Muniland retail bond buying is getting more attention

May 31, 2012

A little-known provision in the Dodd-Frank financial reform law expanded the board of directors of the Municipal Securities Rulemaking Board (MSRB), the self-regulatory organization that oversees muniland. The board used to be composed of employees of municipal bond dealers and big banks, and many would say privately that MSRB rulemaking favored industry players rather the public. Dodd-Frank radically altered the board’s composition to balance representation from the municipal industry and the public. The law firm Duane Morris explained the change (emphasis mine):

The [Dodd Frank] Act alters the composition of the MSRB so that a majority of the minimum 15-member Board are independent of municipal securities brokers, dealers or advisors. The new composition of the Board meets the stated goal of the Act, to ensure that the public interest is better protected on the Board. The Board has a new charge to protect the public interest in addition to municipal entities and investors. The Board will consist of eight individuals known as “public representatives,” independent of any municipal securities broker, municipal securities dealer or municipal securities advisor. At least one of the public representatives must be a representative of institutional or retail investors in municipal securities. At least one of the public representatives must also represent municipal entities, and another of the public representatives must have knowledge or experience in the municipal securities industries.

The remaining seven “regulated representatives” will consist of individuals associated with a broker, dealer, municipal securities dealer or municipal advisor. At least one of the regulated representatives will be a “broker-dealer,” representative of nonbank brokers, dealers or municipal securities dealers. At least one individual must be a representative of banks, and at least one individual must be associated with a municipal advisor. The number of public representatives on the Board must always exceed the number of regulated representatives.

To keep the statutory balance, the board now has 11 members representing the public, 3 members representing securities firms, 3 members who are municipal advisors and 4 members representing banks. With these 21 representatives, the board exceeds the statutory requirements of a minimum of 15 members and a majority of public ones. Some of the public members do have previous ties to the municipal bond business, but if they remain “public-minded,” their past experience can be very useful.

In my view, all this public representation at the MSRB is bringing about a more open and transparent municipal bond market. What I’ve seen so far is an expanded focus on information flow to investors via enhancements to the EMMA system, the publication of an investor toolkit, a vast increase in continuing disclosure by issuers of material events (continuing disclosure documents totaled 39,549 in the first quarter of 2012), and a soon-to-be-released MSRB study on pre-trade transparency, or the market information made available before one buys a muni bond. Recently, the MSRB has announced that it is turning its attention toward online retail investing platforms to understand how investors are directly participating in muniland without going through a broker. The Bond Buyer had a great article on the issue:

The increasing popularity of electronic brokerage has led the Municipal Securities Rulemaking Board to examine whether retail investors who trade municipal securities through broker-dealers’ online systems have adequate protection under its rules.

Last year, the MSRB launched a review of “electronic brokerage systems” and has since received demonstrations from several of them, MSRB officials told reporters during a teleconference call summarizing their recent board meeting.

The firms include Fidelity Brokerage Services LLC, TD Ameritrade, Charles Schwab & Co., Scottrade and E*Trade Financial Corp.

Electronic brokerage systems are platforms offered by broker-dealers that allow retail customers to buy municipal bonds online. About 10 firms have significant electronic brokerage systems, according to the MSRB. Some of the platforms also allow investors to sell bonds.

Bonds available for purchase on these platforms typically are those offered by alternative trading systems, or ATS, which are used primarily by dealers and institutional investors and are operated by four firms: Knight BondPoint, TMC Bonds LLC, Tradeweb Markets LLC and Bonddesk Group LLC.

The four firms who sponsor alternative trading systems (Bonddesk, MuniCenter, Knight and Tradeweb) have all operated these systems for years. In a sense, these are the “dark pools” of municipal bond trading. Neither the MSRB nor the SEC has done much oversight on this part of the market, although they process most of the direct investor trades. On the press call in which the MSRB announced the change in strategy, I asked if it knew how many retail trades were happening through online brokers. The MSRB answered that it is in the process of collecting this data.

It’s fantastic that the MSRB, a quasi-regulator, is taking such an active interest in this overlooked area of muniland. Well-to-do investors have always had special help in choosing municipal bonds through their securities broker or financial adviser. Middle-class investors, though, have been left to struggle with online investing platforms and can only hope that they are buying munis at a reasonable price. More often, this class of investors avoids the market entirely.

Municipal bonds are an excellent investment for most retail investors. As the MSRB fully embraces its public focus, it’s retail investors who will likely benefit.

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