In the News: Recent Developments

July 21, 2008

Moves Toward ARS, VRDO Transparency

By Andrew Ackerman

MSRB Eyes 2009 For New System

WASHINGTON – The Municipal Securities Rulemaking Board plans to launch the first phase of a new system aimed at improving the transparency of auction-rate securities and variable-rate demand obligations during the first quarter of 2009, the board announced Friday after a three-day meeting in Beaver Creek, Colo.

The first phase of the system will include basic reset rates for ARS and VRDOs. Later phases will expand the publicly available data about both types of securities, MSRB chairman Frank Chin told reporters during a teleconference. Currently there is no source of comprehensive same-day information about either types of security available to non-market professionals – even information as basic as the clearing rates for ARS.

“This measure reflects the market and regulatory support for increasing the available data on classes of municipal securities that have not been fully transparent,” said Chin, managing director and manager of public finance at Citi. “We’ve taken a phased-in approach to allow market participants time to accommodate new requirements.”

The system comes after the $330 billion auction-rate market collapsed in February when dealers withdrew support for auctions, shunning ARS because it was backed by insurance from downgraded bond insurers and lacked the put option featured on VRDOs. The auctions failed when the banks stopped using their own capital to prop them up, and it’s taken issuers months to refinance into other modes, including VRDOs.

While the board is still deciding what additional bid-related information to require broker-dealers to publicly disclose, Chin said the bard will collect the ARS and VRDO data through the MSRB’s Municipal Securities Information Library system.

Broker-dealers currently send ARS and VRDO offering documents to the MSIL. By the time the system is implemented, the MSIL will have been replaced by the board’s new Electronic Municipal Market Access, or EMMA, system, which is where the board plans to display the data.

The Securities Industry and Financial Markets Association applauded the MSRB’s new system, saying: “The ability to access increased data on these securities is extremely useful for market participants, especially in the current period of market dislocation.”

But some market participants were puzzled that it will take the board at least six months to implement an initial phase of the new system because reset rates already are available to investors through information vendors like Bloomberg LP.

“Now is the time for decisive action,” said Joseph Fichera, senior managing director and chief executive officer of Saber Partners LLC, who recently proposed the MSRB model its ARS/VRDO disclosures on Treasury auction information. “The need for transparency for investors is immediate, and other regulators have been able to respond quickly and efficiently to the credit crisis.”

He added that the Securities and Exchange Commission as well as the Internal Revenue Service were both able to give issuers hit by the auction-rate crisis specific securities and tax regulatory relief “in record time.”

MSRB executive director Lynnette Hotchkiss declined to comment on the remarks, but market participants said that regulatory agencies have to go through procedural hoops and can rarely implement new rules in a few months. Any MSRB proposal is subject to public comment after which a finalized rule proposal must be sent to the SEC, where it is subject to another round of comment before approval and implementation.

Separately, the board said that it discussed the development of EMMA and predicted the project, which launched in a pilot format at the end of March, will move forward soon. But they referred several questions about the timing of subsequent EMMA phases to the SEC, which has asked the board to wait to move forward with a second, primary market disclosure phase until after the commission proposes changes to its Rule 15c2-12.

The proposed rule changes would require issuers to provide secondary market disclosure documents to EMMA rather than the four existing nationally recognized municipal statistical information repositories.

The board plans to issue a notice within the next two weeks that will clarify its Rule G-15 on customer confirmations. Under the proposed changes to the rule, dealers will be able to meet G-15 requirements with electronic confirmations sent using Omgeo LLC’s Trade Suite Service. In addition, dealers with an exemption from the “trade-by-trade” confirmation requirements of the SEC will have a similar exemption under the amended G-15, the board said.

Separately, the MSRB deferred a decision on whether Rule G-14 on transaction reporting should require that all transactions with dealer proprietary desks be reported as customer transactions. Chin said the board will continue to discuss that issue.

Turning to administrative matters, the board voted to prohibit two individuals from the same broker-dealer or bank from serving on the board simultaneously and to limit representation of a single firm on the board to no more than six consecutive years. Chin said those actions were taken because of the consolidation of broker-dealers in the muni market and to help maintain a diverse group of members.

The board elected a new chair and vice-chair for one-year terms and approved five new board members for three-year terms. They will begin their terms on Oct. 1, but the board said it would not announce the slate of new officers and members until later in the summer. A source said Friday that Chin did not run for a second term as chairman, though he was eligible to do so under new rules approved this year.

The 15-member board is made up of five securities firm officials, five bank-dealer officials, and five members of the public – all of whom serve three-year staggered terms.

The membership changes on the board are somewhat more difficult to follow than in the past because two bank dealer members left the MSRB during the winter. Chin, whose chairmanship and board terms end Sept. 30, plans to stay an additional year to complete the last year of an unfinished term of one of the two open bank dealer seats. James Posthauer, director of municipal trading at SunTrust Capital Markets in Atlanta, returned to the board earlier this year to fill the other seat, after completing his own three-year term last fall.

The members whose terms end Sept. 30 are: vice chair Donald O’Brien, managing director and national syndicate manager at Morgan Stanley in New York; John Hull, financial vice president and chief investment officer at the Andrew W. Mellon Foundation in New York; Michael Imhoff, managing director at Stifel Nicolaus & Co. in Denver; and Milroy Alexander, executive director and chief executive officer of the Colorado Housing and Finance Authority, also in Denver.
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