MSRB to debate issuing more stringent suitability rule at next month's meeting.

MINNEAPOLIS -- The Municipal Securities Rulemaking Board will debate next month whether to push forward with tough new rules that would tighten the board's requirement that dealers sell only suitable bonds to customers.

"We are going to consider it at our next meeting" scheduled for July, MSRB member Alice Handy said Saturday during the Government Finance Officers Association's annual meeting that lasts through Wednesday.

But preliminary discussions among board members signal that it is going to be "very difficult to change our regulations in a way that's practical for brokers to sell bonds, period," said Handy, treasurer of the University of Virginia, who was asked for an update on the issue by Jeffrey Green, a member of the GFOA board.

Handy, who was speaking on a panel with two other MSRB members at a meeting of the GFOA's governmental debt and fiscal policy committee, was referring to a rule that the MSRB drafted last year. The measure was put on the back burner when SEC Chairman Arthur Levitt Jr. decided to have the Securities and Exchange Commission take the lead in developing new disclosure rules for municipals, which the SEC proposed on March 9.

The MSRB's shelved rule would have required a dealer to tell a customer in writing whether the issuer of the bonds has committed to providing ongoing disclosure for the issue. Dealers also would have to explain the effect that the lack of continuing disclosure may have on the customer's ability to get accurate price information on the bonds in the future and to find a ready market if they are sold before maturity, according to the MSRB plan.

The SEC, however, is now warming up to the MSRB issuing the rule because the board's rule would apply to the billions of dollars of outstanding municipal bonds that would not be covered by the SEC's March 9 rule. The March 9 rule would apply only to new issues.

The SEC's rule would bar dealers from recommending bonds to customers unless they have reviewed an issuer's financial statements. The rule also would bar dealers from underwriting bonds unless the issuer has pledged in writing to provide ongoing disclosure to a nationally recognized repository. Comments on the SEC proposals are due July 15.

The commission gave the MSRB the green light to begin looking at the board's dormant proposal in the interpretive release on disclosure responsibilities that was also issued on March 9.

The SEC said in the last paragraph of the release that a joint statement on disclosure published by a dozen industry groups in December called for a strengthening of the suitability rules to require disclosure of whether the issuer has committed to provide annual financial reports.

"The MSRB has indicated that it has under consideration a plan requiring municipal securities dealers to disclose to their customers the importance of secondary market information and whether the issuer has agreed to voluntarily provide such disclosures," the SEC said.

"The commission will defer to the MSRB's reexamination of its suitability rules in implementing those aspects of the joint statement," the SEC document said.

But the GFOA's Green said Saturday that the deferral may be the SEC's polite way of saying get it done now or else the commission will step in.

"The SEC threw the ball to the MSRB in terms of suitability," said Green, who is the general counsel of the Port Authority of New York and New Jersey. "That doesn't mean that they are not going to take it back," he said.

Meanwhile, Handy said the MSRB members were "talking in the last meeting a little bit about what the problems are for the issuers" if the board goes ahead with such a suitability rule. The discussions centered on "what kind of information do you give and whether or not you are going to be sued because information is lacking," Handy said.

"And then you can multiply that 10, 20, maybe 100-fold when you start to think about what the liability could potentially be on the broker-dealer side if they have an issue and they call it up on whatever the nationally recognized municipal securities information repository is and get the information from them," she said.

"In the 30 seconds when they are selling the bonds in the secondary market, they have to have read through all this information, digested it, decided if it were suitable for the person and disclosed all the important information," Handy said.

"It's and issue that the board and I are personally wrestling with. We have to assess how serious the problem is in terms of the remedy because the alternatives that are out there are really a problem," Handy said.

She said preliminary discussions have centered on what role the rating agencies would play if the MSRB tightened its suitability rule. "Is there something that can be done on that front that would take some of the burden off the broker-dealer community?" Handy asked.

"We have not come up yet with a good solution but we are planning to have a continuing discussion in this area about what would be the right direction to take," she said.

Also speaking on Saturday's panel were MSRB members Walter Knorr, comptroller of Chicago, and Robert Inzer, treasurer-clerk of Tallahassee, Fla.

Knorr shared with the GFOA his first reaction to the SEC's proposed rules and its interpretative release and signaled that the MSRB could raise some major concerns with the SEC's proposals when it files its comments in July.

"When I first read the release, I read it as a major issuer of municipal bonds," Knorr said. "I had a palpitation on the spot. My mind went to great wanderings as to the amount of information" to be provided that the SEC purposely left unspecified.

"I started to think about the airport. Twenty percent of the cash flow for the airport comes from an airline. I have to be on top of all the airline credits," he said.

"Then I think of all this information being dumped into the repository and about a market already accused of not being the most liquid. And then I think about a broker-dealer trying to retrieve all of this information before he can make a reasonable basis for a recommendation."

Is all of this "just going to end up making good issuers better and bad issuers worse?" Knorr asked. "Is it going to improve the situation? This is going to be a very enlightened discussion at the July meeting on this topic."

Knorr also wondered how much interpreting of the information a broker-dealer has to do in order to make a reasonable recommendation to a buyer. "What's timely? What's material? [Then there is] what I call the 11 helpful hints," Knorr said, referring to 11 events that the SEC said should be automatically disclosed.

"Do you eliminate some of them because they are either positive or they don't exist?" he asked.

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