-trade basis, then the dealer would be
required to comply with all aspects of MSRB Rule G-19, including
both the quantitative suitability requirement and the customer-
specific suitability requirement, for those recommendations for
which the Institutional SMMP did not provide the applicable customer
affirmation. See Supplementary Material .02 of MSRB Rule D-15
(discussing trade-by-trade affirmations).
\45\ See supra note 21 and related discussion.
---------------------------------------------------------------------------
While the investor protection benefits associated with requiring
dealers to perform a potentially duplicative suitability analysis can
be appropriate
[[Page 28089]]
in other circumstances,\46\ the MSRB believes that the compliance
burden associated with performing a quantitative suitability analysis
on recommendations made to Institutional SMMPs outweighs the potential
marginal investor protection benefits. In this way, the proposed
Institutional SMMP Amendment would promote efficiency in the municipal
securities market by eliminating a regulatory burden on dealers that
generally provides a duplicative or unneeded analyses in supplement of
an Institutional SMMPs' own independent and informed judgment, and,
consequently, the proposed Institutional SMMP Amendment would allow
dealers to redirect the resources associated with this regulatory
burden to other more productive market activities.
---------------------------------------------------------------------------
\46\ For example, the MSRB believes that the obligation to
perform quantitative suitability analyses under MSRB rules remains
appropriate, regardless of the potential for such duplication, in
circumstances of recommendations made to retail customers; non-
retail, institutional customers who fail to meet the characteristics
of an SMMP; and/or non-retail customers who have declined to make
the affirmations necessary to be appropriately deemed an SMMP.
---------------------------------------------------------------------------
2. Statutory Basis
The MSRB believes that the proposed rule change is consistent with
Section 15B(b)(2) of the Act,\47\ which provides that the Board shall
propose and adopt rules to effect the purposes of this title with
respect to transactions in municipal securities effected by brokers,
dealers, and municipal securities dealers and advice provided to or on
behalf of municipal entities or obligated persons by brokers, dealers,
municipal securities dealers, and municipal advisors with respect to
municipal financial products, the issuance of municipal securities, and
solicitations of municipal entities or obligated persons undertaken by
brokers, dealers, municipal securities dealers, and municipal
advisors.\48\
---------------------------------------------------------------------------
\47\ 15 U.S.C. 78o-4(b)(2).
\48\ Id.
---------------------------------------------------------------------------
Section 15B(b)(2)(C) of the Act \49\ provides that the MSRB's rules
shall be designed to prevent fraudulent and manipulative acts and
practices, to promote just and equitable principles of trade, to foster
cooperation and coordination with persons engaged in regulating,
clearing, settling, processing information with respect to, and
facilitating transactions in municipal securities and municipal
financial products, to remove impediments to and perfect the mechanism
of a free and open market in municipal securities and municipal
financial products, and, in general, to protect investors, municipal
entities, obligated persons, and the public interest.\50\ The MSRB
believes the proposed rule change is consistent with Section
15B(b)(2)(C) of the Act \51\ for the following reasons.
---------------------------------------------------------------------------
\49\ 15 U.S.C. 78o-4(b)(2)(C).
\50\ Id.
\51\ Id.
---------------------------------------------------------------------------
Statutory Basis for the Best Interest Amendments
The proposed Best Interest Amendments are consistent with Section
15B(b)(2)(C) of the Act \52\ because the amendments would: Foster
cooperation and coordination with regulators; prevent fraudulent and
manipulative acts and practices; protect investors; remove impediments
to and perfect the mechanism of a free and open market in municipal
securities; and promote capital formation in the municipal securities
market.
---------------------------------------------------------------------------
\52\ Id.
---------------------------------------------------------------------------
Fostering Cooperation and Coordination With Regulators
The proposed Best Interest Amendments would foster cooperation and
coordination with regulators by more tightly aligning the suitability
obligations of MSRB Rule G-19 with the suitability obligations of
Regulation Best Interest. By providing a uniform standard for all types
of dealers, this alignment of the regulatory scheme applicable to
retail municipal recommendations will foster greater cooperation and
coordination among the MSRB and the SEC, as well as greater cooperation
and coordination among the authorities that examine Broker-Dealers and
Bank Dealers for compliance with MSRB rules.
Protecting Investors and Preventing Fraudulent and Manipulative Act and
Practices
The proposed Best Interest Amendments would protect investors and
prevent fraudulent and manipulative acts and practices by extending the
enhanced standards of conduct required by Regulation Best Interest to
the retail municipal recommendations of Bank Dealers. As noted by the
Commission in the adopting release for Regulation Best Interest,
Regulation Best Interest enhances the broker-dealer standard of conduct
beyond existing suitability obligations, and aligns the standard of
conduct with retail customers' reasonable expectations by requiring
broker-dealers, among other things, to: Act in the best interest of the
retail customer at the time the recommendation is made, without placing
the financial or other interest of the broker-dealer ahead of the
interests of the retail customer; and address conflicts of interest by
establishing, maintaining, and enforcing policies and procedures
reasonably designed to identify and fully and fairly disclose material
facts about conflicts of interest, and in instances where we have
determined that disclosure is insufficient to reasonably address the
conflict, to mitigate or, in certain instances, eliminate the
conflict.\53\
---------------------------------------------------------------------------
\53\ Regulation Best Interest Adopting Release, 84 FR at 33318.
---------------------------------------------------------------------------
In addition, the Commission stated the enhancements contained in
Regulation Best Interest are designed to improve investor protection by
enhancing the quality of broker-dealer recommendations to retail
customers and reducing the potential harm to retail customers that may
be caused by conflicts of interest.\54\ For the same reasons, the MSRB
believes that extending Regulation Best Interest to the retail
municipal recommendations of Bank Dealers would prevent potential
fraudulent and manipulative acts and practices and promote the
protection of the retail customers of Bank Dealers.
---------------------------------------------------------------------------
\54\ Regulation Best Interest Adopting Release, 84 FR at 33321.
---------------------------------------------------------------------------
Removing Impediments and Perfecting the Mechanisms of a Free and Open
Market
The proposed Best Interest Amendments would remove impediments to
and perfect the mechanism of a free and open market in municipal
securities by applying a uniform regulatory standard for retail
municipal recommendations that would promote parity regarding the
regulatory obligations of Broker-Dealers and Bank Dealers and, thereby,
reduce potential confusion among market participants as to which
standard of conduct applies.
Promoting Capital Formation
The proposed Best Interest Amendments would not have a deleterious
effect on capital formation in the municipal securities market and
would have the potential to improve capital formation for the following
reasons. Similar to the Commission's reasoning in its adoption of
Regulation Best Interest,\55\ the enhanced obligations
[[Page 28090]]
of Regulation Best Interest may increase the efficiency of retail
municipal recommendations and increase the attractiveness of Bank
Dealer services for those retail customers who do not invest with a
Bank Dealer because recommendations made by bank dealers are not
currently subject to the additional standards of investor protection
afforded by Regulation Best Interest. Additionally, by adopting a
uniform regulatory standard for retail municipal recommendations across
all dealers (i.e., across Bank Dealers and Broker-Dealers), the overall
attractiveness of the municipal securities activities of dealers may
improve. Consequently, if more retail customers are more willing to
participate in municipal securities activities, then the proposed Best
Interest Amendments would promote capital formation in the municipal
securities market.
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\55\ Regulation Best Interest Adopting Release, 84 FR at 33462
(``The possibility that Regulation Best Interest may increase the
efficiency of the recommendations provided by the associated persons
of the broker-dealer may enhance the attractiveness of broker-dealer
services for those investors who currently do not invest through
broker-dealers . . . If retail customers are more willing to
participate in the securities markets through broker-dealers,
Regulation Best Interest would have a positive effect on capital
formation.'')
---------------------------------------------------------------------------
Statutory Basis for the Institutional SMMP Amendment
The proposed Institutional SMMP Amendment is consistent with
Section 15B(b)(2)(C) \56\ of the Act because the amendment would
facilitate transactions in municipal securities and remove impediments
to and perfect the mechanism of a free and open market in municipal
securities, while not compromising investor protection.
---------------------------------------------------------------------------
\56\ 15 U.S.C. 78o-4(b)(2)(C).
---------------------------------------------------------------------------
The proposed Institutional SMMP Amendment would facilitate
transactions in municipal securities and remove impediments to and
perfect the mechanism of a free and open market in municipal securities
by reducing a compliance burden on dealers. The modification of a
dealer's suitability obligations to eliminate the current requirement
to perform a quantitative suitability analysis for recommendations in
circumstances where the dealer does not have actual control or de facto
control over an Institutional SMMP's account will eliminate what could
potentially be duplicative analyses undertaken by dealers on behalf of
Institutional SMMPs--analyses which Institutional SMMPs have already
affirmed their capacity and expertise to conduct for themselves, and
which the Institutional SMMPs presumably have taken upon themselves to
perform. In this regard, the proposed Institutional SMMP Amendment will
remove an impediment to the mechanisms of a free and open market in
municipal securities and promote greater efficiency. By eliminating
this regulatory burden, the proposed Institutional SMMP Amendment would
allow dealers to redirect the resources associated with this regulatory
burden to other more productive market activities. As a separate, but
related benefit, the MSRB believes that the Institutional SMMP
Amendment would allow dealers to more efficiently serve those
Institutional SMMPs who may be seeking relatively greater transaction
activity and/or are more comfortable taking on the risks associated
with more frequent transaction activity.
The MSRB believes that the proposed Institutional SMMP Amendment to
MSRB Rule G-48 will not compromise investor protections. The MSRB
believes that allowing dealers to make recommendations to their
Institutional SMMP customers without the burden of performing a
quantitative suitability analysis is consistent with the SMMP Customer
Affirmations and dealers' SMMP Reasonable Basis Determination. More
specifically, the SMMP Customer Affirmations ensure that an
Institutional SMMP itself believes that it has the requisite knowledge
and judgment to be afforded SMMP status; and, as an additional
safeguard to investor protection, the SMMP Reasonable Basis
Determination separately ensures that the dealer also has a reasonable
basis to conclude that an Institutional SMMP has the knowledge and
sophistication to be treated as a SMMP based on supplemental factors
beyond just the SMMP Customer Affirmations. If either definitional
prong is not met, a dealer is not permitted to afford an institutional
customer the status of a SMMP. Therefore, the MSRB believes that the
proposed Institutional SMMP Amendment is generally consistent with an
Institutional SMMP's more sophisticated understanding of (i) the
commercial nature of its relationship with a dealer and (ii) the lesser
regulatory standards of conduct governing the SMMP-dealer relationship.
In addition, the proposed Institutional SMMP Amendment would
incorporate the concepts of actual control or de facto control.
Reinstating these control elements would help address potential
scenarios in which the ability of an Institutional SMMP to exercise
independent judgment is undermined or circumvented, such as when a
dealer may not have formal discretionary authority over an
Institutional SMMP's account, but nevertheless exercises de facto
control over the account to, for example, engage in churning activity
in clear contravention of an Institutional SMMP's investment
interests.\57\ The MSRB believes that incorporating the actual control
or de facto control elements maintains baseline investor protections
for Institutional SMMPs in such scenarios of greater dealer impropriety
or intentional wrongdoing.
---------------------------------------------------------------------------
\57\ See, e.g., Harry Gliksman, 54 SEC. 471, 475 (1999)
(upholding a NASD finding that a registered representative violated
his suitability obligations by recommending frequent and short-term
securities transactions even though the registered representative
did not have written discretionary authority).
---------------------------------------------------------------------------
The MSRB also notes that new institutional customers, who otherwise
would qualify as SMMPs but desire the additional investor protections
afforded by quantitative suitability under MSRB Rule G-19, can decline
to provide the required affirmations under MSRB Rule D-15.\58\
Similarly, existing Institutional SMMPs could withdraw their SMMP
status and obtain the suitability protections afforded by MSRB Rule G-
19. This ability to self-identify as an Institutional SMMP will ensure
that those institutional customers who desire additional investor
protection can secure them under MSRB rules, and thus, require the
dealers to undertake a quantitative suitability analysis.
---------------------------------------------------------------------------
\58\ See related discussion supra under Background and Purpose
of the Institutional SMMP Amendment--Background on MSRB Rule D-15
and SMMP Affirmation Requirements. See also MSRB Rule D-15(c)(1)-
(2).
---------------------------------------------------------------------------
Accordingly, the MSRB believes that the proposed Institutional SMMP
Amendment would maintain essential safeguards for investor protection
and, overall, not compromise investor protections inconsistent with
Section 15B(b)(2)(C) \59\ of the Act.
---------------------------------------------------------------------------
\59\ 15 U.S.C. 78o-4(b)(2)(C).
---------------------------------------------------------------------------
B. Self-Regulatory Organization's Statement on Burden on Competition
Section 15B(b)(2)(C) of the Act \60\ requires that MSRB rules not
be designed to impose any burden on competition not necessary or
appropriate in furtherance of the purposes of the Exchange Act. The
MSRB considered the economic impact associated with the proposed rule
change, including a comparison to reasonable alternative regulatory
approaches, relative to the baseline.\61\ The MSRB believes the
proposed rule changes would relieve a burden on competition and do not
impose any
[[Page 28091]]
burden on competition not necessary or appropriate in furtherance of
the purposes of the Exchange Act.
---------------------------------------------------------------------------
\60\ Id.
\61\ See Policy on the Use of Economic Analysis in MSRB
Rulemaking, available at <a href="http://msrb.org/Rules-and-Interpretations/Economic-Analysis-Policy.aspx">http://msrb.org/Rules-and-Interpretations/Economic-Analysis-Policy.aspx</a>. In evaluating whether there was a
burden on competition, the Board was guided by its principles that
required the Board to consider costs and benefits of a rule change,
its impact on capital formation and the main reasonable alternative
regulatory approach.
---------------------------------------------------------------------------
Necessity of Rule Change
Best Interest Amendments
As previously mentioned, the retail municipal recommendations made
by Bank Dealers currently are outside the scope of Regulation Best
Interest,\62\ and the municipal securities activities of Bank Dealers
continue to be subject to the existing investor protection obligations
of MSRB rules, including MSRB Rule G-19. The proposed Best Interest
Amendments to MSRB Rule G-19 would require each Bank Dealer to comply
with the requirements of Regulation Best Interest to the same extent as
a Broker-Dealer must. The proposed Best Interest Amendments are
necessary because they would increase investor protection in the
municipal securities market by creating regulatory uniformity in the
market between the municipal securities activities of Bank Dealers and
those of Broker-Dealers, each of whom may provide retail municipal
recommendations. Similar to the Broker-Dealer Harmonization Filing for
Broker-Dealers in 2020, the MSRB believes another benefit of the
proposed Best Interest Amendments is that the amendments would reduce
agency costs and information asymmetry between Bank Dealers and retail
customers.\63\
---------------------------------------------------------------------------
\62\ Regulation Best Interest applies to ``a broker, dealer or a
natural person who is an associated person of a broker or dealer,''
which does not apply Bank Dealers. See 17 CFR 240.15l-1(a)(1).
\63\ The SEC describes this reduction in agency cost, in the
Regulation Best Interest Adopting Release, as ``the difference
between the net benefit to the retail customer from accepting a less
than efficient recommendation about a securities transaction or
investment strategy, where the associated person or Broker-Dealer
puts its interests ahead of the interests of the retail customer,
and the net benefit the retail customer might expect from a similar
securities transaction or investment strategy that is efficient for
him or her.'' See Regulation Best Interest Adopting Release, 84 FR
at 33403.
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The MSRB addresses reasonable alternatives where applicable when
considering the costs, benefits, and impact of a proposed amendment.
The MSRB believes the only reasonable alternative for evaluation is the
option of leaving in place the current regulatory state in which a Bank
Dealer's retail municipal recommendations are not subject to the
requirements of Regulation Best Interest, while a Broker-Dealer's
retail municipal recommendations are subject to the full requirements
of Regulation Best Interest, even though the activities of both groups
of dealers are similar. As shown below, the MSRB believes that
maintaining the status quo would preserve a regulatory imbalance and
therefore competitive imbalance in this regard between Bank Dealers and
Broker-Dealers engaged in the same activity, as well as deprive certain
retail customers of the investor protections afforded by Regulation
Best Interest. In this way, maintaining the status quo would maintain a
discrepancy in the investor protections afforded to the retail
customers receiving retail municipal recommendations from Bank Dealers
as compared to the investor protections afforded to retail customers
receiving retail municipal recommendations from Broker-Dealers and,
thereby, maintain a competitive imbalance in terms of the compliance
burdens of Bank Dealers versus Broker-Dealers.
Institutional SMMP Amendment
The purpose of amending MSRB Rule G-48 is to reinstate the
requirement that a dealer have actual control or de facto control with
respect to Institutional SMMP accounts to trigger a dealer's
quantitative suitability obligation. A prior rule provision, applying
the quantitative suitability obligation only when a dealer had actual
control or de facto control over the account, was removed as part of
the Broker-Dealer Harmonization Filing; and, as a result, dealers
currently have an obligation to conduct a quantitative suitability
analysis for transactions with Institutional SMMP customers whether or
not the dealer has actual control or de facto control over the
Institutional SMMP's account. The proposed Institutional SMMP Amendment
to MSRB Rule G-48 will clarify that the quantitative suitability
requirement of MSRB Rule G-19 is only applicable to natural person
SMMPs but not to Institutional SMMPs. Since the proposed Institutional
SMMP Amendment reinstates a previous requirement in the MSRB's
suitability rule, the MSRB considered the alternative of placing the
reinstated requirement in MSRB Rule G-19 for all institutional entities
but decided that MSRB Rule G-48 is a more appropriate place to
incorporate the reinstated standard, as Institutional SMMPs are by
their nature sophisticated entities that have freely affirmed and self-
identified their capacity to independently evaluate dealers'
recommendations.
Benefits, Costs and Effect on Competition
Best Interest Amendments
The proposed Best Interest Amendments to MSRB Rule G-19 would help
create a uniform standard of investor protection for retail municipal
recommendations. The proposed Best Interest Amendments to MSRB Rule G-
19 would obligate a Bank Dealer to comply with Regulation Best Interest
to the same extent as a Broker-Dealer making retail municipal
recommendations. In this regard, the MSRB believes the effects of the
proposed Best Interest Amendments would be similar and comparable to
the effects resulting from when Broker-Dealers were first required to
comply with Regulation Best Interest, though at a much smaller scale
concerning only retail municipal recommendations.\64\ Therefore, the
MSRB believes that the SEC's estimates of the burdens on competition
and benefits of applying Regulation Best Interest to Broker-Dealers is
a reasonable reference point for analyzing burdens on competition and
benefits of applying Regulation Best Interest to Bank Dealers' retail
municipal recommendations. The MSRB therefore built upon the findings
of the SEC's multiyear in-depth analysis for its analysis of the
proposed Best Interest Amendments.
---------------------------------------------------------------------------
\64\ See Regulation Best Interest Adopting Release, 84 FR at
33403.
---------------------------------------------------------------------------
Notably, in the Regulation Best Interest Adopting Release, the SEC
emphasized that it is ``difficult to quantify such benefits and costs
with meaningful precision'' for Broker-Dealers and, particularly over
long time periods, the quantification may be insufficiently precise and
inherently speculative,\65\ mainly due to the following factors, among
others, (i) a lack of data on the extent to which Broker-Dealers with
different business practices engage in disclosure and conflict
mitigation activities to comply with existing requirements, and
therefore how costly it would be to comply with the proposed
requirements; \66\ (ii) Regulation Best Interest provides Broker-
Dealers flexibility in how to comply with the obligations and, as a
result, there could be multiple ways in which Broker-Dealers will
satisfy their obligations; \67\ and (iii) Regulation Best Interest may
affect Broker-Dealers differently depending on their business model
(e.g., full-service Broker-Dealer, Broker-Dealer that uses independent
contractors,
[[Page 28092]]
insurance-affiliated Broker-Dealer) and size.\68\
---------------------------------------------------------------------------
\65\ Id. The MSRB is not aware of any post-implementation study
or other analysis that provides data on the costs and benefits of
adopting Regulation Best Interest.
\66\ See Regulation Best Interest Adopting Release, 84 FR at
33434.
\67\ Id.
\68\ Id.
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The SEC further cautioned that the associated costs for each
individual Broker-Dealer firm could not be anticipated because of the
wide variation in size and scope of business practices across firms as
well as the many unknown factors associated with the principles-based
nature of the Regulation Best Interest.\69\ The MSRB believes the same
difficulties and complexities experienced by the SEC in attempting to
analyze the economic effects of applying Regulation Best Interest to
Broker-Dealers also applies to the MSRB's attempt to provide a
meaningful quantitative estimate of the impact of the proposed Best
Interest Amendments on Bank Dealers.\70\
---------------------------------------------------------------------------
\69\ Id.
\70\ The MSRB sought public comment to solicit data to use in a
quantitative analysis relating to the proposed changes in its
Request for Comments. While commenters did provide some specifics on
the scope of Bank Dealers' activities that would be subject to the
proposed Best Interest Amendments, the MSRB did not receive any
quantitative estimate of the impact of the proposed Best Interest
Amendments on Bank Dealers. In addition, the MSRB is not aware of
any post-implementation study that provides data on the costs and
benefits of adopting Regulation Best Interest.
---------------------------------------------------------------------------
While acknowledging these challenges, the MSRB attempted to
determine the scope of activity that would be subject to the proposed
Best Interest Amendments, which is summarized in Table 1 below. The
summary table provides an estimate of the number of Bank Dealers likely
to be affected by the proposed Best Interest Amendments. The Bank
Dealers were included in that table based on their market share of
retail-sized dealer-to-customer trades in calendar year 2020 (i.e.,
dealer-to-customer trades with a par value of $100,000 or less).\71\
Among the over 1,200 dealers registered with the MSRB, only 21 firms
are registered as Bank Dealers. Those 21 Bank Dealers conducted only
1.6% of all retail-sized dealer-to-customer trades in municipal
securities in 2020.\72\ Even among the 21 Bank Dealers, nearly all of
this activity was concentrated in a small number of firms, with the top
seven most-active Bank Dealers conducting the vast majority of all
retail-sized customer trades in 2020 (about 99.5%). The remaining
number of registered Bank Dealers were significantly less active in
executing retail-sized trades with customers during that same period,
with six Bank Dealers not executing any retail-sized customer trades
over the course of the entire year and the remaining eight Bank Dealers
altogether averaging a little over one retail-sized customer trade per
day.
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\71\ The MSRB does not have access to reliable data to determine
the precise number of Bank Dealers who provide (or may provide)
recommendations to investors who meet the definition of a retail
customer. To develop a reasonable proxy, the MSRB analyzed market
data to determine the number of retail-sized trades (par value at
$100,000 or less in this case). In the absence of more specific data
about a trade, total par size of $100,000 or less is commonly used
in the municipal securities market as an indicator of a retail
activity. Data were obtained from the MSRB's Real-Time Transaction
Reporting System (RTRS) and the MSRB's registration database.
\72\ These figures are provided by an MSRB analysis with data
obtained from MSRB's Real-Time Transaction Reporting System (RTRS)
combined with existing registration data.
Table 1--Market Share of Municipal Securities Retail-Sized Customer
Trades by Dealers January 2020-December 2020
------------------------------------------------------------------------
Number of Market share
retail-sized of retail-
Type of dealers customer sized customer
trades trades (%)
------------------------------------------------------------------------
Non-Bank Dealers........................ 3,865,880 98.4
Top Seven Bank Dealers.................. 61,140 1.6
All Fourteen Other Bank Dealers......... 325 0.0
------------------------------------------------------------------------
Source: MSRB analysis with data obtained from the MSRB's Real-Time
Transaction Reporting System (RTRS) and the MSRB's registration
database.
In developing these numbers, the MSRB believes they are likely
overly inclusive of potential retail activity, because there is a high
probability the numbers capture more trades than would be subject to
the requirements of the proposed Best Interest Amendments.
Nevertheless, the MSRB believes the numbers are a reasonable estimate
for the purpose of this economic analysis and are conservative to the
extent that they are more likely to over-estimate the potential burden
on Bank Dealers than underestimate it. In terms of the limitations of
this data, dealer-to-customer trades with a par value of $100,000 or
less are not always conducted with investors who would meet the
definition of a retail customer under Regulation Best Interest, as
representatives acting on behalf of non-retail customers potentially
execute trades with a par value of $100,000 or less (i.e., small
institutional trades). Conversely, retail investors may execute trades
above $100,000 par value (i.e., large retail trades); however, the MSRB
believes large retail trades occur less frequently and, thus, do not
fully offset the more frequent occurrences of sub-$100,000 par value
non-retail trades.\73\
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\73\ For example, one commenter, the Capital Markets Group of
Commerce Bank (``CMG'') based in Kansas City, MO, stated that ``For
CMG, retail customers comprise approximately 9% of CMG's total open
account customer base. Further, only a portion of these retail
accounts actually executed transactions in the last 12 months,
comprising approximately 3% of CMG's total customers. . . .'' See
letter from Erik Swanson, Managing Director, and Joseph Reece, Chief
Compliance Officer, Capital Markets Group of Commerce Bank
(``Commerce Bank''), not dated (the ``Commerce Bank Letter'') in
response to MSRB Notice 2021-06 (March 4, 2021).
---------------------------------------------------------------------------
Additionally, the MSRB acknowledges that the number of trades is
not a reasonable proxy for the number of retail municipal
recommendations. That is, the fact that a Bank Dealer executes a trade
with an investor who meets the definition of a retail customer under
Regulation Best Interest does not necessarily mean that the Bank Dealer
has made a ``recommendation'' to such retail customer for purposes of
Regulation Best Interest. The Bank Dealer may have, for example,
executed a non-recommended trade at the customer's request. Hence, the
MSRB believes that some unknown number of these retail-sized trades
would not be subject to the proposed Best Interest Amendments (i.e.,
the trades would not be subject to Regulation Best Interest).
Benefits
The MSRB believes extending the requirements of Regulation Best
Interest to Bank Dealers would reduce or eliminate a regulatory
imbalance between Bank Dealers, on the one hand,
[[Page 28093]]
and Broker-Dealers, on the other, as the terms of Regulation Best
Interest do not currently apply to Bank Dealers. The proposed Best
Interest Amendments would both close a regulatory gap and also mitigate
certain market risks and inefficiencies associated with a potentially
lower compliance standard.\74\ Therefore, the proposed Best Interest
Amendments would protect retail customers seeking investment
recommendations and transacting in municipal securities, regardless of
whether they are customers of a Broker-Dealer or a Bank Dealer. The
MSRB believes retail customers receiving retail municipal
recommendations should benefit from a uniform standard of enhanced
investor protections, which would not be dependent upon the type of
dealer entity making the retail municipal recommendation.
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\74\ As one potential example, where a Bank Dealer and a Broker-
Dealer are both subsidiary entities of a common parent holding
company, the MSRB is concerned that the parent holding company may
attempt to take advantage of any regulatory imbalance by utilizing a
regulatory arbitraging strategy to move retail customer accounts to
the subsidiary with the lowest compliance standard, and, thus,
Broker-Dealers may relocate retail customers accounts to affiliated
Bank Dealers to avoid compliance with Regulation Best Interest.
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As to the overall merit of the proposed new requirements, they are
intended to reduce Bank-Dealer retail customer agency costs by
lessening conflicts of interest that currently exist between Bank
Dealers and retail customers and reduce information asymmetries
limiting the ability of retail customers to assess the efficiency of
recommendations from Bank Dealers.\75\
---------------------------------------------------------------------------
\75\ For a detailed discussion of the economic theory behind
agency costs, please refer to the Regulation Best Interest Adopting
Release, 84 FR at 33400-41.
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Costs
If the proposed Best Interest Amendments were enacted, the MSRB
believes Bank Dealers would experience initial costs associated with
establishing the revised policies and procedures to comply with the
requirements of Regulation Best Interest, as well as the costs of
ongoing compliance. The initial setup costs likely would be
proportionately higher for smaller and less active Bank Dealers with
fewer retail municipal recommendations than for the larger and more
active Bank Dealers with more retail municipal recommendations, while
the ongoing costs would likely be proportionate with each Bank Dealer's
retail business activities. Additionally, Bank Dealers with an
affiliated Broker-Dealer that is subject to Regulation Best Interest
likely would not experience as much initial set-up costs as other Bank
Dealers because they can leverage established policies and procedures
from their Broker-Dealers affiliates presumably in compliance with
Regulation Best Interest.
The MSRB believes the average per-firm total costs (initial and
ongoing) would be substantially lower for a Bank Dealer providing
retail municipal recommendations that are only related to municipal
securities, as compared to the overall costs associated with a Broker-
Dealer providing recommendations to retail customers of securities
transactions or investment strategies involving securities related to
many different types of securities. On average, there are many more
retail-sized trades in other types of securities--for example,
equities, corporate bonds, treasury and agency securities, options,
convertible bonds, mutual funds, and exchange-traded funds--than in
municipal securities alone.\76\ A Broker-Dealer subject to Regulation
Best Interest incurs compliance costs any time it provides a
recommendation to its retail customers on any security, while a Bank
Dealer would only incur cost when it provides a retail municipal
recommendation. As a result, the MSRB believes the average per-Bank
Dealer total costs would not approach the per-Broker-Dealer level, as
estimated by the SEC in relation to Regulation Best Interest. Table 2
provides an illustration of potential costs to be expected for a Bank
Dealer with an average number of retail-sized trades in municipal
securities as a result of the proposed rule change. Using the SEC's
estimates of initial cost and ongoing cost for 2,766 Broker-Dealers,
the MSRB estimated the portion of the costs attributable to municipal
securities only for a Broker-Dealer with an average number of retail-
sized trades in municipal securities, with the assumption that the same
Broker-Dealer would incur only 35% of the initial cost and one percent
of the ongoing cost if the Broker-Dealer only provided recommendations
on municipal securities to retail customers.\77\ The MSRB then applied
the cost estimates to an average Bank Dealer.
---------------------------------------------------------------------------
\76\ Based on the MSRB's estimate, there were approximately five
million retail-sized customer trades in municipal securities in
2018, compared to 6.8 million retail-sized customer trades in
corporate bonds, 132.5 million retail-sized customer trades in
treasury securities and 4.4 billion retail-sized customer trades in
equities, which include exchange-traded funds.
\77\ The MSRB's analysis focuses on four securities that have
substantial retail customer trades: Municipal securities, corporate
bonds, treasury securities and equities, which include exchange-
traded funds. To be conservative, all other securities, such as
stock options, federal agency securities, mortgage-backed
securities, asset-backed securities, mutual funds, etc., are assumed
to have no retail trades. For the initial cost, the MSRB assumes a
cost saving of 65% when establishing policies and procedures for one
security only, municipal bonds, as opposed to for four securities,
accounting for some fixed costs when working on a single security
product. For the ongoing cost, the MSRB estimated the number of
retail-sized customer trades for municipal securities that are
likely based on a Broker-Dealer's recommendation relative to
comparable retail-sized customer trades for corporate bonds,
treasury securities and equities (including exchange-traded funds),
and derived that the proportion for municipal securities would be
less than one percent of the total. Conservatively, one percent is
used for estimating the ongoing costs related to municipal
securities. Data were obtained from the MSRB's Real-Time Transaction
Reporting System (RTRS), MSRB's registration database, and SEC's
estimates of costs and benefits of applying Regulation Best Interest
to Broker-Dealers.
\78\ See Regulation Best Interest Adopting Release, 84 FR at
33318.
Table 2--Estimated Initial Setup and Ongoing Compliance Costs for an Average Bank Dealer
----------------------------------------------------------------------------------------------------------------
Number of
retail-sized
Initial cost Ongoing cost customer
trades
----------------------------------------------------------------------------------------------------------------
SEC Estimate
Average Broker-Dealer (Non-Bank Dealer)......................... $2,153,290 $855,897
Average Broker-Dealer Trading Municipal Bonds Only.............. 753,651 8,559 5,523
Apply SEC Estimate to Average Bank Dealer Trading Municipal 753,651 4,590 2,962
Bonds..........................................................
----------------------------------------------------------------------------------------------------------------
Source: MSRB analysis with data obtained from the MSRB's Real-Time Transaction Reporting System (RTRS), MSRB's
registration data and SEC's estimates of costs and benefits of applying Regulation Best Interest to Broker-
Dealers.\78\
[[Page 28094]]
Effect on Competition, Efficiency, and Capital Formation \79\
The MSRB believes that, if the proposed Best Interest Amendments
were adopted, there is a possibility some Bank Dealers that rarely
execute retail-sized customer trades, assuming those trades represent
retail municipal recommendations, may choose to forgo retail business
entirely to avoid the costs of compliance with proposed Best Interest
Amendments and Regulation Best Interest, or more narrowly, stop
providing retail municipal recommendations to limit the costs of
compliance. Therefore, some Bank Dealers may be impacted by the
proposed Regulation Best Interest Amendments by deciding to forego
retail municipal recommendations or retail customer business
altogether, though the broader impact on competition in the municipal
securities market is expected to be minor given these Bank Dealers'
relatively minor presence in executing retail-sized trades for
municipal securities currently; accordingly, even if those Bank Dealers
choose to relinquish their retail business, there should not be any
significant reduction in the supply of services to retail investors. On
the other hand, the MSRB does not expect a significant alteration to
the competitive landscape from retail investors' perspective if the
proposed Best Interest Amendments were adopted, as retail investors
rarely use Bank Dealers for retail trading. Moreover, for those retail
investors who do choose Bank Dealers to conduct retail activities,
their activities are concentrated in a small number of Bank Dealers who
are less likely to withdraw from the retail business as a result of the
burdens created by the proposed Best Interest Amendments.
---------------------------------------------------------------------------
\79\ Capital formation is defined by the SEC on their website
``What we do,'' available at <a href="https://www.sec.gov/about/what-we-do#section2">https://www.sec.gov/about/what-we-do#section2</a>. It refers to companies and entrepreneurs accessing
America's capital markets to help them create jobs, develop
innovations and technology, and provide financial opportunities for
those who invest in them. Id.
---------------------------------------------------------------------------
The MSRB believes requiring Bank Dealers to comply with the
requirements of Regulation Best Interest, when making retail municipal
recommendations, would improve market efficiency by imposing the same
requirements on Bank Dealers when making such recommendations as on
Broker-Dealers under Regulation Best Interest. The harmonization of
MSRB rule requirements for Bank Dealers with SEC requirements for
Broker-Dealers would create consistency for firms who have both Broker-
Dealer and Bank Dealer subsidiaries, and, thus, would increase
efficiency in terms of firms' compliance burdens. It also may encourage
competition for retail customers among Bank Dealers (and between Bank
Dealers and Broker-Dealers in some instances) to the extent that the
disclosure of fees and conflicts of interest would increase
transparency and facilitate more comparability across Bank Dealers and
Broker-Dealers among retail investors, and, therefore, would further
inform customers' decisions of whether to utilize a Bank Dealer versus
a Broker-Dealer for transactions in municipal securities. In addition,
the MSRB believes investors should benefit from receiving the same type
of information from Bank Dealers and Broker-Dealers in relation to an
investment recommendation. Therefore, as stated above, because of the
creation of consistent regulatory requirements across Bank Dealers and
Broker-Dealers for their retail municipal recommendations and the
greater competition fostered by this consistency among firms serving
retail customers, the MSRB believes that the proposed Best Interest
Amendments would facilitate capital formation.
Institutional SMMP Amendment
The MSRB proposal to amend MSRB Rule G-48 would reinstate a
previously existing actual control or de facto control standard for
Institutional SMMP accounts for purposes of dealers' quantitative
suitability obligations.
Benefits
The proposed Institutional SMMP Amendment to MSRB Rule G-48 would
reduce the compliance burden for all dealers, including Bank Dealers
and Broker-Dealers, by eliminating the requirements to undertake a
quantitative suitability analysis for Institutional SMMPs when a dealer
does not have actual control or de facto control over the customer's
accounts. The requirement is not necessary because of the
sophistication and differing needs of Institutional SMMPs who have
knowingly declined to have such requirements apply to them, as
described herein.
Costs
The MSRB believes the proposed Institutional SMMP Amendment to MSRB
Rule G-48 to modify the quantitative suitability obligation of a dealer
in the limited circumstances provided under the proposed Institutional
SMMP Amendment would have minimal costs associated, particularly since
the intent was to reinstate an exemption from quantitative suitability
previously enacted for all recommendations through MSRB Rule G-19. One
potential one-time cost would be for all dealers, including Bank
Dealers and Broker-Dealers, to update their policies and procedures.
Because of the recent existence of the same actual control or de facto
control standard that would be reestablished by the proposed
Institutional SMMP Amendment, the MSRB believes this one-time change
should be familiar to firms and the cost of compliance implementation
will be reduced in this regard. Moreover, to the degree that dealers
are likely to reintroduce the same standards in their policies and
procedures as previously existed, the cost of implementation would be
minimized.
In addition, one impetus of the Broker-Dealer Harmonization Filing
was to harmonize the rule with Regulation Best Interest and FINRA Rule
2111 and to reduce inconsistency on suitability requirements between
FINRA's rules and MSRB's rules. By amending MSRB Rule G-48 to provide a
narrow exemption from the application of quantitative suitability, this
rule would not be fully harmonized with FINRA Rule 2111, and, thus,
would establish two standards for accounts across the corporate and
municipal securities markets. The MSRB believes that this lack of
harmonization is justified in this instance for all the reasons stated
herein,\80\ including the fact that Institutional SMMPs are by their
nature sophisticated entities that have affirmed and self-identified
their capacity to independently evaluate dealers' recommendations of
municipal securities transactions.
---------------------------------------------------------------------------
\80\ See related discussion supra under Purpose and Intent of
the Institutional SMMP Amendment to MSRB Rule G-48.
---------------------------------------------------------------------------
Effect on Competition, Efficiency, and Capital Formation
The MSRB believes the proposed Institutional SMMP Amendment to MSRB
Rule G-48 would improve the operational efficiency of the municipal
securities market by reintroducing the element of actual control or de
facto control with respect to Institutional SMMP accounts that would
trigger a dealer's quantitative suitability obligation, as dealers
would have one fewer compliance burden. The MSRB does not expect that
the proposed Institutional SMMP Amendment to MSRB Rule G-48 would harm
competition in the municipal securities market, because the proposed
Institutional SMMP Amendment would be applicable to all dealers and,
[[Page 28095]]
therefore, any of the benefits and burdens created by the proposed
Institutional SMMP Amendments would be evenly applied to all such firms
transacting with Institutional SMMP customers and, thereby, avoid
discriminatory impacts among dealer firms.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
On March 4, 2021, the Board published a request for comment seeking
public feedback on requiring Bank Dealers to comply with Regulation
Best Interest when making a retail municipal recommendation (the
``Request for Comments'').\81\ The Board received five comments letters
in response to the Request for Comments.\82\ Each of these will be
addressed below. The comment letters addressing the proposed Best
Interest Amendments will be discussed separately from the one comment
letter addressing the proposed Institutional SMMP Amendment.
---------------------------------------------------------------------------
\81\ MSRB Notice 2021-06 (March 4, 2021).
\82\ Letter from Justin M. Underwood, Executive Director,
American Bankers Association (``Bankers Association''), dated June
2, 2021 (the ``Bankers Association Letter''); Letter from
Christopher A. Iacovella, Chief Executive Officer, American
Securities Association (``Securities Association''), dated May 27,
2021 (the ``Securities Association Letter''); the Commerce Bank
Letter; Letter from Leslie M. Norwood, Managing Director and
Associate General Counsel, Securities Industry and Financial Markets
Association (``SIFMA''), dated June 2, 2021 (the ``SIFMA Bank Dealer
Letter''); and Letter from Leslie M. Norwood, Managing Director and
Associate General Counsel, SIFMA, dated June 2, 2021 (the ``SIFMA
SMMP Letter'').
---------------------------------------------------------------------------
Discussion of Comments Related to the Best Interest Amendments
The MSRB received four comment letters addressing the proposed Best
Interest Amendments in response to its Request for Comments. Comments
submitted by SIFMA and the Securities Association were supportive of
the proposed Best Interest Amendments, while the comments submitted by
the Bankers Association and Commerce Bank expressed concerns about the
proposed Best Interest Amendments, generally, in terms of the
consequences of the potential compliance burden in relation to Bank
Dealers' limited retail customer activity, as further discussed below.
Support for a Uniform Regulatory Standard
SIFMA cited the goal of achieving regulatory parity among regulated
entities as the reason for being in favor of the proposed rule
change.\83\ Specifically, the SIFMA Bank Dealer Letter stated that
``SIFMA supports the proposed amendment to extend Regulation Best
Interest to bank dealers, as defined in the notice'' and that ``we
believe that regulatory parity among regulated entities, which this
amendment achieves, is a worthwhile goal.'' \84\ The Securities
Association cited a reduction in regulatory confusion and establishing
Regulation Best Interest as the standard for Broker-Dealers and Bank
Dealers as the reasons for being in favor of the proposed rule
change.\85\ The Securities Association stated that adopting Regulation
Best Interest for bank dealers will ``reduce regulatory confusion for
municipal dealers and further establish [Regulation Best Interest] as
the national standard for broker-dealers and bank dealers.'' \86\
Further, the Securities Association stated that ``[it] appreciates the
work by the MSRB in the Proposal to align their rules with the SEC and
Financial Industry Regulatory Authority's (FINRA) when possible so that
broker-dealers are not subjected to multiple standards.'' \87\ As
discussed above, the Board agrees with the commenters that the proposed
Best Interest Amendments would benefit the municipal securities market
through more uniform regulatory standards.
---------------------------------------------------------------------------
\83\ SIFMA Bank Dealer Letter at 2.
\84\ SIFMA Bank Dealer Letter at 1-2.
\85\ Securities Association Letter at 1.
\86\ Id. at 1.
\87\ Id. at 2.
---------------------------------------------------------------------------
Concerns Regarding Bank Dealer's Compliance Burden and Effects on
Competition
Among other topics in the Request for Comments, the Board sought
public input on the potential burdens associated with the proposed Best
Interest Amendments and, in particular, if requiring Bank Dealers to
comply with Regulation Best Interest would disincentivize Bank Dealers
from engaging in certain municipal securities activities with retail
customers.\88\ Commerce Bank and the Bankers Association offered
comments. The Bankers Association commented that, while its members
have long supported the notion that financial professionals offering
investment advice to retail customers should be subject to a best
interest standard, the Bankers Association urged the Board to consider
the compliance costs imposed by such a rule on Bank Dealers in relation
to their limited amount of retail customer activity.\89\ The Bankers
Association continued, stating that, ultimately, Bank Dealers in
municipal securities do not have a significant retail customer base to
warrant a new regulatory compliance regime in this manner.\90\
---------------------------------------------------------------------------
\88\ Request for Comments at 7.
\89\ Bankers Association Letter at 2
\90\ Id.
---------------------------------------------------------------------------
Echoing this concern regarding the potential compliance burden of
the proposed Best Interest Amendments, Commerce Bank responded that
they would assess the additional compliance costs that come with
compliance with Regulation Best Interest and consider the elimination
of providing recommendations for securities or strategies to retail
customers.\91\ Commerce Bank also expressed concern that the compliance
burden of the proposed Best Interest Amendments may cause it to
eliminate or become uncompetitive in relation to certain underwriting
activities, particularly for services provided to issuers utilizing
retail order periods.\92\
---------------------------------------------------------------------------
\91\ Commerce Bank Letter at 2.
\92\ Commerce Bank Letter at 3 (``Assuming the amendments are
approved as adopted and bank dealers begin to move away from
providing services to retail customers, bank dealers that underwrite
municipal bonds would need controls in place to ensure underwriting
or related commitments are appropriate for any retail order periods
required by an issuer. The potential impact may be a smaller number
of underwriting firms available or willing to work with smaller
issuers and public entities in the market, limiting the number of
competitors available for either competitive or negotiated deals.'')
In addition to the reasons discussed below, the MSRB observes that
analogous concerns regarding such dampening effects of Regulation
Best Interest's requirements on the competition for underwriting
activities equally apply to Broker-Dealers. Yet, the Commission
ultimately found that Regulation Best Interest would not have a
deleterious effect on capital formation. See, generally, Regulation
Best Interest Adopting Release, 84 FR at 33461 et seq.
---------------------------------------------------------------------------
While the Board believes that commenters' concerns regarding the
potential compliance burden for Bank Dealers associated with the
proposed Best Interest Amendments are valid, the Board also believes
that the potential investor protection benefits associated with the
proposed Best Interest Amendments outweigh these potential compliance
burdens for Bank Dealers. The Bankers Association Letter and the
Commerce Bank Letter articulated concerns regarding the potential
compliance burden associated with the proposed Best Interest
Amendments,\93\ but these commenters did not specifically address why
Bank Dealers face compliance burdens that are materially different from
those faced by
[[Page 28096]]
Broker-Dealers, who are already required to adhere to the enhanced
suitability standards required by Regulation Best Interest.
Consequently, the MSRB is unaware of any material distinctions between
the municipal securities activities of Bank Dealers and Broker-Dealers
that would persuade the MSRB to propose a non-uniform regulatory scheme
of lesser investor protections for the retail municipal recommendations
of Bank Dealers.
---------------------------------------------------------------------------
\93\ See, respectively, Bankers Association Letter at 2 and
Commerce Bank Letter at 2 (noting that retail accounts account for
approximately 9% of their total open accounts and only a portion of
these accounts transacted in the previous twelve months).
---------------------------------------------------------------------------
Moreover, in developing the proposed Best Interest Amendments, the
MSRB observed that Regulation Best Interest did not adopt de minimis
thresholds or other standards to exclude smaller regulated entities
with lesser amounts of retail customer activity from Regulation Best
Interest's baseline compliance burdens.\94\ Relatedly, the Commission
concluded that the final version of its Regulation Best Interest
appropriately balanced the concerns of various commenters from larger
and smaller entities.\95\ Similar to the Commission's determination,
the MSRB believes that the proposed Best Interest Amendments are
written to balance the interests of commenters, including the various
types and sizes of dealer entities, to best achieve the important goals
of enhancing retail investor protection and decision making, while
preserving, to the extent possible, retail investor access (in terms of
choice and cost) to differing types of municipal security investment
services and municipal security products.
---------------------------------------------------------------------------
\94\ See, generally, Regulation Best Interest Adopting Release,
84 FR at 33485 et seq (discussing impact on ``Small Entities Subject
to the Rule'').
\95\ Regulation Best Interest Adopting Release, 84 FR at 33323
(``After careful consideration of the comments and additional
information we have received, we believe that Regulation Best
Interest, as modified, appropriately balances the concerns of the
various commenters in a way that will best achieve the Commission's
important goals of enhancing retail investor protection and decision
making, while preserving, to the extent possible, retail investor
access (in terms of choice and cost) to differing types of
investment services and products.'')
---------------------------------------------------------------------------
Relatedly, the MSRB observes that the Commission determined that
Regulation Best Interest would not have a deleterious effect on capital
formation.\96\ More specifically, the Commission concluded that (i) the
possibility that Regulation Best Interest may increase the efficiency
of the recommendations provided by the associated persons of the
broker-dealer may enhance the attractiveness of broker-dealer services
for those investors who currently do not invest through broker-
dealers,\97\ and (ii) if retail customers are more willing to
participate in the securities markets through broker-dealers,
Regulation Best Interest would have a positive effect on capital
formation.\98\
---------------------------------------------------------------------------
\96\ See, generally, Regulation Best Interest Adopting Release,
84 FR at 33461 et seq.
\97\ Regulation Best Interest Adopting Release, 84 FR at 33462.
\98\ Id.
---------------------------------------------------------------------------
For similar reasons, the MSRB believes that the proposed Best
Interest Amendments would not hinder capital formation in the municipal
securities market, as suggested by the Commerce Bank Letter, such as in
instances where there is less underwriter competition for small
municipal issuers or municipal issuers who seek to utilize retail order
periods. To the degree that retail municipal recommendations are
subject to a uniform regulatory standard across Bank Dealers and
Broker-Dealers, the MSRB believes that the proposed Best Interest
Amendments may increase the efficiency of retail municipal
recommendations and enhance the attractiveness of dealer's municipal
security services. This uniform regulatory standard could draw more
retail customers to the primary offering of municipal securities with
retail order periods and, in this respect, incrementally reduce issuer
borrowing costs.
Discussion of Comments Related to the Institutional SMMP Amendment
The Board did not seek separate comment on the proposed
Institutional SMMP Amendment but did receive the SIFMA SMMP Letter as
part of the Request for Comments, which was generally supportive of the
proposed Institutional SMMP Amendment. SIFMA stated in the SMMP Letter
that its members ``feel strongly that the Quantitative Suitability
Requirement in Rule G-19 should be clarified, and interpreted as
applicable only to natural person SMMPs, but not to institutional
SMMPs. Extending the Quantitative Suitability Requirement to all SMMPs
would be unduly costly and burdensome.'' \99\ As discussed above, the
Board agrees with the commenter that requiring a dealer to undertake a
quantitative suitability analysis, when an institutional customer has
already affirmatively opted out of receiving such an analysis, is an
unnecessarily burdensome requirement to place on dealer's
recommendations to Institutional SMMPs.
---------------------------------------------------------------------------
\99\ SIFMA SMMP Letter at 2.
---------------------------------------------------------------------------
SIFMA cited the MSRB's ``history of treating SMMPs differently from
non-SMMPs, based on a reasoned recognition of the differences between
these two investor classes and the relative protections that should be
afforded to both.'' \100\ The Board agrees that in limited
circumstances it is appropriate for certain investor classes to be
afforded different protections under MSRB rules, as different classes
can have differing levels of sophistication, differing risk tolerances,
and differing investment goals. As noted above, the SMMP concept and
the modified regulatory obligations afforded to SMMPs under MSRB rules
are intended to account for the distinct capabilities of certain self-
identifying, sophisticated, non-retail customers, as well as the varied
types of dealer-customer relationships occurring in the municipal
securities markets. Thus, the MSRB believes it is appropriate to afford
Institutional SMMPS more finely tailored protections, and that the
proposed Institutional SMMP Amendment would not erode the overall
protections afforded to Institutional SMMPs.
---------------------------------------------------------------------------
\100\ SIFMA SMMP Letter at 3.
---------------------------------------------------------------------------
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period of up to 90 days (i) as
the Commission may designate if it finds such longer period to be
appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve or disapprove such proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="http://www.sec.gov/rules/sro.shtml">http://www.sec.gov/rules/sro.shtml</a>); or
<bullet<ls-thn-eq> Send an email to <a href="/cdn-cgi/l/email-protection#0f7d7a636a226c6062626a617b7c4f7c6a6c21686079"><span class="__cf_email__" data-cfemail="047671686129676b6969616a7077447761672a636b72">[email protected]</span></a>. Please
include File Number SR-MSRB-2022-02 on the subject line.
Paper Comments
<bullet> Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549.
All submissions should refer to File Number SR-MSRB-2022-02. This file
[[Page 28097]]
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (<a href="http://www.sec.gov/rules/sro.shtml">http://www.sec.gov/rules/sro.shtml</a>).
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for website viewing and printing in
the Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549 on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of the filing also will be available for inspection
and copying at the principal office of the MSRB. All comments received
will be posted without change. Persons submitting comments are
cautioned that we do not redact or edit personal identifying
information from comment submissions. You should submit only
information that you wish to make available publicly. All submissions
should refer to File Number SR-MSRB-2022-02 and should be submitted on
or before May 31, 2022.
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\101\ 17 CFR 200.30-3(a)(12).
For the Commission, pursuant to delegated authority.\101\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2022-09960 Filed 5-9-22; 8:45 am]
BILLING CODE 8011-01-P
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</html>Indexed from Federal Register on May 10, 2022.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.