The Municipal Securities Rulemaking Board (MSRB) has outlined key compliance risks in its first compliance advisory for brokers, dealers and municipal securities dealers. The guidance, which is intended to help dealers assess the adequacy of their compliance programs, includes questions for dealers to consider when performing their evaluation of compliance controls.
The compliance advisory outlines the core components of established MSRB fair practice regulations, according to a press release, and addresses a new best execution rule for the municipal securities market that will go into effect March 21, 2016.
Best execution rule. Rule G-18 will require a dealer, in any transaction in a municipal security for or with a customer, or a customer order from another dealer routed for handling and execution, to use reasonable diligence to ascertain the best market for the subject security. The dealer must then buy or sell in that market so that the resulting price to the customer is as favorable as possible. In the advisory, the MSRB reminds dealers to be especially diligent in ensuring that they have met the best-execution obligations with respect to customer transactions involving securities for which there is limited pricing information or quotations available.
The MSRB suggests that dealers ask whether they have a process to monitor retail orders that are filled from inventory shortly after the dealer completes a primary offering to determine whether those orders could have been filled with securities available during the primary offering. It also recommends that they consider whether they have a process to conduct reviews of their best execution policies to ensure they are reasonably designed, taking into account the quality of the executions the dealer is obtaining, changes in market structure, and the availability of new technologies.
Suitability obligations. MSRB Rule G-19, on suitability of recommendations and transactions, requires a dealer to have a reasonable basis to believe that a recommendation it is making to its customer is suitable for a least some investors. The MSRB advises dealers to take particular care with respect to new types of municipal financial products and existing products that may have unique structures that can differ materially from issue to issue. In addition, it warns that outstanding municipal securities may be so complex or risky that they are inherently unsuitable for most retail investors.
Pay-to-play restrictions. MSRB Rule G-37 imposes a two-year restriction on a dealer from seeking municipal securities business from municipal issuers if political contributions prohibited by the rule have been made. The MSRB reminds dealers that similar limits on political contributions apply to political action committees (PACs) if they are deemed to be controlled by the dealer or one of its municipal finance professionals. The use of PACs to make indirect contributions is prohibited by the rule, according to the MSRB.
Gifts and gratuities. The advisory also addresses the failure to adhere to restrictions on gifts, gratuities and non-cash compensation. MSRB Rule G-20 prohibits, with limited exceptions, a dealer from giving or permitting to be given, directly or indirectly, any service or thing of value in excess of $100 per person per year in relation to the municipal securities activities of the recipient’s employer. The MSRB advises dealers that they may not accept or make payments, or offers of payments, of any non-cash compensation in connection with the sale and distribution of a primary offering of municipal securities.
The MSRB reminds dealers that as of May 6, 2016, a dealer that engages in municipal securities activities for or on behalf of a municipal entity or obligated person is prohibited from requesting or obtaining reimbursement from the proceeds of the offering for its entertainment expenses not related to ordinary and reasonable expenses for meals hosted by the dealer and directly related to the offering for which the dealer was retained.
The other topics covered in the compliance advisory include failure to disclose material information to customers, failure to deal fairly with all persons in the conduct of municipal securities activity, failure to observe prohibitions on underwriting activities when engaged in financial advisory activities, failure to maintain adequate supervisory procedures, and failure to observe professional qualification standards.
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