Customer Notice Need Not Reveal GIC Investment, MSRB States

WASHINGTON -- The Municipal Securities Rulemaking Board recently said that dealers do not have to disclose in customer confirmations whether bond proceeds are invested in guaranteed investment contracts.

The board stated the position in a letter of interpretation to an undisclosed market participant, which will be published next week in the MSRB Reports. It comes in the wake of growing concern about the safety of GICs following the April placement of Executive Life Insurance Co., a California-based GIC provider, into conservatorship.

The brief letter, signed by MSRB General Counsel Diane Klinke, says that board rule G-15, which spells out what information should be included on customer confirmations to describe securities being sold, does not require disclosure of "the investment of bond proceeds."

Christopher Taylor, the board's executive director, said the interpretation was requested following a ruling earlier this year by an MSRB arbitration panel that held Merrill Lynch & Co. liable for $176,982 in losses resulting from bonds backed by Executive Life GICs that it sold in 1988 and 1989 to an Illinois bank.

Arbitrators concluded that the firm and one of its brokers told the bank the bonds were insured either by Municipal Bond Investors insurance Corp. or Financial Guaranty Insurance Co. when, in fact, they were not. They also found that Merrill Lynch and the broker, Robert Peele, failed to disclose that bond proceeds were invested in GICs issued by Executive Life.

The bank had charged the confirmation contained no reference to Executive Life or GICs. The panel did not address the question of whether the confirmation should have disclosed the contracts.

But the board said in its letter of interpretation this week that the confirmation is not the place to disclose a GIC. It warned, however, that board rule G-17 on fair dealing requires a dealer to disclose all material facts that could affect a customer's investment decision at the time of a trade's execution or before. The confirmation occurs within five business days of the trade date.

"Thus, if information on the investment of bond proceeds of a particular issue is a material fact, board rules require disclosure at the time of trade," says the MSRB letter.

Mr. Taylor said the GIC-confirmation question is on the mind of market participants because of the flurry of deals done in the mid-1980s. "People want to know if they did things right," said Mr. Taylor. "There's a fear of liability."

Richard Lehmann, president of the Miami-based Bond Investors Association, said the MSRB is on the right track with its interpretation.

"It makes perfectly good sense" not to tell the investors about the GIC on the confirmation, he said. Regardless of the Executive Life situation, investors may see that the deal is backed by a GIC and assume that their investment is guaranteed and, therefore, not read the official statement, he said.

"What you are really doing by [telling the customer about the GIC] is to give him more and more reasons not to look at the official statement," he said. "And you're setting a trap for the broker. In effect, if this is not in the confirmation, you have grounds to sue the broker. The broker should not be burdened by that type of thing. The customer has the responsibility to get a copy of the official statement and read it."

MSRB rule G-15 says that customer confirmations should have a description of the securities, including, at a minimum, the name of the issuer, the interest rate, maturity date, and an indication if the bonds are limited tax, callable, or revenue bonds.

The confirmation also should disclose, if it is material, "the name of any company or other person in addition to the issuer obligated, directly or indirectly, with respect to debt service."

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