Registered representatives have increasingly inquired about the application of certain MSRB rules to managed accounts in which a RIA is exercising discretion to buy and sell municipal securities on behalf of the account holder. Specifically, with respect to these transactions, they are expected to:
- Provide the time-of-trade disclosures required by MSRB Rule G-47 to the ultimate investor, who is the account holder (i.e., the RIA’s client), particularly if the dealer does not know the identity of the investor; and
- Obtain a customer affirmation from such an investor for purposes of qualifying the person, separately, as a SMMP under MSRB Rule D-15, and owing the modified obligations under MSRB Rule G-48, on transactions with SMMPs, if the RIA is itself an SMMP.
The principal rules relevant to these interpretive questions are Rules G-47, D-15, and G-48.
MSRB Rule G-47 – Time of Trade Disclosure
Rule G-47 sets forth the general time-of-trade disclosure obligations. Specifically, pursuant to Rule G-47, firms cannot sell municipal securities to a customer, or purchase municipal securities from a customer, without disclosing to the customer, at or prior to the time of trade, all material information known about the transaction and material information about the security that is reasonably accessible to the market.
MSRB Rule D-15 – Sophisticated Municipal Market Professional
Rule D-15 defines the set of customers that may be SMMPs as (1) a bank, savings and loan association, insurance company, or registered investment company; (2) an RIA; or (3) any other person or entity with total assets of at least $50 million. To qualify as a SMMP under the rule, firms must have a reasonable basis to believe the customer is capable of independently evaluating investment risks and market value, in general and with respect to particular transactions and investment strategies in municipal securities. In addition, the customer is required to affirm that it is exercising independent judgment in evaluating the quality of execution of the customer’s transactions. Further, the customer is required to affirm that it is exercising independent judgment in evaluating the transaction price in non-recommended agency secondary market transactions where the firm’s services are explicitly limited to providing anonymity, communication, order matching and/or clearance functions, and the firm does not exercise discretion as to how or when the transactions are executed.
MSRB Rule G-48 – Transactions with Sophisticated Municipal Market Professionals
Rule G-48 addresses modified obligations when dealing with SMMPs. It relieves firms of the time-of-trade disclosure obligation under Rule G-47 for information reasonably accessible to the market, the pricing obligations under MSRB Rule G-30 under certain circumstances, the customer-specific suitability obligation under MSRB Rule G-19, certain obligations with respect to the dissemination of quotations under MSRB Rule G-13, and the best-execution obligation under Rule G-18.
The rules referenced above, including Rule G-48 on certain modified obligations, are, or relate to the application of, various investor/customer protections. As such, a threshold approach to the interpretive questions is to focus on who the firm’s customer is, and, thus, to whom the firm owes these protections when an RIA has full discretion over investor clients’ accounts.
There are facts and circumstances under which the MSRB considers the RIA, and not the underlying investors, to be the firm’s customer. When an RIA purchases securities from one firm and instructs that firm to make delivery of the securities to other firms where the RIA’s clients have accounts, and the identities of individual account holders are not given to the delivering firm, the RIA is the customer and must be treated as such for recordkeeping and other regulatory purposes. Accordingly, in those scenarios, the dealer does not have any customer obligations to the underlying investors.
When an investor has granted an RIA full discretion to act on the investor’s behalf for all transactions in an account, the RIA has effectively become that investor for purposes of the application of Rule G-48 when engaging in transactions with the firm. Therefore, if that RIA is an SMMP, then, for purposes of complying with the rules addressed in Rule G-48, the firm should not be required to satisfy any greater or additional obligations with respect to the ultimate investor who holds that account.
This interpretation, under which firm obligations to certain investors would be modified, is supported by the existence of substantially similar federal and/or state obligations. For example, RIAs registered with the SEC are subject to the Investment Advisers Act of 1940 and the rules thereunder, including a fiduciary duty extending to all services undertaken on behalf of clients. Obligations flowing from the fiduciary duty, include, but are not limited to, the requirements to:
- Provide full disclosure of material facts, including conflicts of interest and disciplinary events and precarious financial condition;
- Give suitable advice;
- Have a reasonable basis for recommendations; and
- Meet best-execution obligations.
These and other investor protections provided by the regulatory regime under the Advisers Act reduce the need for the similar investor protections provided by time-of-trade disclosure, customer-specific suitability, best execution and the other obligations required by MSRB rules but modified under Rule G-48. Additionally, where an investor has affirmatively and in writing authorized the RIA to exercise full discretion in the investor’s account, the investor has delegated decision-making authority over what to buy and sell in the account. Finally, the MSRB notes that, where the RIA is an SMMP, the RIA has affirmed and the dealer has a reasonable basis to believe that the RIA has the sophistication to obviate the need for the protections flowing from the obligations modified under Rule G-48, which the MSRB believes is also indicative of the RIA’s ability to provide similar protections to its clients when a firm is not required to do so.
For more guidance related to this topic, please refer to MSRB Regulatory Notice 2016-29.