The full committee voted to approve the municipal securities subcommittee recommendation on "blind bids," with four members dissenting.
The SEC’s Fixed Income Market Structure Advisory Committee (FIMSAC) voted in favor of a preliminary recommendation of the Municipal Securities Transparency Subcommittee urging the Commission to consider a rule permitting a broker-dealer acting in an advisory capacity to sell certain client bond positions by allowing dealers to submit "blind bids" on a principal basis against its advisory clients. The recommendation was approved by a 12 to 4 vote by the FIMSAC. Proponents argued that such a rule could help improve liquidity, while one opponent raised concerns about the recommendation’s lack of definition of "blind bidding" and the limited types of accounts to which it would apply.
Allowing "blind bids."Under the current regulatory framework, broker-dealers with a customer looking to sell a bond solicit bids from dealers and will often commit their own capital by providing a bid for the broker-dealer’s own account. However, this practice is restricted for advisory accounts held by broker-dealers that are also SEC-registered investment advisers. These firms are not allowed to enter a bid for the broker-dealer’s own account for their client wishing to sell the bond without first complying with certain disclosure and consent requirements of the Advisers Act. According to the subcommittee, this could cause a client in an advisory account to receive a less favorable price.
To address this issue, the subcommittee recommended that the SEC consider a rule that would permit a broker-dealer to meet these Advisers Act requirements when acting in a principal capacity to sell certain client bond positions within the normal liquidation process by allowing dealers to submit a "blind bid" on a principal basis against its advisory clients. The subcommittee believes that allowing a broker-dealer to submit a "blind" bid (i.e., without having access to the bids from other dealers and requiring the dealer who initiates the auction to submit their best price to that auction at that time) could result in advisory clients receiving better execution without undermining the process.
Background considerations. The recommendation notes that in 2007, the SEC adopted temporary Rule 206(3)-3T on an interim final basis, which permitted broker-dealers to sell their non-discretionary advisory clients certain securities on a principal basis that might not be available on an agency basis. The rule was extended several times before it sunset in 2016. While the SEC had requested qualitative data and economic analysis about the costs and benefits regarding the standards of conduct for broker-dealers and investment advisers, including Rule 206(3)-3T, none of the 300 comment letters addressed this regarding the interim final rule. According to the subcommittee, the lack of data and analysis does not necessarily mean that the costs outweigh the benefits, but rather that it is difficult to obtain the data. "The benefits in terms of additional liquidity and the presence of auditable outputs would far outweigh the cost of the implementation of the recommended rule," the subcommittee concluded.
Discussion. The full committee heard from panelists who gave their perspectives on the subcommittee’s recommendation. One concern that was raised related to the infrastructure that would be needed to implement a blind-bidding process. John Cahalane of Tradeweb said that his firm’s platform already has the capability to implement this process. Jude Arena of Bank of America Merrill Lynch added that the duty to provide best execution does not change because of the technology being used.
Craig Noble of Wells Fargo Advisors expressed concern about implementing this process only for municipal securities and not all securities. According to Noble, this would require additional coding just for munis and could result in a "layering" effect.
FIMSAC member Lynn Martin of ICE Data Services, who moderated the discussion, asked about how implementing blind bidding can protect investors. John Bagley of the MSRB noted that firms would be required to have written policies and procedures in place addressing how they would handle blind bids. He added that there is an audit trail on bids wanted, so if anyone tried to get around the rule, it would show up on the audit trail.
Vote and dissent. The full committee voted 12 to 4 to approve the subcommittee’s recommendation. FIMSAC member Matt Andresen, CEO and founder of global trading firm Headlands Technologies, submitted a statement outlining his reasons for opposing the recommendation. For one, Andresen noted, the recommendation does not include a definition for what it means to "bid blind." While the "spirit" of the recommendation points to "blind" meaning that the dealer who initiates the ATS auction must submit their best price to that ATS at the time the auction is initiated [emphasis in original], and the dealer must then award the trade to the winning bidder even if the best bid is not by the initiating dealer, without a clear definition, the practice could be left open to interpretation.
Andresen observed that at an earlier FIMSAC meeting, committee members had expressed concern about the use of "pennying," where a dealer, rather than execute the trade with the highest bidder, will instead nominally exceed the high bid to the client and buy the bonds for the dealer’s own trading account. Given these previous discussions on pennying, Andresen feared that it may be premature to assume that market participants could seamlessly integrate blind bidding with best execution, especially without a clear definition of blind bidding and guidance.
Andresen also opposed the recommendation because it only requires dealers to bid blind on managed accounts and not traditional brokerage accounts. He inquired why this should not be extended to all accounts if having dealers bid blind is indeed a positive for best execution in managed accounts.
If the recommendation had an explicit definition for true blind bidding and if it covered all retail orders from all accounts, Andresen stated that he would be open to voting in favor of it. However, in its current form, he must vote against it, Andresen concluded.
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