Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the Municipal Securities Rulemaking Board Relating to Reports of Sales or Purchases, and Procedures for Reporting Inter-dealer Transactions Pursuant to Rule G-14

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34458; File No. SR-MSRB-94-9]

Self-Regulatory Organizations; Notice of Filing of Proposed Rule

Change by the Municipal Securities Rulemaking Board Relating to Reports

of Sales or Purchases, and Procedures for Reporting Inter-dealer

Transactions Pursuant to Rule G-14

July 28, 1994.

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934

(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on June 20,

1994, the Municipal Securities Rulemaking Board (``Board'' or ``MSRB'')

filed with the Securities and Exchange Commission (``Commission'' or

``SEC'') a proposed rule change (File No. SR-MSRB-94-9). The proposed

rule change is described in Items I, II, and III below, which Items

have been prepared by the Board. The Commission is publishing this

notice to solicit comments on the proposed rule change from interested

persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance

of the Proposed Rule Change

The Board is filing a proposal to amend Board rule G-14, concerning

reports of sales or purchases, and procedures for reporting inter-

dealer transactions (hereafter collectively referred to as ``the

proposed rule change'').\1\ The proposed rule change states that it is

the duty of brokers, dealers and municipal securities dealers to report

transactions in municipal securities to the Board or its designee, and

describes procedures for reporting.

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\1\The Commission notes that the MSRB intends to enact the

proposed rule change, in its entirely, as a temporary pilot program

to be in place for a minimum of one year. Telephone conversation

between Larry M. Lawrence, Policy and Technology Advisor, MSRB, and

Betsy Prout, Staff Attorney, Commission, on July 27, 1994.

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II. Self-Regulatory Organization's Statement of the Terms of Substance

of the Proposed Rule Change

In its filing with the Commission, the Board included statements

concerning the purpose of and basis for the proposed rule change and

discussed any comments it received on the proposed rule change. The

texts of these statements may be examined at the places specified in

Item IV below. The Board has prepared summaries, set forth in Section

(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

(a) Purpose

The purpose of the proposed rule change is to achieve a certain

degree of transparency in the municipal securities market in a cost-

effective manner by collecting and disseminating information on inter-

dealer transactions. Under the proposed rule change, aggregate data

about market activity and certain volume and price information about

frequently traded securities would be disseminated to promote investor

confidence in the market and its pricing mechanisms. In addition, all

transaction information collected would be made available to regulatory

agencies responsible for enforcement of Board rules as a means to

assist in the inspection for compliance with, and the enforcement of,

Board rules.

The proposed rule change is a first step to increase transparency

in the municipal securities market. After gaining experience with the

collection and dissemination of inter-dealer transactions, the Board's

future steps would include adding institutional and retail customer

information, and moving toward the ultimate goal of making available

transaction information that is both comprehensive and contemporaneous.

Background. The municipal securities market has grown dramatically

in recent years. At the same time, retail investors have entered the

market in increasing numbers. These factors have increased the need for

access to information on municipal securities trading in the market,

including information which may help to establish more accurate

valuation of individual municipal securities.\2\ Recognizing this need,

the Board has adopted long-term goals and priorities for action, among

which is the goal of providing market participants with more

information about the value of securities.\3\

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\2\For a more general discussion of the evolution of the

municipal securities market, see MSRB, Report of the Municipal

Securities Rulemaking Board on Regulation of the Municipal

Securities Market (September 1993), at 19-27.

\3\See, e.g., ``From the Chairman,'' MSRB Reports, Vol. 8, No. 5

(December 1988), at 2.

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Similarly, the staff of the Division of Market Regulation of the

Commission has stated:

The Staff believes that the degree of transparency in the

municipal securities market is not adequate, and should be increased

to better inform investors in their dealings with broker-dealers and

to make the market more efficient.\4\

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\4\SEC, Division of Market Regulation, Staff Report on the

Municipal Securities Market (September 1993) (``Staff Report''), at

36.

In the equities markets, quotations, trade prices and volumes are

reported publicly for all securities listed on the exchanges and in the

National Association of Securities Dealers Automated Quotation

(``Nasdaq'') System. The Commission has noted at least three benefits

to the equities markets from transparency: enhanced investor

protection, market liquidity, and market efficiency.\5\ The Board

believes that these same benefits would be desirable in the municipal

securities market.

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\5\SEC, Division of Market Regulation, Market 2000: An

Examination of Current Equity Market Developments (January 1994), at

IV-2.

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The Pilot Program for Transaction Reporting. In 1993, the Board

announced its plan to undertake a pilot program to collect and publish

information on transactions occurring in the inter-dealer market for

municipal securities (the ``pilot program''). The Board has designed

the pilot program to take into account the distinctive aspects of the

municipal securities market that distinguish it from the exchange-

listed and Nasdaq markets. A primary distinguishing characteristic of

the municipal securities market is the large number of outstanding

issues. There are approximately 1.2 million municipal securities that

are distinct, non-fungible entities for purposes of trading and

reporting. In addition, the municipal securities market lacks any core

group of issues that trade frequently and consistently over sustained

periods of time. While, on any given day, a certain number of municipal

securities are traded frequently, the identity of these frequently

traded issues is continually changing over time. A third distinguishing

characteristic is that, in the municipal securities market, most issues

are purchased by ``buy and hold'' investors relatively quickly after

initial issuance. When frequent trading does occur in an issue, it

generally occurs immediately after issuance and then subsides within a

week to 10 days.\6\

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\6\The Board has examined inter-dealer trading data provided by

the National Securities Clearing Corporation (``NSCC'') for a six-

month period during 1991. During this six-month period, only 40

issues traded three or more times per day for a minimum of 10

consecutive business days. It is important to note that these 40

issues did not trade frequently for the entire six-month period and

that, on any given day, only a few of the 40 would be trading

frequently. In most cases, frequent trading in these issues--

primarily new issues--tended to trail off shortly after a 10-day

run. Altogether, approximately 75 percent of all issues trading

during the six-month period were traded only once or twice in a

given week.

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In the markets covered by Nasdaq and the National Association of

Securities Dealer's (``NASD's'') recently inaugurated Fixed Income

Pricing System (``FIPS'') for high-yield fixed-income corporate

securities,\7\ displays of data about a security are organized based on

firm quotations. The Board believes that a different concept is needed

for municipal securities, since firm two-sided quotations exist only

for very few municipal securities at any given time. There are several

reasons for this. For most municipal securities, there is only a small

``float'' of securities available to be the subject of trading. This

small ``float'' is a primary disincentive to market making. In

addition, the tax treatment of borrowing tax-exempt securities (along

with the small floats) effectively prevents short-sales of an issue.

This denies potential market makers a technique that otherwise could be

used to manage risks. Finally, the traditional ``buy and hold''

philosophy of most tax-exempt purchasers simply does to provide the

incentive or create the need for continuous, two-sided quotations

traditionally offered by market makers in equity securities.

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\7\See Securities Exchange Act Release No. 32019 (March 19,

1993), 58 FR 12428.

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The Board has designed the transaction reporting pilot program to

provide the public with price and volume information in a way that

reflects the unique aspects of the municipal securities market. The

pilot program will make information available in the form of a daily,

public report containing volume and pricing information for the inter-

dealer market (``daily report''). The issues that will be reported

individually each day will be those that traded at or above a threshold

number of times on the previous business day. Initially the threshold

will be four trades per day. As trading in an issue increases, it will

be reported; as an issue's trading frequency decreases, it will be

replaced by others that are trading frequently. In this way, the daily

report will reflect the ever-changing pattern of trading activity in

the universe of some 1.2 million municipal securities. The pilot

program will make information on all inter-dealer trades in municipal

securities available to the Commission and other regulatory agencies to

assist in the inspection for compliance with and the enforcement of

Board rules.

Requirement to Report. There is currently no affirmative

requirement for public reporting of transactions in municipal

securities. In its present form, the Board's rule G-14 does not require

the reporting of transactions in municipal securities, but does require

that any such report represent a legitimate trade. The rule requires a

dealer that distributes or publishes a report of a transaction in a

municipal security to know or have reason to believe that the

transaction was actually effected and to have no reason to believe that

the transaction was fictitious or in furtherance of any fraudulent,

misleading or deceptive purpose.

The proposed rule change would impose a duty upon dealers to report

inter-dealer transaction information to the Board or its designee. It

states that such information would be used to make public reports and

would be provided to the Commission, the NASD, and bank regulatory

organizations charged with enforcing Board rules, i.e., the Comptroller

of the Currency in the case of national banks, the Board of Governors

of the Federal Reserve System in the case of state member banks of the

Federal Reserve System, and the Federal Deposit Insurance Corporation

(``FDIC'') in the case of other banks insured by the FDIC.

Reporting Procedures. Brokers, dealers and municipal securities

dealers would report transactions under Rule G-14 Transaction Reporting

Procedures, which are also part of the proposed rule change. The

transaction reporting procedures designate the NSCC as the Board's

agent to receive transaction information. NSCC is a clearing agency

registered with the Commission under Section 17A of the Act and is the

central facility for automated comparison processing for inter-dealer

municipal securities transactions. Automated comparison is the process

by which each party to an inter-dealer trade ensures that its contra-

party knows the terms of the trade and will be ready to settle, on

those terms, on settlement date. In general, the automated comparison

process requires each dealer in a transaction to submit information on

a trade (e.g., price, quantity, contra-party) to a comparison system

operated by a clearing agency registered with the Commission. This

information is then matched (``compared'') by computer in the

comparison system and the results reported back to each dealer.

Currently, pursuant to the Board's rule G-12(f)(i), dealers must

use the facilities of a registered clearing agency to compare all

inter-dealer transactions in securities with CUSIP numbers. Since NSCC

and all other registered clearing agencies offering municipal

securities comparison services are linked by automated interfaces, it

will be possible for transactions to be submitted to NSCC by submitting

them to any such clearing agency. Accordingly, the proposed procedures

state that dealers may provide transaction information to NSCC or any

other registered clearing agency linked with NSCC for the purpose of

automated comparison. Dealers may submit transaction information

directly or through an agent that is a member of the registered

clearing agency.\8\ Thus, under the proposed rule change, dealers would

not be required to submit transaction data to a separate reporting

system and should not incur additional operational costs to fulfill

their reporting obligations.

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\8\These are the same procedures currently used to submit

information for automated comparison.

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With one exception, NSCC automated comparison procedures require

both the purchasing and selling dealers to submit information about the

trade. Thus, the proposed reporting procedures require transaction

information to be submitted by both parties. For transactions involving

the distribution of new issue securities from a syndicate manager to

syndicate members, however, NSCC comparison procedures require only a

submission from the syndicate manager. The proposed procedures allow

for the same ``one-sided'' submission of information for public

reporting.

The comparison process requires various data elements to be

submitted with regard to each transaction. The proposed transaction

reporting program makes an identical requirement for these data items.

The following transaction information will be collected by the Board

through NSCC:

Identification of seller

Identification of buyer

Trade date

CUSIP number of security traded

Trade type (e.g., syndicate takedown, new issue or regular way)

Par value (quantity) traded

Price, in one of the following formats:

Dollar price of security

``Final money'' (total dollar amount of the transaction)

Yield or basis of concession, if any

Settlement date, if not ``regular way''

As noted above, dealers already are required to provide this

information to a registered clearing agency as part of the automated

comparison process required under rule G-12(f)(i). Currently, the

accrued interest is an optional data element for the purpose of the

automated comparison process, ie., it can be submitted, but is not

required to match or compare a transaction. However, accrued interest

will be a mandatory submission for the purpose of transaction reporting

pursuant to the Rule G-14 Transaction Reporting Procedures. This

requirement is necessary for accurate computation of dollar price in

certain circumstances (see ``Price Computation,'' infra).

Timing. In the current comparison cycle, dealers submit required

information to a registered clearing agency by the evening of trade

date (``T''). NSCC, as the central facilities provider for the

comparison system, accepts this submitted data, compares the

submissions of the parties on the night of T and reports the results

back to the dealers on T+1. Trades that are successfully compared on T

will be the basis of the daily report produced by the Board's proposed

program. Accordingly, trades that are not successfully compared on the

night of the trade will not be subject to reporting on T+1.\9\ As an

indication of the reliability of the data in the daily report, the

percentage of submissions that were successfully compared (``comparison

rate'') will be shown in each day's report.\10\

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\9\It was determined to use data for compared trades rather than

data for both compared and uncompared trades because the compared

data is more reliable than uncompared data. If uncompared data were

reported, this might cause the daily report to include erroneous

prices or to include duplicate trades. Uncompared submissions

eventually are resolved as trades or as mistakes. Those that are

resolved as trades will be entered in the transaction reporting

database after T+1 and thus will be made available to the

enforcement agencies.

\10\ The Board has previously stated its concern about the need

to increase the comparison rate to obtain improvements as a

prerequisite to implementing T+3 settlement for municipal

securities.

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The Daily Report. The daily report will be provided to subscribers

for public use by approximately 6:00 a.m. on T+1. This will make the

data available prior to the beginning of trading activity. The daily

report will be available both as a computer-readable file and as a

printed report. The computer-readable file will be electronically

disseminated by an automated interface between Board computers and

those of subscribers or by magnetic tape delivered by a courier

service.

The Daily Report. The daily report will include aggregate

information for each day of trade, as follows:

(i) Total par value traded;

(ii) Total number of compared transactions; and

(iii) Total number of issues traded (i.e., the number of different

CUSIP numbers that were involved in compared transactions on that day).

In addition to the aggregate data, the daily report will contain

price and volume information about certain municipal securities that

were ``frequently traded'' on that day. The Board believes that it

would be appropriate to report issue-specific information only if four

or more transactions in the issue are reported as compared on a given

day. Using this threshold and based on recent levels of market

activity, the Board anticipates that the daily list of frequently

traded issues normally will range between 80 to 350 issues, with an

average of about 180 issues each day. The size and composition of the

list obviously would vary from day to day, depending upon market

activity in specific cases.

The information in the daily report about each ``frequently

traded'' security will include:

(i) The CUSIP number and security's description;

(ii) The total number of transactions in the security and total

volume traded;

(iii) The highest and lowest prices of transactions in the

security; and

(iv) ``Average price'' information, i.e., the number of

transactions in the security involving par values between $100,000 and

$1,000,000 inclusive, and the average price of those transactions.

The Board will provide a statement to be included in the report

pointing out that (a) the daily report represents only those inter-

dealer transactions that have been submitted for comparison and that

actually were compared on the previous day and (b) reported prices are

affected by various factors such as transaction size. This statement is

intended to ensure that readers unfamiliar with the municipal

securities market do not misinterpret the daily report.

Price Computation. Municipal securities transactions are sometimes

executed on a dollar price basis and sometimes executed on a yield

basis. The Board has chosen to use dollar price as the uniform

expression of ``price'' in the daily report to simplify reporting

procedures. In cases where dollar price is submitted for comparison,

that dollar price, as compared by the comparison system, will be used

in the daily report. In certain cases the security ``price'' for the

daily report will need to be computed from other submitted data. For

example, current procedures required for automated comparison allow the

submission of par value and ``final money'' (total dollar amount of the

transaction) to achieve comparison. The proposed Rule G-14 Transaction

Reporting Procedures provide that the dealers will submit the amount of

accrued interest in the trade to allow for computation of dollar price

in these cases. The following formula will be used:

Dollar price = (Final money--Accrued interest) / Par value

For ``when, as if issued'' trades submitted for comparison on a

yield basis, final money will be computed and a dollar price similarly

derived if a settlement date is known. For yield transactions whose

settlement date is not known, an assumed settlement date will be used.

The assumed settlement date will be 20 business days from the first

trade date on which that issue is submitted for comparison. On the

daily report, a note will be added to the trade information stating

that an assumed settlement date was used to compute the dollar price in

the trade and showing the date used. Once the actual settlement date is

known to NSCC, it will be used and noted as such when the issue is next

included on a daily report.

Fees and Costs. Subscription fees, estimated production costs for

the daily report, and further technical details of the pilot program

will be provided in a subsequent filing prior to beginning operation of

the facility.

Surveillance and Enforcement Uses of Pilot Program Information. In

addition to public reporting, the proposed rule change would make

transaction data available to the regulatory organizations charged with

enforcing Board rules. Commenting on the need for better information in

this area, the Commission's staff stated:

In the Staff's view, a central flaw in the present regulatory

system is the lack of an integrated audit trail in the municipal

securities market of the type that exists in the stock and options

markets. Because of the limited pricing information available in the

secondary market for many thinly traded municipal securities, it is

extremely difficult for the NASD to assess the fairness of the

prices being charged retail customers by municipal securities

broker-dealers. The Staff believes that the MSRB, the NASD, and the

banking agencies should work to create a cost-effective trade

reporting system that will provide the regulators with an integrated

audit trail of municipal securities and result in improved

surveillance for all segments of the market. The development of such

an audit trail would increase the NASD's ability to examine and

enforce the existing customer protection rules of the Commission and

the NASD.\11\

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\11\Staff Report, supra note 4, and 37.

The transaction reporting pilot program will result in a

centralized data base of trade information that is expected to improve

the efficiency and effectiveness of inspection for compliance with and

the enforcement of Board rules. All compared trades will be made

available to these regulatory organizations, including those that

compare after trade date and those not frequently traded. Comprehensive

information will be made available, including identification of parties

to each trade and the prices of all securities traded.

The information to be made available through the pilot program will

enable enforcement agencies to identify transaction patterns to detect

market manipulation and other anomalies. It will also assist regulators

in determining the market value of securities as they assess compliance

with the Board's rule G-30 on fair and reasonable prices and

commissions. The Board is working with the NASD and the bank regulatory

organizations to ensure that the pilot system's outputs will meet their

requirements for surveillance of the municipal securities market and

enforcement of the Board's rules.

The Board plans to evaluate expansion of the pilot program as

experience is gained and comments on program operations are received

from information users and the industry. The Board's first

consideration will be how the daily report and surveillance mechanisms

could be improved by including institutional customer transaction data

and information on the time of trade. During this evaluation, the

Board's goal will be not only to enhance the information contained in

the daily report, but also to find cost-effective methods for providing

even greater levels of transparency to the market, particularly with

respect to customer transactions and the dissemination of transaction

price information on a more contemporaneous basis.

Effect of Proposed Rule Change upon Dealers. Dealers should

experience minimal operational impact from the proposed rule change,

since, as mentioned above, they are now required, pursuant to the

Board's rule G-12(f)(i), to use the facilities of a registered clearing

agency for the automated comparison of transactions. The transaction

data submitted by dealers for comparison will be used by the

transaction reporting pilot program. Thus, under the proposed program,

dealers would not have to submit transaction data to a separate

reporting system and should not incur additional operational costs.

(b) Statutory Basis

The Board believes the proposed rule change is consistent with

Section 15B(b)(2)(C) of the Act, which requires, in pertinent part,

that the Board's rules be designed:

* * * to remove impediments to and perfect the mechanism of a free

and open market in municipal securities, and, in general, to protect

investors and the public interest * * *.

The transaction reporting pilot program will make it possible to

provide pricing reports to all market participants and to the public.

The availability of this information is expected to support market

integrity, increase investor confidence, improve pricing efficiency and

increase liquidity in the market.

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

The Board does not believe that the proposed rule change will

impose any burden on competition not necessary or appropriate in

furtherance of the purpose of the Act, since it would apply equally to

all brokers, dealers and municipal securities dealers.

C. Self-Regulatory Organization's Statement on Comments on the Proposed

Rule Change Received From Members, Participants, or Others

In May 1993 the Board published a notice explaining its plan to

collect inter-dealer transaction data by using information required for

automated comparison, clearance and settlement. The notice set forth

the proposed method of collection inter-dealer transaction data and of

publishing it. The Board received four comments of which two supported

the proposed pilot program and made suggestions for expansion. The

remaining two commenters suggested certain modifications of the daily

report format and the selection criteria for reported issues without

expressing general support or opposition.

Sample Format for Daily Report. One commenter noted that the

reporting of transaction data by the Board should include a statement

stating that prices change with market conditions and that prices for

individual transactions may depend upon factors such as size of

transaction, interest rate, maturity date, and call features. Another

commenter stated that the daily report should note that the data

represents transactions that have been submitted for comparison. The

Board agrees that statements similar to those requested by the

commenters should be included on or with the daily reports to help

clarify the meaning of the data to the general public and has decided

to include such statements on the daily report. The Board also plans to

ask recipients of the daily report who intend to publish it for a

general audience also to include such statements in their publications.

Average Price Calculation. One commenter suggested widening the

band used for average price calculation to include more price

information. In contrast, another commenter suggested narrowing the

band to exclude some trades that might be considered ``odd lots''

(certain zero-coupon bond trades reported by NSCC on the basis of

maturity value).

The Board believes that it is appropriate to use the band from

$100,000 to $1 million for average price calculations for initial

production of the daily report. Once the program goes into operation

and feedback is received from data users, it will be possible to judge

how well the ``average price'' concept actually works in practice. As

experience is gained, the price band concept will be reviewed to

determine whether it is serving its intended purpose of indicating a

``typical'' inter-dealer market price. The pilot program's computer

system will be designed to enable the parameters of the price band to

be changed easily and quickly.

Compilations of Data. One commenter urged the Board to provide

compilations of transaction data (e.g., a month of data on a computer

disk) to facilitate study of the data by academics. The Board has

decided not to make such compilations available at the beginning of the

pilot program, but may do so in the future.

Information on Daily Reports. One commenter suggested that the

Board publish individual transaction data (CUSIP number, description,

par value, price) for each transaction, without regard to whether a

security is being frequently traded on a specific day. This commenter

believes that, by limiting reporting to individual maturities of an

issue that are trading frequently, the program would withhold

information that, in the aggregate, would be useful. For example, the

commenter believes that the general price levels for prerefunded

securities could be extracted from aggregate transaction data on

prerefunded securities, even when no one prerefunded security is

trading frequently.

The Board believes that reporting an isolated transaction in a

security does not necessarily provide a reliable indicator of ``market

price'' and might be misleading to an observer not familiar with the

market. Nevertheless, after the pilot program begins operation and

experience is obtained, the Board will review the use of the daily

report and consider expanding the information included to accommodate

requests from information users and the industry.

III. Date of Effectiveness of the Proposed Rule Change and Timing for

Commission Action

Within 35 days of the date of publication of this notice in the

Federal Register or within such longer period (i) as the Commission may

designate up to 90 days of such date if it finds such longer period to

be appropriate and publishes its reasons for so finding or (ii) as to

which the MSRB consents, the Commission will:

(A) By order approve such proposed rule change, or

(B) Institute proceedings to determine whether the proposed rule

change should be disapproved.

IV. Solicitation of Comments

Interested people are invited to submit written data, views, and

arguments concerning the foregoing. People making written submissions

should file six copies thereof with the Secretary, Securities and

Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549.

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 inspection and copying in the

Commission's Public Reference Room. Copies of the filing will also be

available for inspection and copying at the Board's principal offices.

All submissions should refer to File No. SR-MSRB-94-9 and should be

submitted by August 25, 1994.

For the Commission by the Division of Market Regulation,

pursuant to delegated authority, 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 94-19008 Filed 8-3-94; 8:45 am]

BILLING CODE 8010-01-M