SIFMA Proposes "Execution with Diligence" Standard for Munis Trading (with Lofchie Comment)

SIFMA issued a comment letter as to the level of effort that a broker-dealer should be required to undertake in order to obtain an execution of legally sufficient quality in the municipal bond markets. The comment letter was in reports to the July 31 SEC Report on the Municipal Securities Markets, asserting that retail customers in the municipal bond markets are disadvantaged in execution, pricing, and disclosure as they do not have access to the same information as dealers and institutional customers. In this regard, the SEC had recommended a rule change that would require municipal bond dealers to seek "best execution" of customer orders.

In response, the SIFMA letter proposes an amendment to MSRB Rule G-18 ("Execution of Transactions") to reflect an "execution-with-diligence" standard. The gist of the SIMFA's argument is that the amount of effort to obtain best execution is not economically feasible in light of (i) the vast number of small issues that trade in the munis market; (ii) the fact that most issues do not trade on any particular day; (iii) the relatively small size of trades; and (iv) the fact that the number of requests for bids or offers is substantially in excess of the actual number of trades. Thus, holding dealers to an obligation to obtain the best price available in the market would effectively raise their costs to a level that is not economically feasible, given the way in which the market works. Nonetheless, SIFMA does propose a level of dealer obligation that is higher (or at least more explicit) than what arguably exists.

Lofchie Comment: This debate over the level of obligation that a dealer in the munis market has to its customers is, to a good extent, an analogy to the debate over whether a broker-dealer owes a "fiduciary" obligation to its customers. While the regulators can raise the bar of dealer obligation as high as they like, they can't make business bottom lines profitable: impose too high a level of obligation and drive (reputable) firms out of the business because they can't make a profit. On the other hand, regulators are obviously reluctant to concede limits on a dealer's obligation to its customers for fear that they (the regulators) are allowing customers to go unprotected. Part of the solution to this regulatory challenge is for the regulators to avoid focusing on feel-good terms like "fiduciary" and "best execution" and instead, to focus on the actual processes that regulated firms must undertake.For those wanting to take a look at the SEC munis report, the principal discussion of best execution is on page 131, although there are additional references throughout the document. Based on the report, it is not clear that the SEC would agree with SIFMA as to the level of obligation that a muni dealer has to a customer under current law.

See: SIFMA Recommendation Letter; SIFMA Press Release.See also: SEC July 31 Report on the Munis Markets (Link to the 2012 Studies Page); SEC Report on the Municipal Securities Market (July 31 Cabinet News Story).See also: SIFMA letter on broker-dealer obligations to sophisticated muni investors.