
[Federal Register Volume 79, Number 173 (Monday, September 8, 2014)]
[Notices]
[Pages 53236-53247]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-21249]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-72956; File No. SR-MSRB-2014-07]


Self-Regulatory Organizations; Municipal Securities Rulemaking 
Board; Notice of Filing of a Proposed Rule Change Consisting of Rule G-
18, on Best Execution of Transactions in Municipal Securities, and 
Amendments to Rule G-48, on Transactions With Sophisticated Municipal 
Market Professionals (``SMMP''), and Rule D-15, on the Definition of 
SMMP

September 2, 2014.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(the ``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given 
that on August 20, 2014, the Municipal Securities Rulemaking Board (the 
``MSRB'' or ``Board'') filed with the Securities and Exchange 
Commission (the ``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 Sec.  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 is filing with the Commission a proposed rule change 
consisting of Rule G-18, on best execution of transactions in municipal 
securities, and amendments to Rule G-48,\3\ on transactions with 
sophisticated municipal market professionals (``SMMPs''), and Rule D-
15, on the definition of SMMP (the ``proposed rule change''). The MSRB 
requests that the proposed rule change be approved with an 
implementation date one year after the Commission approval date.
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    \3\ The MSRB recently received approval from the Commission to 
adopt new Rule G-48, which became effective July 5, 2014. See MSRB 
Notice 2014-07 (Mar. 12, 2014).
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    The text of the proposed rule change is available on the MSRB's Web 
site at www.msrb.org/Rules-and-Interpretations/SEC-Filings/2014-Filings.aspx, 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

[[Page 53237]]

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 MSRB is charged by Congress to protect investors and foster a 
free and open municipal securities market. The MSRB, consistent with 
that charge, has advanced a number of initiatives to improve the 
transparency, efficiency and structure of the municipal securities 
market. In alignment with these efforts, the MSRB believes that the 
establishment of a requirement that dealers seek best execution of 
retail customer transactions in municipal securities will have benefits 
for investors, promote fair competition among dealers and improve 
market efficiency.
    As generally understood, best-execution obligations and fair-
pricing obligations are closely related but distinct. MSRB Rule G-30 
(Prices and Commissions) \4\ generally requires brokers, dealers and 
municipal securities dealers (``dealers'') to trade with customers at 
fair and reasonable prices and to exercise diligence in establishing 
the market value of municipal securities and the reasonableness of 
their compensation.\5\ A best-execution standard generally requires 
broker-dealers to use reasonable diligence to ascertain the best market 
for the subject security and to buy or sell in that market so that the 
resultant price to the customer is as favorable as possible under 
prevailing market conditions. While Rule G-30 contains substantive 
pricing standards, under which dealers must (among other things) use 
reasonable diligence in determining a security's fair market value,\6\ 
a best-execution standard is an order-handling and transaction-
execution standard, under which the goal of the dealer's reasonable 
diligence would be to ascertain, among the variety of venues where the 
municipal security may be executed, the best market for the 
security.\7\
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    \4\ The MSRB recently received approval from the Commission to 
consolidate and codify former MSRB Rules G-18 and G-30 into a single 
pricing rule, Rule G-30, which changes became effective July 7, 
2014. See MSRB Notice 2014-11 (May 12, 2014).
    \5\ Rule G-30(a), on principal transactions, provides: ``No 
broker, dealer or municipal securities dealer shall purchase 
municipal securities for its own account from a customer, or sell 
municipal securities for its own account to a customer, except at an 
aggregate price (including any mark-up or mark-down) that is fair 
and reasonable.'' Rule G-30(b), on agency transactions, provides: 
``Each broker, dealer and municipal securities dealer, when 
executing a transaction in municipal securities for or on behalf of 
a customer as agent, shall make a reasonable effort to obtain a 
price for the customer that is fair and reasonable in relation to 
prevailing market conditions'' and ``No broker, dealer or municipal 
securities dealer shall purchase or sell municipal securities as 
agent for a customer for a commission or service charge in excess of 
a fair and reasonable amount.''
    \6\ See MSRB Interpretive Notice, ``Review of Dealer Pricing 
Responsibilities'' (Jan. 26, 2004); MSRB Interpretive Notice, 
``Interpretive Notice on Commissions and Other Charges, 
Advertisements and Official Statements Relating to Municipal Fund 
Securities'' (Dec. 19, 2001); MSRB Interpretive Notice, ``Report on 
Pricing'' (Sept. 1980). See also SEC Report on the Municipal 
Securities Markets at 149 and n.835 (Jul. 31, 2012) (``SEC 
Report''), available at http://www.sec.gov/reportspubs/studies/munireport073112.pdf.
    \7\ See SEC Report at 149.
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    In March 2012, the MSRB noted (in connection with a rulemaking 
initiative related to brokers' brokers) that, while its pricing rules 
require dealers to obtain prices for their customers that are fair and 
reasonable, those rules do not address all dealer conduct that would be 
regulated by an explicit best-execution rule.\8\ The MSRB stated at 
that time that it would consider this issue in connection with its 
ongoing review of its rules.\9\
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    \8\ See ``Notice of Filing of Proposed Rule G-43, on Broker's 
Brokers; Proposed Amendments to Rule G-8, on Books and Records, Rule 
G-9, on Record Retention, and Rule G-18, on Execution of 
Transactions; and a Proposed Interpretive Notice on the Duties of 
Dealers that Use the Services of Broker's Brokers,'' Exchange Act 
Release No. 66625, 77 FR 17548 (Mar. 26, 2012), File No. SR-MSRB-
2012-04, at pp. 29-30 (Mar. 20, 2012), available at http://www.sec.gov/rules/sro/msrb/2012/34-66625.pdf.
    \9\ See id.
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    Shortly thereafter, in July 2012, the Commission issued its Report 
on the Municipal Securities Market (the ``SEC Report'').\10\ The SEC 
Report contained a number of recommendations that the Commission 
concluded should be considered for improvement of the municipal 
securities market, including possible legislative reforms by Congress, 
possible steps to be taken by the Commission itself, possible voluntary 
initiatives by market participants and possible measures to be 
considered by the MSRB. Some of those measures were ways in which the 
MSRB could buttress existing pricing standards, including establishing 
a best-execution obligation and providing guidance to dealers on how 
best-execution concepts would be applied to municipal securities 
transactions.\11\ The SEC Report focused to a large extent on the 
circumstances of retail investors in the municipal securities market 
and the possible measures that could benefit them, including the 
facilitation of ``the best execution of retail customer orders.'' \12\
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    \10\ See SEC Report.
    \11\ Id. at 149-50.
    \12\ Id. at ix; see generally id.
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    In April 2013, the Commission hosted a roundtable on fixed income 
markets, in which various market participants, academics and the MSRB 
participated.\13\ The roundtable generated important and useful 
dialogue about the potential application of best-execution concepts to 
the municipal securities market.\14\
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    \13\ Roundtable on Fixed Income Markets, Securities and Exchange 
Commission, April 16, 2013; http://www.sec.gov/news/otherwebcasts/2013/fixed-income-roundtable-041613.shtml.
    \14\ See id. Tr. pp. 209-19.
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    In August 2013, the MSRB published a Concept Proposal on best 
execution, requesting comment on whether and how a new MSRB rule should 
apply best-execution concepts to the municipal securities market.\15\ 
The Concept Proposal specifically raised the issue of whether a best-
execution requirement would effectively buttress existing MSRB fair-
pricing obligations. In addition, the MSRB observed that, although the 
Financial Industry Regulatory Authority's (``FINRA'') best-execution 
rule, FINRA Rule 5310 (Best Execution and Interpositioning), applies to 
non-municipal fixed income securities,\16\ there are certain concepts 
and requirements in FINRA Rule 5310 that appeared to be more applicable 
to transactions in equity securities, particularly those that are a 
part of the electronically interconnected national market system.
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    \15\ Request for Comment on Whether to Require Dealers to Adopt 
a ``Best Execution'' Standard for Municipal Securities Transactions, 
MSRB Notice 2013-16 (Aug. 6, 2013) (the ``Concept Proposal'').
    \16\ Under FINRA Rule 0150 (Application of Rules to Exempted 
Securities Except Municipal Securities), FINRA rules do not apply to 
transactions in, and business activities relating to, municipal 
securities. Accordingly, FINRA Rule 5310 on best execution does not 
apply to the municipal securities market.
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    Many commenters \17\ supported the development of an explicit best-

[[Page 53238]]

execution standard for the municipal securities market, and several 
major themes emerged from the comments. Commenters expressed a view 
that any best-execution rule should focus on the order-handling 
process. In addition, there was a general consensus against requiring a 
minimum number of quotations to support a determination of the 
prevailing market price, a general view regarding the importance of 
dealer inventories in providing liquidity, and a view that any best-
execution rule should not favor any one execution venue over another.
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    \17\ The MSRB received eleven comment letters. Comments were 
received from Ambassador Financial Group: Email from Allen Collins 
dated August 8, 2013 (``Ambassador''); Barclays Capital Inc.: Letter 
from Jennifer Small, Municipal Compliance, dated October 7, 2013 
(``Barclays''); Bond Dealers of America: Letter from Michael 
Nicholas, Chief Executive Officer, dated October 7, 2013 (``BDA''); 
Chris Melton: Letter dated September 26, 2013 (``Melton''); 
Financial Services Institute: Letter from David T. Bellaire, 
Executive Vice President and General Counsel, dated October 4, 2013 
(``Financial Services Institute''); Interactive Data Corporation: 
Letter from Mark Hepsworth, President, dated October 7, 2013 
(``IDC''); Investment Company Institute: Letter from Tamara K. 
Salmon, Senior Associate Counsel, dated September 20, 2013 
(``ICI''); J.J.B. Hilliard, W.L. Lyons LLC: Email from Alex Rorke, 
Director, Public Finance, dated October 4, 2013 (``Hilliard''); 
Private Investor: Email from Private Investor dated September 2, 
2013 (``Investor''); Securities Industry and Financial Markets 
Association: Letter from David L. Cohen, Managing Director and 
Associate General Counsel, dated October 7, 2013 (``SIFMA''); and 
Wells Fargo Advisors, LLC: Letter from Robert J. McCarthy, Director 
of Regulatory Policy, dated October 7, 2013 (``Wells Fargo'').
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    The MSRB carefully considered all of the comments received in 
response to the publication of the Concept Proposal, and determined to 
publish a request for comment on a draft best-execution rule, including 
an exception for transactions with SMMPs.\18\ The draft rule changes 
incorporated the feedback received on the Concept Proposal, as 
appropriate. The MSRB received ten comment letters, in response to the 
Request for Comment, on draft Rule G-18 and the draft amendments to 
Rule G-48.\19\ After carefully considering all of the comments received 
in response to the Concept Proposal and the Request for Comment, the 
MSRB determined to file this proposed rule change to adopt an explicit 
best-execution rule for transactions in municipal securities.
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    \18\ See MSRB Notice 2014-02 (Feb. 19, 2014) (``Request for 
Comment'').
    \19\ See infra n. 27.
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    The proposed rule change reflects the MSRB's belief that a best-
execution rule should be generally harmonized with FINRA Rule 5310 for 
purposes of regulatory efficiency but appropriately tailored to the 
characteristics of the municipal securities market. The MSRB also 
believes that, unlike FINRA Rule 5310, it is appropriate to provide an 
exception from the requirements of the best-execution rule for all 
transactions with SMMPs, which can only be institutional investors or 
individual investors with assets of at least $50 million.\20\ The 
proposed best-execution requirement generally would target the process 
by which dealers handle orders and execute transactions, and would 
complement and buttress the MSRB's existing fair-pricing rules, as 
further described below under ``Summary of the Proposed Rule Change'' 
and under ``Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received from Members, Participants, or Others.''
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    \20\ New MSRB Rule D-15, like the former relevant interpretive 
guidance under Rule G-17, defines the term ``sophisticated municipal 
market professional'' to potentially include a customer of a dealer 
that is a bank, savings and loan association, insurance company, or 
registered investment company; an investment adviser registered with 
the Commission under Section 203 of the Investment Advisers Act of 
1940 or with a state securities commission (or any agency or office 
performing like functions); or any other entity or person with total 
assets of at least $50 million. Rule D-15 became effective July 5, 
2014. See MSRB Notice 2014-07 (Mar. 12, 2014).
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    The MSRB requests that the proposed rule change be approved with an 
implementation date one year after the Commission approval date.\21\ 
This would allow dealers sufficient time to develop or modify their 
policies and procedures and to acquire or adjust the level of their 
resources as necessary. It also would allow time for the MSRB to create 
educational materials and conduct outreach to the dealer community, as 
appropriate, regarding the new rules.
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    \21\ Specifically, the MSRB intends that the proposed rule 
change become effective for trades having a trade date and time on 
or after 12:01 a.m. on the first business day occurring one year 
after the Commission approval date.
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Proposed Rule G-18
    Proposed Rule G-18 generally would require dealers to use 
reasonable diligence in seeking to obtain for their customer 
transactions the most favorable terms available under prevailing market 
conditions. Under proposed Rule G-18, dealers would be required 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 customer is as favorable as possible under prevailing market 
conditions.
    Proposed Rule G-18 includes rule language and supplementary 
material designed to tailor best-execution obligations to the 
characteristics of the municipal securities market and to provide 
guidance on how best-execution concepts apply to municipal securities 
transactions. This tailoring includes accommodations for: Situations 
involving less availability of quotations and relevant pricing 
information, the role of broker's brokers in providing liquidity, the 
role of dealers' inventories in providing liquidity, the variance in 
the nature of dealers' municipal securities business, and the lack of 
standardized and publicly reported statistical data regarding the 
quality of executions of municipal securities transactions. Proposed 
Rule G-18 gives due consideration to the existing market structure and 
other current realities of the municipal securities market; however, it 
is designed to be sufficiently flexible to allow for the evolution of 
the market's structure and future developments in applied technology.
    Paragraph (a) of proposed Rule G-18 is the core provision of the 
rule which would require dealers to use reasonable diligence to 
ascertain the best market for the subject security and to buy or sell 
in that market so that the resultant price to the customer is as 
favorable as possible under prevailing market conditions. Paragraph (a) 
includes a non-exhaustive list of factors that a dealer must consider 
when exercising this diligence. The factors that must be considered 
are: The character of the market for the security, the size and type of 
transaction, the number of markets checked, the information reviewed to 
determine the current market for the subject security or similar 
securities, the accessibility of quotations, and the terms and 
conditions of the customer's inquiry or order.
    Paragraph (a) includes a factor that is not listed in the FINRA 
rule--``information reviewed to determine the current market for the 
subject security or similar securities.'' This factor helps guide the 
use of reasonable diligence when, for example, there are no available 
quotations for a security. Moreover, this factor takes into account 
that dealers may use information about similar securities and other 
reasonably relevant information.
    Paragraph (b) of proposed Rule G-18 prohibits a dealer from 
interjecting a third party between itself and the best market for the 
security in a manner inconsistent with paragraph (a), a practice known 
as ``interpositioning.'' Historically, in non-municipal securities 
transactions, a dealer was required to demonstrate that the use of a 
third party reduced the costs of the transaction to the customer. Over 
time, however, that standard came to be seen as overbroad. 
Consequently, under the current FINRA rule, the use of a third party is 
allowed so long as it is not detrimental to the customer.\22\ 
Consistent with this current

[[Page 53239]]

policy, and in light of the role of broker's brokers in the municipal 
securities market in providing liquidity, paragraph (b) would not 
prohibit the use of a broker's broker, unless it was inconsistent with 
the best-execution obligation in paragraph (a).
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    \22\ In approving provisions contained in the precursor to the 
current FINRA rule, the Commission noted that ``the cost to the 
customer under the proposed rule will `remain a crucial factor in 
determining whether a member has fulfilled its best execution 
obligations under [the rule],' including transactions involving 
interposed third parties.'' See Exchange Act Release No. 60635 
(Sept. 8, 2009), 74 FR 47302 (Sept. 15, 2009) at 47303, File No. SR-
FINRA-2007-024 (Nov. 27, 2007). The Commission also noted that 
interpositioning ``that is unnecessary or violates a member's 
general best execution obligations--either because of unnecessary 
costs to the customer or improperly delayed executions--would still 
be prohibited.'' Id.
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    Also in light of the role of broker's brokers in the municipal 
securities market, proposed Rule G-18 does not include a provision like 
that in FINRA Rule 5310(b), which requires dealers to show why it was 
reasonable to use a broker's broker.\23\ In this way, the proposed rule 
is consistent with the MSRB's objective, supported by commenters on the 
Concept Proposal, of developing a principles-based rule that does not 
favor any particular venue over another (on bases beyond the merits of 
the execution quality available at any venue). Moreover, broker's 
brokers in the municipal securities market must comply with MSRB Rule 
G-43 (Broker's Brokers), which serves to address investor-protection 
issues without additional requirements being imposed by proposed Rule 
G-18.
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    \23\ FINRA Rule 5310(b) provides: ``When a member cannot execute 
directly with a market but must employ a broker's broker or some 
other means in order to ensure an execution advantageous to the 
customer, the burden of showing the acceptable circumstances for 
doing so is on the member.''
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    Paragraph (c) of proposed Rule G-18 specifies that the rule applies 
to both principal and agency transactions. It also specifies that best-
execution obligations are distinct from certain pricing obligations of 
dealers under Rule G-30.
    Paragraph .01 of the Supplementary Material indicates that Rule G-
18 is not intended to be a substantive pricing standard but an order-
handling standard for the execution of transactions. The paragraph 
explains that the principal purpose of proposed Rule G-18 is to promote 
dealers' use of reasonable diligence in obtaining the best price for 
customers under prevailing market conditions. This is generally 
accomplished through the requirements to use, and periodically improve, 
sound procedures. The paragraph expressly provides that, as 
characteristic of any reasonableness standard, a failure to have 
actually obtained the most favorable price possible will not 
necessarily mean that the dealer failed to use reasonable diligence 
under the circumstances. Note that existing Rule G-27, on supervision, 
would require written supervisory procedures reasonably designed to 
ensure compliance with the proposed best-execution rule, if adopted.
    Paragraph .02 of the Supplementary Material provides, like FINRA 
Rule 5310(c), that a dealer's failure to maintain adequate resources 
(e.g., staff or technology) cannot justify executing away from the best 
available market. This paragraph, however, includes an acknowledgement 
that the level of adequate resources may differ based on the nature of 
a dealer's municipal securities business, including its level of sales 
and trading activity.
    Paragraph .03 of the Supplementary Material provides that dealers 
must make every effort to execute customer transactions promptly, 
taking into account prevailing market conditions. In addition, this 
paragraph recognizes that in certain market conditions, a dealer may 
need more time to use reasonable diligence to ascertain the best market 
for the subject security.
    Paragraph .04 of the Supplementary Material defines the term 
``market'' for purposes of proposed Rule G-18, including the rule's 
core provision, section (a), requiring the exercise of reasonable 
diligence in ascertaining the ``best market'' for the security. The 
definition specifically includes ``alternative trading systems or 
platforms,'' ``broker's brokers,'' and ``other counterparties, which 
may include the dealer itself as principal.'' The purpose of this 
language is to tailor the definition of the critical term ``market'' to 
the characteristics of the municipal securities market and to provide 
flexibility for future developments in both market structure and 
applied technology. For example, the language expressly recognizes that 
the executing dealer itself, acting in a principal capacity, may be the 
best market for the security.\24\ This tailoring is in recognition of 
the role of dealer inventories in providing liquidity in the municipal 
market.
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    \24\ FINRA Rule 5310 also allows the dealer acting in a 
principal capacity to be the ``best market,'' but does not have 
express language to that effect. Paragraph .09 of the Supplementary 
Material of the FINRA rule, in discussing the requirements to review 
execution quality, contemplates a firm's ``internalization'' of 
customer orders.
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    Paragraph .05 of the Supplementary Material is intended to avoid 
the imposition of redundant or unnecessary obligations on a dealer 
involved in a transaction when another dealer appropriately bears best-
execution obligations. The paragraph provides that a dealer's duty to 
provide best execution to customer orders received from another dealer 
arises only when an order is routed from the other dealer to the dealer 
for handling and execution. The best-execution obligation does not 
apply to a dealer when another dealer is simply executing a customer 
transaction against that dealer's quote.
    Paragraph .06 of the Supplementary Material addresses transactions 
involving securities for which there is limited pricing information or 
quotations. It requires each dealer to have written policies and 
procedures that address how its best-execution determinations will be 
made for such securities, and to document its compliance with those 
policies and procedures. The paragraph states that a dealer generally 
should seek out other sources of pricing information and potential 
liquidity, including other dealers the dealer previously has traded 
within the security. The paragraph also states that a dealer generally 
should analyze other relevant data to which it reasonably has access.
    Paragraph .07 of the Supplementary Material would allow a customer 
to designate a particular market for the execution of the customer's 
transaction. The paragraph provides that, if a dealer receives an 
unsolicited instruction so designating a particular market, the dealer 
is not required to make a best-execution determination beyond the 
customer's specific instruction. A blanket customer instruction 
obtained through means like account-opening documents would not qualify 
as an ``unsolicited'' instruction. The paragraph also provides that, 
even in the case of a customer's specific instruction, dealers are 
still required to process the customer's transaction promptly and in 
accordance with the terms of the customer's bid or offer.
    Paragraph .08 of the Supplementary Material specifies dealers' 
minimum obligations concerning the periodic review of their policies 
and procedures for ascertaining the best market. This paragraph is a 
departure from the FINRA rule's requirement that dealers engage in 
``regular and rigorous review'' of execution quality, on at least a 
quarterly basis, assessing any material differences among markets based 
on a highly detailed list of factors. Dealers in municipal securities 
currently do not have access to data similar to that used by broker-
dealers in other contexts and the MSRB has modified the proposed review 
requirement accordingly.
    The proposed rule reflects the broad principle that a dealer's 
policies and procedures must be reasonably designed to achieve best 
execution. The MSRB believes that proposed Rule G-18 will result in 
improved dealer policies and procedures and allow for the future 
evolution of the market by requiring dealers' reviews to take account 
of: The

[[Page 53240]]

quality of the executions the dealer is obtaining under its current 
policies and procedures, changes in market structure, new entrants, the 
availability of additional pre-trade and post-trade data and the 
availability of new technologies. Proposed Rule G-18 would not require 
in all cases that dealers conduct reviews on at least a quarterly basis 
(as required by FINRA Rule 5310). It instead would require the 
frequency of reviews to be at least annual and reasonably related to 
the nature of the dealer's business, including its level of sales and 
trading activity. Under this standard, smaller dealers that handle 
customer transactions in municipal securities infrequently might not, 
depending on all of the facts and circumstances, be required to conduct 
reviews of their policies and procedures as frequently as dealers with 
a more active municipal securities business. Note that existing Rule G-
27(f)(i), on supervisory controls, requires at least annual testing, 
verification and revision of all written supervisory procedures to 
determine whether they are reasonably designed to achieve compliance 
with applicable securities laws, including all other applicable MSRB 
rules.
    Paragraph .09 of the Supplementary Material would exempt 
transactions in municipal fund securities, including interests in 529 
college savings plans, from the application of proposed Rule G-18. Such 
securities are typically distributed through continuous primary 
offerings at calculated prices (based on the calculated net asset value 
of the investment portfolio on the day of the contribution), and the 
decision whether to purchase involves special tax and other 
considerations unique to such securities, making the application of 
proposed Rule G-18 inapt.
Proposed Amendments to Rule G-48
    The proposed amendments to Rule G-48 would provide that the best-
execution obligations under proposed Rule G-18 do not apply to 
transactions with customers that are SMMPs as defined in Rule D-15. 
Rule G-48 is the new consolidated MSRB rule under which all modified 
obligations of dealers when dealing with SMMPs are addressed. It 
provides for a reduced time-of-trade disclosure obligation under Rule 
G-47, a reduced suitability obligation under Rule G-19, reduced 
obligations with respect to the dissemination of quotations under Rule 
G-13, and a reduced pricing obligation under Rule G-30. With respect to 
pricing, specifically, Rule G-48(b) relieves dealers of their 
obligation under Rule G-30 to ensure on a transaction-by-transaction 
basis that prices are fair and reasonable for non-recommended secondary 
market agency transactions where: the dealer's services are explicitly 
limited to providing anonymity, communication, order matching and/or 
clearance functions. The proposed amendments would add a new section 
(e) to Rule G-48 to provide that a dealer shall not have any 
obligations 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.
Proposed Amendments to Rule D-15
    Rule D-15 contains the MSRB's definition of an SMMP. The proposed 
amendments to Rule D-15 would help ensure that the exemption for 
dealer's from the best-execution obligation for transactions with SMMPs 
would only apply to appropriate customers. To qualify as an SMMP under 
existing Rule D-15, the customer must affirm that it is exercising 
independent judgment in evaluating the recommendations of the dealer. 
Under existing paragraph .02 of the Supplementary Material to Rule D-
15, the affirmation may be given orally or in writing, and may be given 
on a transaction-by-transaction basis, a type-of-municipal security 
basis, or an account-wide basis. The affirmation requirement is 
significant because of the elimination under existing Rule G-48(c) of 
the dealer's obligation under Rule G-19 to make a customer-specific 
suitability determination for its recommendations when dealing with an 
SMMP. The proposed amendments to Rule D-15 would create additional 
elements for the required customer affirmation--one element related to 
best execution and, consistent with that addition, two elements related 
to two of the other modified obligations when dealing with an SMMP.
    First, significant for the purposes of the elimination, under the 
proposed new section (e) in Rule G-48, of a best-execution obligation 
for transactions with SMMPs, the customer would be required to affirm 
that it is exercising independent judgment in evaluating the quality of 
execution of the customer's transactions by the dealer.
    Second, significant for the elimination, under existing Rule G-
48(b), of the dealer obligation to ensure on a transaction-by-
transaction basis that prices are fair and reasonable in a specified 
subset of transactions with SMMPs, the customer would be required to 
affirm that it is exercising independent judgment in evaluating the 
transaction price in that subset of transactions. The specified 
transactions are non-recommended agency secondary market transactions 
where the dealer's services are 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.
    Third, significant for the elimination, under existing Rule G-
48(a), of the dealer obligation to make time-of-trade disclosure under 
Rule G-47 of all material information about the security available 
publicly from established industry sources, the customer would be 
required to affirm that it has timely access to ``material 
information'' available publicly from ``established industry sources'' 
as those terms are defined in Rule G-47(b)(i) and (ii).
    Consistent with these changes, paragraph .02 of the Supplementary 
Material to Rule D-15 would be revised to provide that the customer 
affirmation may be made on, in addition to the existing bases, a type-
of-transaction basis. The ability to make the affirmation on such a 
basis would become relevant due to the creation of an exemption from 
the proposed best-execution rule for transactions with SMMPs. The 
proposed amendments to Rule D-15 also include non-substantive (e.g., 
technical, conforming and organizational) revisions to accommodate the 
above substantive changes and improve the readability of the rule.
    Importantly, the definition of SMMP under the proposed revisions to 
the rule (as under the existing rule) is not self-executing, nor are 
the contingencies for its application in the unilateral control of the 
interfacing dealer. Rather, classification as an SMMP would require a 
particular affirmation by the SMMP.\25\ Consequently, any customer that 
preferred to have its transactions be subject to the best-execution 
regulatory framework, even if the customer otherwise would qualify as 
an SMMP, could simply not make the requisite affirmation and not bring 
itself within the definition of an SMMP. The same would be true for a 
customer that preferred to have the dealer be subject to any of the 
other obligations that would otherwise be modified under Rule G-48. Due 
to the proposed implementation date of the proposed rule change, a 
dealer could not treat any customer as an SMMP after the proposed best-
execution rule is implemented unless the dealer reasonably determined 
(as required by Rule G-48) that the customer had given

[[Page 53241]]

the broader affirmation required under the proposed amendments to Rule 
D-15.
---------------------------------------------------------------------------

    \25\ See MSRB Rule D-15.
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2. Statutory Basis
    The MSRB believes that the proposed rule change is consistent with 
Section 15B(b)(2)(C) of the Act,\26\ which provides that the MSRB's 
rules shall:
---------------------------------------------------------------------------

    \26\ 15 U.S.C. 78o4(b)(2)(C).

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.

    The MSRB believes that the establishment of a requirement that 
dealers seek best execution of customer transactions in municipal 
securities will have benefits for investors, promote fair competition 
among dealers and improve market efficiency.
    The MSRB believes that proposed Rule G-18 will protect investors, 
particularly retail investors, in many ways. The proposed rule would 
require dealers to use reasonable diligence in seeking to obtain for 
their customer transactions the most favorable terms available. 
Specifically, under proposed Rule G-18, dealers would be required to 
use reasonable diligence to ascertain the best market for the subject 
security and buy and sell in that market so that the resultant price to 
the customer is as favorable as possible under prevailing market 
conditions. This would be accomplished through the proposed rule's 
general requirements of the use of, and periodic improvement of, sound 
procedures for the handling of orders and execution of transactions. 
Whether a dealer would be viewed as having used reasonable diligence 
would depend in part upon a non-exhaustive list of relevant factors. 
The MSRB believes that these new order-handling obligations will 
buttress and complement the MSRB's substantive pricing standards and 
foster compliance with those standards, helping to ensure that 
investors receive fair and reasonable prices and to improve execution 
quality for investors in municipal securities.
    The proposed rule would also make it a violation for a dealer to 
interject a third party between itself and the best market for the 
security but would allow the use of a third party so long as it is not 
inconsistent with the proposed best-execution obligations. The proposed 
rule would allow for a dealer to use a broker's broker while retaining 
sufficient protections for investors because broker's brokers, and 
dealers who use broker's brokers, are required to comply with the 
substantial investor-protection provisions of Rule G-43. Proposed Rule 
G-18 would provide that dealers must make every effort to execute 
customer transactions promptly, taking into account prevailing market 
conditions. Finally, the proposed rule would allow a customer to 
specifically designate a particular market for the execution of a 
transaction, and such an instruction would relieve the dealer from 
making a best-execution determination beyond the customer's unsolicited 
specific instruction. In addition, the MSRB believes that the proposed 
amendments to Rule D-15 will protect investors by helping to ensure 
that the exemption for dealers from the best-execution obligation for 
transactions with SMMPs (as well as the reduced dealer obligations 
related to time-of-trade disclosure and pricing) will only apply to 
transactions with sufficiently sophisticated customers.
    The MSRB believes that proposed Rule G-18 will promote fair 
competition among dealers and improve market efficiency. It would 
provide that a dealer's duty to provide best execution to customer 
orders received from another dealer arises only when an order is routed 
from the other dealer to the dealer for handling and execution. The 
best-execution obligation would not apply to a dealer when another 
dealer is simply executing a customer transaction against that dealer's 
quote. In the case of transactions involving securities for which there 
is limited pricing information or quotations, the rule would provide 
that a dealer generally should seek out other sources of pricing 
information and potential liquidity, including other dealers the dealer 
previously has traded within the security. The number-of-markets-
checked factor of the proposed rule would promote dealers' exposure of 
quotations to fair competition among dealers (including broker's 
brokers), alternative trading systems and platforms and any other 
venues that may emerge. Because the proposed rule does not favor any 
particular venue over another, the MSRB believes it will support a free 
and open market in municipal securities. Also, the proposed rule's 
definition of ``market'' would be sufficiently flexible to accommodate 
future developments in market structure and technology. In addition, 
because the definition of ``market'' in the proposed rule would 
expressly recognize that the executing dealer itself acting as 
principal may be the best market for the security, a dealer's inventory 
could be utilized for sales of municipal securities to that dealer's 
customers, in recognition of the role of dealer inventories in 
providing needed liquidity to investors in the municipal market.
    The MSRB believes that the proposed amendments to Rule G-48 and 
Rule D-15 to effectuate the exemption for transactions with SMMPs will 
facilitate transactions in municipal securities and help perfect the 
mechanism of a free and open market in municipal securities by avoiding 
the imposition of regulatory burdens where they appear not to be 
needed. The MSRB currently understands that SMMPs typically have as 
much (and in some cases more) information regarding the different 
venues at which a transaction in a municipal security might be executed 
as most individual dealers.

B. Self-Regulatory Organization's Statement on Burden on Competition

    Section 15B(b)(2)(C) of the Act requires that MSRB rules not be 
designed to impose any burden on competition not necessary or 
appropriate in furtherance of the purposes of the Act. In determining 
whether this standard has been met, the MSRB has been guided by the 
Board's recently-adopted policy to more formally integrate economic 
analysis into the rulemaking process. The Board has evaluated the 
potential impacts of the proposed rule change, including in comparison 
with alternative regulatory approaches.
    The MSRB does not believe that the proposed rule change would 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Act. The MSRB has considered whether 
it is possible that the added costs associated with the compliance and 
supervisory requirements of the proposed rule change may lead some 
dealers of municipal securities to consolidate with other dealers. For 
example, some dealers may choose to consolidate with other dealers in 
order to benefit from economies of scale (e.g., by leveraging existing 
compliance resources of a larger firm) rather than to incur separately 
the costs associated with the proposed rule change. Based in part on 
public comments received, it appears that the costs associated with the 
proposed rule change are unlikely to be of such a magnitude as to 
significantly affect consolidation decisions on a broad

[[Page 53242]]

market basis. Moreover, many smaller firms may rely on other dealers to 
handle execution of their customers' orders and may leverage upon the 
practices and periodic reviews of the executing broker as a means to 
help ensure that the firm is meeting its best-execution obligations.
    The MSRB also considered whether the proposed rule change would 
affect the dimensions, or attributes, upon which market participants 
compete. A rule that focuses on a single execution attribute, such as a 
price, could diminish competition for other execution attributes that 
might be valued by investors, such as speed of execution. In addition, 
to the extent dealers might consider the difficulty of fulfilling their 
best-execution obligations to be greater with respect to some 
securities, such as those that are less widely traded, the Board 
considered whether the proposed rule change could have an effect on the 
relative marketability of such securities. Based in part on public 
comments received, the Board does not believe that any such effect will 
result in a burden on competition that is not necessary or appropriate 
in furtherance of the purposes of the Act.
    The MSRB solicited and received comment on several potential 
burdens of the proposed rule change in the Concept Proposal and in the 
request for comment on the proposed rules. The MSRB also solicited 
comment on the potential burdens of the proposed rule change in the 
most recent request for comment.\27\ The specific comments and 
responses thereto are discussed in Part 5 below.
---------------------------------------------------------------------------

    \27\ See MSRB Notice 2014-02 (Feb. 19, 2014) (``Request for 
Comment'').
---------------------------------------------------------------------------

    The MSRB believes that the proposed rule change will not impose an 
undue burden on smaller dealers. Proposed Rule G-18 would provide that 
a failure to maintain adequate resources (e.g., staff or technology) 
cannot justify executing away from the best available market; however, 
because Paragraph .02 of the Supplementary Material contains an 
acknowledgment that dealers differ in the nature of their municipal 
securities business, including their level of sales and trading 
activity, the proposed rule change does not impose one standard for 
``adequate resources'' on all dealers. The proposed rule would not 
require a dealer to purchase evaluated pricing or other market and 
reference data but rather generally provides that a dealer engaged in 
transactions involving securities for which there is limited pricing 
information or quotations, should analyze data to which it reasonably 
has access. The proposed rule would not require in all cases that 
dealers conduct reviews of their policies and procedures on a specified 
interval. It instead would require the frequency of reviews to be 
reasonably related to the nature of the dealer's municipal securities 
business, including its level of sales and trading activity. Under this 
standard, smaller dealers that handle customer transactions in 
municipal securities infrequently may not, depending on all of the 
facts and circumstances, be required to conduct reviews of their 
policies and procedures as frequently as dealers with a more active 
municipal securities business.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The MSRB received ten comment letters in response to the Request 
for Comment.\28\ The comment letters are summarized below by topic.
---------------------------------------------------------------------------

    \28\ Comments were received from Bond Dealers of America: Letter 
from Michael Nicholas, Chief Executive Officer, dated March 21, 2014 
(``BDA''); City of New York, Office of the Comptroller: Letter from 
Scott M. Stringer, New York City Comptroller, dated March 21, 2014 
(``NYC''); Coastal Securities: Letter from Chris Melton, Executive 
Vice President, dated March 21, 2014 (``Coastal''); Interactive Data 
Corporation: Letter from Andrew Hausman, President, dated March 21, 
2014 (``IDC''); National Association of Independent Public Finance 
Advisors: Letter from Jeanine Rodgers Caruso, President, dated March 
21, 2014 (``NAIPFA''); NYSE Euronext: Letter from Martha Redding, 
Chief Counsel, dated March 31, 2014 (``NYSE''); Regional Brokers, 
Inc.: Letter from H. Deane Armstrong, CCO, dated March 14, 2014 
(``RBI''); Securities Industry and Financial Markets Association: 
Letter from David L. Cohen, Managing Director and Associate General 
Counsel, dated March 13, 2014 (``SIFMA''); Wells Fargo Advisors, 
LLC: Letter from Robert J. McCarthy, Director of Regulatory Policy, 
dated April 2, 2014 (``Wells Fargo''); and Wulff, Hansen & Co.: 
Letter from Chris Charles, President, dated March 21, 2014 
(``Wulff'').
---------------------------------------------------------------------------

Support for the Proposal
    Most commenters supported to some degree the initiative to 
establish an explicit best-execution rule for the municipal securities 
market. NYC stated that requiring dealers to use reasonable diligence 
in seeking to obtain for customers the most favorable terms available 
under prevailing market conditions would foster a more open, 
transparent, even-handed market environment for individual investors. 
IDC supported the objective of the rule proposal to safeguard investor 
interests while promoting competition among dealers and improving 
market efficiency. NYSE supported the proposal on the grounds that it 
would help create a more transparent and fair market for all investors, 
particularly retail investors.
    Several other commenters expressed support for specific provisions 
of the proposed rule change. SIFMA and Wells Fargo supported the 
execution handling aspects of draft Rule G-18. RBI supported the 
provision of draft Rule G-18 that would not prohibit the use of a 
broker's broker unless it proves detrimental to the customer. In 
general, SIFMA and Wells Fargo supported draft Rule G-18's approach to 
the review of execution quality because it does not mirror the type of 
regular and rigorous review requirements in FINRA Rule 5310. NYC 
commended the MSRB for introducing policy and procedure guidelines into 
draft Rule G-18 that would require dealers to address how best 
execution determinations would be made for securities with limited 
pricing information or quotations and stated that the rule should 
maintain elements of flexibility in its policies and procedures in 
order to reduce compliance costs and allow continued diversity of 
dealer characteristics. IDC stated that draft Rule G-18(a)(4) 
represents an important factor for determining whether a dealer has 
used reasonable diligence to ascertain the best market for the subject 
security and also stated that paragraph .06 of the Supplementary 
Material is valuable and in particular supported the MSRB's view that 
dealers should seek out other sources of pricing information and 
analyze other data to which they reasonably have access in making best-
execution determinations. BDA and SIFMA supported the proposed 
amendment to Rule G-48 that would create an exception to the best-
execution obligations for transactions with SMMPs.
The Relationship Between Best-Execution and the MSRB's Pricing 
Standards
    NAIPFA stated that draft Rule G-18 creates a new pricing standard 
because dealers must strive to obtain the best price possible whereas 
existing Rules G-18 and G-30 \29\ establish pricing floors, i.e., the 
prices must be at least fair and reasonable. NAIPFA stated its belief 
that dealers wishing to avoid violations of MSRB rules must either (a) 
obtain the most favorable price or (b) in the event that the most 
favorable price is not obtained, show that reasonable diligence was 
utilized in attempting to obtain the most favorable price and that the 
price ultimately obtained was nevertheless fair and reasonable.
---------------------------------------------------------------------------

    \29\ See Request for Comment at nn.4-6.

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[[Page 53243]]

    Wells Fargo stated that the existing fair-pricing standards were 
better situated to municipal market conditions than a best-execution 
requirement based upon FINRA's equity-oriented best-execution rule. 
Wulff stated that the concept of ``best execution'' as applied to more 
liquid markets in which individual securities are widely known and 
trade frequently is an inappropriate standard for the municipal market 
as there is simply not enough price information available for a 
traditional best execution standard to be workable. SIFMA requested 
that the MSRB provide guidance on the interplay between draft Rule G-18 
and current pricing rules, in light of the consolidation of years of 
fair-pricing guidance into Rule G-30, specifically the applicability of 
interpretive guidance entitled ``Relevant Factors in Determining the 
Fairness and Reasonableness of Prices.''
    NAIPFA stated that, if the best-execution obligations apply within 
the context of a new offering of securities, this will create an 
inconsistency in terms of a dealer's obligations to issuers and 
investors under the interpretive guidance adopted by the MSRB in 2012 
\30\ because the G-17 Underwriters' Notice provides, among other 
things, that the underwriter has a duty to purchase securities from the 
issuer at a fair and reasonable price. NAIPFA recommended that the MSRB 
either limit the application of a best-execution rule to secondary 
market transactions or, in the alternative, ensure that Rule G-17 does 
not conflict with the new rule. NAIPFA further suggested that the term 
``customer'' is not defined in draft Rule G-18 and therefore an issuer 
of municipal securities could arguably be considered a customer for 
purposes of the rule proposal.
---------------------------------------------------------------------------

    \30\ See MSRB Notice 2012-25 (May 7, 2012) (``G-17 Underwriters' 
Notice'').
---------------------------------------------------------------------------

    RBI stated that the municipal market is a negotiated, subjective 
market where prices of bonds are developed based on many factors, 
including supply and demand, interest rate fluctuations, 
creditworthiness of any issue and the cost of carry. Traders make 
assumptions about these and other factors as they decide what price 
they should pay for a bond in order to be able to sell it at a profit. 
Unlike the stock market, traders in the municipal market must often be 
willing to take bonds into their inventories and carry them for days or 
weeks. The fact that assumptions play a role in the pricing of 
municipal bonds means, inherently, that there can be no exact price at 
which a bond should trade on any given day. RBI was concerned that an 
attempt to hold traders to a strict ``best execution'' rule would have 
a chilling effect on the willingness of some traders to place bids in a 
market that already faces liquidity problems. RBI stated that traders 
will be even more leery of exposing themselves to regulatory scrutiny 
with a fear that regulators might argue that there is only one exact 
price that should be paid for a bond. RBI asked the question, ``which 
prices on EMMA are correct?''
    BDA stated that where dealers effect their trades in the municipal 
securities market has much less to do with what pricing a customer 
receives than the proper diligence of a dealer in ensuring that 
customers receive a fair and reasonable price. MSRB's fair-pricing and 
suitability rules, combined with current improvements and future 
strides in the transparency of the municipal securities market, such 
as: The availability of alternative trading systems; an enhanced, 
public electronic database through EMMA; and, possibly, the creation of 
an index for retail customers, may improve pricing. NYC noted that its 
own ability as an issuer to increase transparency in the secondary 
market for municipal securities is limited. Municipal securities are 
not traded on an exchange; therefore, firm bid and ask quotations are 
generally unavailable and individual investors in particular have 
limited access to information regarding which market participants would 
be interested in buying or selling municipal securities, and at what 
prices. NYSE also noted that the fragmented view of dealer inventory 
and limited distribution of ``bids wanted'' price information 
contribute to opacity and stated its belief that the creation of a 
consolidated feed of these data would be an extremely powerful 
information tool for customers engaging in municipal securities 
transactions because it would increase market transparency, facilitate 
retail investors' ability to make informed investment decisions, 
enhance a broker's best execution process, and improve regulator's 
surveillance of the market. NYSE suggested that for investors to fully 
realize the benefits of a best-execution rule, the MSRB should propose 
a rule that will advance the efforts of pre-trade transparency.
    Coastal asked what dealer conduct that is not currently regulated 
would be regulated by an explicit best-execution rule.
    As the MSRB explained in the Request for Comment, the proposed 
best-execution rule is an order-handling and transaction-execution 
standard, under which the goal of the dealer's reasonable diligence is 
to provide the customer the most favorable price possible under 
prevailing market conditions. Although fair-pricing and best-execution 
standards are closely related, they are ``distinct.''
    The best-execution requirement generally would target the process 
by which dealers handle orders and execute transactions, which is not 
directly addressed in the MSRB's fair-pricing rules. And, unlike the 
fair-pricing rules, the proposed rule does not contain any substantive 
pricing standard. Paragraph .01 of the Supplementary Material makes 
clear that the rule is not intended to be a substantive pricing 
standard but an order-handling standard for the execution of 
transactions. Paragraph .01 explains that the principal purpose of the 
rule is to promote dealers' use of reasonable diligence in ascertaining 
the best market for the subject security and obtaining the most 
favorable price possible under prevailing market conditions. This is 
accomplished through the rule's general requirements of the use, and 
periodic improvement, of sound procedures. Moreover, this paragraph 
expressly provides that, as characteristic of any reasonableness 
standard, a failure to have actually obtained the most favorable price 
possible will not necessarily mean that the dealer failed to use 
reasonable diligence under the circumstances. A requirement to use 
reasonable diligence in the order-handling and transaction execution 
process likely would increase the probability that customers receive 
fair and reasonable prices, but the proposed rule does not itself 
contain any standard by which the actual transaction price is to be (or 
could be) evaluated. The MSRB therefore does not believe that 
additional guidance related to any interplay between fair pricing and 
proposed Rule G-18 is needed at this time.
    NAIPFA's comment regarding an inconsistency with the G-17 
Underwriters' Notice appears to be premised on a misunderstanding of 
the proposed rule. As explained above, proposed Rule G-18 would not 
change the substantive pricing standard of fair-and-reasonable. An 
underwriter would continue to owe an obligation to issuers to purchase 
newly issued bonds at a price that is fair and reasonable, and must 
balance that obligation with an obligation to customers to sell them 
bonds at a price that is fair and reasonable. NAIPFA reads the rule as 
requiring underwriters to ``attempt to sell municipal securities to 
investors at prices that are the most favorable to such investors.'' 
The rule, however, contains no such open-ended

[[Page 53244]]

requirement and is much more targeted and limited. It would require 
dealers to use reasonable diligence in the handling and execution of 
customer orders, and that order-handling obligation would not impact an 
underwriter's role in the pricing of a new issuance of municipal 
securities.
    The text of proposed Rule G-18 does not include a definition of 
``customer'' because the term ``customer'' is defined in Rule D-9 
(unless specifically provided otherwise) for purposes of all MSRB 
rules. NAIPFA's concern regarding an issuer being treated as a customer 
under the proposed rule is fully addressed by the definition in Rule D-
9 because it excludes an issuer in transactions involving the sale by 
the issuer of a new issue of its securities.\31\ In short, proposed 
Rule G-18, as written, does not apply to a sale of municipal securities 
by an issuer in a new issue of its municipal securities.
---------------------------------------------------------------------------

    \31\ Rule D-9 provides: except as otherwise specifically 
provided by rule of the Board, the term ``customer'' shall mean any 
person other than a broker, dealer, or municipal securities dealer 
acting in its capacity as such or an issuer in transactions 
involving the sale by the issuer of a new issue of its securities 
(emphases added).
---------------------------------------------------------------------------

    The MSRB believes that a best-execution standard carefully tailored 
to the municipal securities market, coupled with the MSRB's fair-
pricing rules, will help to ensure that retail customers receive fair 
pricing. In addition to this rulemaking initiative, the MSRB has 
advanced many initiatives to improve transparency, efficiency and other 
structural aspects of the market \32\ as a part of its efforts to 
protect investors and foster a ``free and open'' municipal securities 
market.\33\ The MSRB is committed to continuing its efforts to engage 
with the industry to assist it in the development of transparency 
systems to improve both pre-trade and post-trade transparency.
---------------------------------------------------------------------------

    \32\ See MSRB Long-Range Plan for Market Transparency Products 
(Jan. 27, 2012), available at http://www.msrb.org/msrb1/pdfs/Long-Range-Plan.pdf. The MSRB has requested comment and is analyzing 
information from market participants on potential improvements to 
the timeliness, fairness and efficiency of price transparency in the 
municipal market. See Concept Release on Pre-Trade and Post-Trade 
Pricing Data Dissemination through a New Central Transparency 
Platform, MSRB Notice 2013-14 (Jul. 31, 2013); Request for Comment 
on More Contemporaneous Trade Price Information Through a New 
Central Transparency Platform, MSRB Notice 2013-02 (Jan. 17, 2013). 
See also SEC Report at pp. 117, 141 (noting transparency 
initiatives).
    \33\ Securities and Exchange Act of 1934 Section 15B(b)(2)(C), 
15 U.S.C.78o-4(b)(2)(C).
---------------------------------------------------------------------------

Consistency With the FINRA Rule's Treatment of Securities With Limited 
Quotations
    BDA stated that there is a significant difference in draft Rule G-
18's treatment of securities with limited quotations when compared to 
FINRA Rule 5310 because draft Rule G-18 does not include the provisions 
of FINRA's Supplementary Material paragraph .03. As a result, BDA 
stated that draft Rule G-18 does not provide supplementary material 
that is necessary to explain how dealers are to comply with a 
transaction-by-transaction best-execution rule in a municipal 
securities market that is not quoted on a centralized exchange. BDA 
noted that, unlike paragraph .03 of the Supplementary Material of the 
FINRA rule, draft Rule G-18 does not remind a dealer that, in the 
absence of accessibility of quotations, dealers are not relieved from 
taking reasonable steps and employing their market expertise in 
achieving best execution of customer orders.
    FINRA Rule 5310 applies to other types of securities in addition to 
debt securities. Accordingly, paragraph .03 of the Supplementary 
Material of the FINRA rule specifically addresses firms' best-execution 
obligations for transactions in debt securities. Proposed Rule G-18, by 
contrast, has been developed solely for transactions in a particular 
class of debt securities--municipal securities. It includes rule 
language and supplementary material to tailor the best-execution 
obligations to the characteristics of the municipal securities market 
and provide guidance on how best-execution concepts apply to municipal 
securities transactions. As explained in the Request for Comment and 
above, this tailoring includes accommodations for the frequent 
unavailability of quotations and pricing information, the relative 
illiquidity of the market generally, the role of broker's brokers in 
providing liquidity, the role of dealers' inventories in providing 
liquidity, the variance in the nature of dealer's municipal securities 
business, and the lack of retrospective statistical data regarding the 
quality of execution.
    The MSRB believes that proposed Rule G-18 generally and paragraph 
.06 of the Supplementary Material specifically strike an appropriate 
balance between a principles-based approach and providing more 
prescriptive guidance to dealers in cases where there are limited 
quotations or pricing information. The proposed rule would allow a 
dealer to determine how it will use reasonable diligence, and paragraph 
.06 requires written policies and procedures that address how the 
dealer will make its best-execution determinations in case of limited 
quotations or pricing information. In any event, the FINRA rule, with 
which the MSRB has endeavored to harmonize (as appropriate), does not 
contain further prescriptions than proposed Rule G-18 in this area. 
Paragraph .03 of the Supplementary Material of the FINRA rule simply 
reiterates to FINRA member firms that in the case of limited 
quotations, firms are not relieved from taking reasonable steps to 
achieve best execution of customer orders. The MSRB does not believe 
that including such language would materially add to proposed Rule G-
18, which already contains the core requirement that dealers use 
reasonable diligence and is tailored to the characteristics of the 
municipal securities market.
Define or Clarify Certain Terms
    IDC and BDA stated that dealers would benefit from a definition of 
``similar securities'' as used in proposed Rule G-18(a)(4). IDC stated 
that this new factor is notable and distinguishable from FINRA Rule 
5310. BDA stated that the term is not clear, could be misunderstood in 
examinations and noted that given the wide array of factors that could 
be weighed to determine what constitutes a ``similar'' security such as 
geographical region, credit type and quality, terms and conditions and 
maturity, the MSRB should include a definition in the rule that should 
incorporate, as an overriding factor, the judgment of the dealer in 
determining the factors that are most relevant in determining whether a 
given security is similar.
    IDC recommended that the MSRB provide dealers with additional 
clarity regarding the use of evaluated pricing in support of best 
execution compliance and specifically include in the rule a non-
exhaustive list of examples of acceptable sources of pricing 
information or other data which might include recent trade activity, 
evaluated pricing and related, relevant market, assumptive and 
reference data. IDC stated that ambiguous interpretations of rules 
create higher compliance costs and other operational complexity.
    SIFMA recommended that the MSRB provide additional information and 
guidance related to compliance issues and specifically how a dealer 
should demonstrate best execution ``reasonable diligence'' compliance 
versus current fair-dealing compliance. Wells Fargo stated that the 
MSRB needs to elaborate on the steps needed to evidence how reasonable 
diligence can be demonstrated. Several questions were posed by Wells 
Fargo to illustrate the point. What does it mean to have ``limited 
pricing information or quotations?'' What constitutes ``adequate 
resources'' and how does a

[[Page 53245]]

firm establish that it has the appropriate level of resources? What are 
the acceptable ``other sources'' of pricing information? Wells Fargo 
also requested that the MSRB delineate how diligence obligations may 
differ when effecting customer purchases versus customer sales of 
municipal securities and additional guidance to illustrate how dealers 
can identify trades that require more time to show reasonable 
diligence. RBI requested guidance as to how to demonstrate compliance 
given that the MSRB doesn't provide a guideline for dealers to use to 
support the basis for determining the ``correct or proper'' price given 
the issues with using prices reported to the Electronic Municipal 
Market Access (``EMMA''[supreg]) system. BDA requested guidance 
relating to sales out of, or into, dealer inventory.
    The MSRB believes that proposed Rule G-18 strikes an appropriate 
balance between a principles-based approach and providing greater 
prescriptions. Proposed Rule G-18 embodies the broad principle that 
dealers must use reasonable diligence in executing customer 
transactions. It is designed to allow flexibility for each dealer to 
adapt its policies and procedures to be reasonably related to the 
nature of its business, including its level of sales and trading 
activity and the type of customer transactions at issue. The reasonable 
diligence standard is sufficiently flexible to be met by a diverse 
population of dealers and allows a dealer to evidence that it has been 
sufficiently diligent in a manner that may be different from that used 
by another dealer. Notably, some commenters contend that the guidance 
regarding similar securities and other information that is included 
should not be included in the rule (e.g., Coastal), whereas others 
contend that more guidance should be provided (e.g., BDA, IDC).
    The proposed rule change, therefore, does not include a definition 
of ``similar securities,'' provide examples of acceptable sources of 
pricing information or data, or further elaborate on how dealers would 
evidence reasonable diligence. Doing so could negate the benefits of a 
principles-based rulemaking approach. While the MSRB understands the 
desire on the part of dealers for concrete steps to follow for their 
particular business model, such a prescriptive rule might undermine the 
flexibility the rule is designed to provide. The MSRB may, however, 
consider providing additional guidance on this and other matters 
related to the proposed rule at a future date. Finally, the proposed 
rule also does not define ``prevailing market conditions.'' This phrase 
is used in the MSRB's fair-pricing rules and guidance, and is used in 
FINRA Rule 5310 without elaboration.
Number of Markets Checked
    SIFMA and Wulff objected to the suggestion that the act of 
contacting other dealers would be the implicit or requisite procedure 
to evidence best execution because making an inquiry could move the 
market away from the customer.
    In proposed Rule G-18, the reasonable diligence factor on the 
number of markets checked is only one factor in a non-exhaustive list 
of factors to be considered, ``with no single factor being 
determinative.'' Depending on the particular facts and circumstances, 
it could be consistent with the reasonable-diligence standard for a 
dealer not to contact other dealers. It, however, would be important, 
given the proposed rule's emphasis on complying with sound procedures, 
for a dealer to have written procedures in place that address the 
subjects of when and on what basis it would not contact other dealers. 
The MSRB believes, for these reasons, that this factor should not be 
deleted from the non-exhaustive list. Its inclusion does not compel a 
dealer to contact other dealers in cases where the executing dealer has 
reasonably concluded that such activity would be detrimental to the 
customer, or otherwise would not be part of ``reasonable diligence'' to 
ascertain the best market.
Information Reviewed To Determine Current Market for Similar Securities
    Coastal stated that the MSRB has unnecessarily increased the 
obligations of a dealer beyond that required of a dealer in corporate 
securities by requiring a dealer to utilize the market of an undefined 
``similar security'' to determine the market price of the subject 
security.
    In proposed Rule G-18, the reasonable-diligence factor on the 
information reviewed to determine the current market for the subject 
security or similar securities was included to tailor the rule to the 
municipal securities market. This factor helps guide the use of 
reasonable diligence when, for example, there are no available 
quotations for a security. It also takes into account that dealers may 
use information about similar securities and other reasonably relevant 
information.
Best-Execution Standard
    NYSE suggested that the rule provide that a dealer has not 
satisfied its best-execution obligation if it ignores a superior price 
available on another ``market'' (as defined in the rule) that offers 
fair access, transparent pricing and firm electronic quotes.
    The suggested change would go beyond a best-execution standard and 
create, in effect, a trade-through rule. Proposed Rule G-18 embodies a 
broad and flexible principles-based standard, using a non-exhaustive 
list of relevant factors with no single factor being determinative. The 
suggested change would instead focus on a short, exhaustive list of 
factors and make them determinative. Under the broad standard in the 
proposed rule, the existence of such a market, assuming under all of 
the circumstances that it is one about which a dealer reasonably should 
know, would inform a dealer's development of its procedures and 
periodic review of them under Paragraph .08 of the Supplementary 
Material. A failure to consider such a market, however, would not 
necessarily constitute violation of the proposed rule.
Economic Analysis
    SIFMA recommended that the MSRB should separately issue a request 
for data and other information, in particular quantitative data, 
relating to the benefits and costs that could result from the various 
alternative approaches regarding the standards of conduct and other 
obligations relating to the rule proposal. SIFMA specifically suggested 
that data be requested for the costs of developing and maintaining a 
comprehensive compliance and supervisory system, the costs of 
developing procedures and training programs to implement the new 
standard, as well the costs for updates when regulatory guidance is 
updated, or legal precedent and/or firm practices change. In addition, 
SIFMA asked that data be requested for the cost components for 
developing, preparing, and maintaining a comprehensive compliance and 
supervisory system including outside legal costs, outside compliance 
consultant costs, other out-of-pocket costs, and employee or staff 
related costs. SIFMA offered to work with the MSRB to obtain reliable 
empirical data and stated that such data cannot be obtained in the 
tight timeframe of a request for comment deadline.
    In addition, SIFMA stated that the proper baseline for comparing 
and evaluating the costs and benefits of the proposal are the current 
Rule G-18 (as of the date of SIFMA's letter) as well as the ``execution 
with diligence'' proposal that SIFMA suggested as a reasonable 
alternative.

[[Page 53246]]

    The Request for Comment incorporated the MSRB's preliminary 
economic analysis of the proposed rule change and specifically invited 
comment on the likely economic consequences of the adoption of the rule 
changes.\34\ The Request for Comment further invited commenters to 
provide statistical, empirical, and other data that may support 
commenter views and/or support or refute the views and assumptions in 
the Request for Comment.\35\ Given those requests, the MSRB expected 
that interested persons would submit any empirical data they wished to 
submit as part of the official rulemaking process. Although the comment 
period for the MSRB's Request for Comment has closed, the MSRB welcomes 
SIFMA's offer to provide the MSRB reliable empirical data. The MSRB 
believes that such data, whenever it is available, can be useful for 
considering whether additional modifications to any proposed rule or 
any adopted rule are warranted. With respect to the proposed rule 
change currently under consideration, the MSRB notes that SIFMA 
proposed a highly similar order-handling rule and it has not been shown 
that the costs of proposed Rule G-18 would be significantly greater 
than the costs of SIFMA's proposal.
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    \34\ On September 26, 2013, the MSRB publicly announced its 
adoption of a policy to more formally integrate the use of economic 
analysis in MSRB rulemaking. By its terms, the policy does not apply 
to rulemaking initiatives, like this initiative, that were initially 
presented to the MSRB Board of Directors before September 26, 2013. 
The MSRB has, however, historically taken account of the likely 
costs and burdens of its rulemaking initiatives, including those 
associated with the proposed rule change.
    \35\ The Concept Proposal, published August 6, 2013, also 
specifically invited commenters to provide statistical, empirical, 
and other data that may support commenter views and assumptions.
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    With respect to the proper baseline, the MSRB regards the current 
consolidated Rule G-30 (which now contains the substance of the former 
Rule G-18) as one relevant baseline to compare and evaluate the costs 
and benefits of the proposal, as noted in its preliminary economic 
analysis. In addition, the MSRB has considered SIFMA's reasonable 
diligence proposal as a reasonable alternative to the proposed rule and 
the proposed rule captures many elements of the SIFMA proposal. As 
noted, it has not been shown that the costs of proposed Rule G-18 would 
be significantly greater than the costs of SIFMA's proposal.
Compliance Burden on Small Dealers
    NYC requested that the MSRB consider the potential burden 
additional compliance could place on small dealers in particular and 
stated that regulations are often criticized for taking a costly one-
size-fits-all approach. NYC suggested that draft Rule G-18 should 
maintain elements of flexibility in its policies and procedures in 
order to reduce compliance costs and allow continued diversity of 
dealer characteristics.
    The MSRB agrees that flexibility and responsiveness to the 
diversity of dealer characteristics is important to retain in the 
proposed rule. For example, the requirements regarding the level of 
adequate resources and the frequency of reviews of the dealer's 
policies and procedures provide for consideration of the nature of the 
dealer's municipal securities business, including its level of sales 
and trading activity.
Costs of Compliance
    IDC, a financial information provider, stated that compliance with 
the proposed rule may result in higher costs and other operational 
complexities related to ambiguous interpretations of the rule. IDC 
stated that by specifying that evaluated pricing can help inform best 
execution assessments, dealers would be better positioned to determine 
the potential scope and cost of any changes to their existing 
compliance workflows.
    The MSRB continues to believe that the flexible and principles-
based approach followed in proposed Rule G-18 has advantages and 
permits a dealer (rather than the MSRB) to use its judgment, so long as 
it is reasonable, to determine whether its policies and procedures will 
include the use of a high quality evaluated pricing tool as its source 
of pricing information. This allows each dealer to make a 
determination, so long as it is reasonable, whether the cost of 
evaluated pricing services should be borne by it or whether there are 
any less costly alternatives that would better serve its purposes.
Dealer Sales of Securities Out of Inventory
    Coastal stated that a major flaw in the proposal is that the rule 
does not address a situation where a dealer is offering a unique 
security out of inventory. Coastal believed that a significant 
challenge is presented when no other dealers are willing to make a bona 
fide offering to sell a municipal security with the full realization 
that they would be creating a potentially unfillable short position. 
Further, the price at which a dealer offers municipal inventory when 
compared to other allegedly similar securities certainly should be a 
regulatory pricing issue, not an execution issue. Coastal stated, 
nevertheless, that the proposal might adequately address the situation 
where the client owns a security that the client wishes to sell.
    As stated above in the responses to other commenters, the MSRB 
believes that proposed Rule G-18 strikes an appropriate balance between 
a principles-based approach and providing greater prescriptions. The 
proposed rule allows flexibility for each dealer to adapt its 
reasonably designed policies and procedures to take account of the 
nature of its business and the type of customer transactions at issue. 
Proposed Rule G-18, by its flexible nature, expressly contemplates that 
an executing dealer acting in a principal capacity may be the best 
market for the subject security.
Implementation Period
    SIFMA requested an implementation period of no less than one year 
from approval by the Commission.
    The MSRB agrees with the comment and has requested Commission 
approval of the proposed rule change with an implementation date one 
year after Commission approval. This timeframe should provide 
sufficient time for dealers to develop or modify their policies and 
procedures and to acquire or adjust the level of their resources as 
necessary.

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.
    As noted above, to qualify as an SMMP under existing Rule D-15, the 
customer must affirm that it is exercising independent judgment in 
evaluating the recommendations of the dealer. The proposed amendments 
to the SMMP definition in Rule D-15, in conjunction with the proposed

[[Page 53247]]

amendments to Rule G-48, generally reflect a unified approach to SMMP 
status, which would require additional affirmations by the customer 
regarding the customer's sophistication on certain matters to qualify 
for SMMP status and which would result in exemptions from certain 
associated MSRB rules for dealer transactions with SMMPs. Relevant to 
the proposed best execution obligation for dealers, the proposed 
amendments to the SMMP definition would require an additional 
affirmation by the customer that the customer is exercising independent 
judgment in evaluating the quality of the dealer's execution of the 
customer's transactions in order for the customer to qualify for SMMP 
status and the proposed amendments to Rule G-48 would provide an 
exemption from a dealer's best execution obligation to customers for 
transactions with SMMPs. The Commission requests comment on the 
proposed unified approach to SMMP status, including the particular 
context of the proposed best execution obligations for dealers. The 
Commission requests comment on whether or not there are circumstances 
in which an otherwise-eligible SMMP may prefer to affirm that it is 
exercising independent judgment in evaluating the recommendations of a 
dealer and not be covered by the protections of the dealer's obligation 
to conduct a customer-specific suitability analysis, but not to affirm 
that it is exercising independent judgment with respect to the dealer's 
quality of execution of the SMMP's transactions and remain protected by 
the proposed best execution obligation imposed on dealers. Commenters 
also are invited to provide comments regarding the required customer 
affirmations generally under the SMMP definition.
    Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-MSRB-2014-07 on the subject line.

Paper Comments

     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-2014-07. This file 
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 Web site (http://www.sec.gov/rules/sro.shtml). 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 Web site 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; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-MSRB-2014-07 and should be 
submitted on or before September 29, 2014.

    For the Commission, pursuant to delegated authority.\36\
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    \36\ 17 CFR Sec.  200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-21249 Filed 9-5-14; 8:45 am]
BILLING CODE 8011-01-P


