New Issue Pricing – The MSRB Issues Compliance Resources for Underwriters and Municipal Advisors

To start, MSRB Rule G-17 includes an “implied representation that the price an underwriter pays to an issuer is fair and reasonable, taking into consideration all relevant factors, including the best judgment of the underwriter as to the fair market value of the issuance at the time it is priced.” (Emphasis supplied).

In negotiated deals, the underwriter has a duty to negotiate in good faith with the issuer and includes the obligation to ensure the accuracy of representations made including those regarding the price negotiated and investor demand. In this regard, there are a number of factors that can be at play and are important as one navigates the landscape.²

Let’s start with the purchase price paid by the underwriter – it must be “fair and reasonable” under Rule G-17. This need not be the “best” price. The MSRB rules recognize that underwriting engagements are “arm’s length” and that the interests of the parties can and do differ. Specifically, that the underwriter can place its own interests ahead of the issuers to ensure the underwriting firm is adequately compensated for its services and by limiting its risk.

What factors are relevant when determining “fair and reasonable?” First, the best judgment of the underwriter as to the fair market value of the new issuance at the time it is priced – this factor is, in and of itself, subjective and the MSRB rules recognize this. The “best judgment” is, however, informed with market information “reasonably available up to and at the time a new issuance is priced.” This can and should include the final purchase price, comparable issues of the recent past as well as where those issues are trading in the secondary market and as appropriate, the side of the market and size of trades. Importantly, “the process by which an underwriter arrives at and documents its best judgment of the fair market value of a new issuance can be helpful to affirming compliance with Rule G-17.” In other words, process and documentation matter.

Next are “facts and circumstances.” Those that might be relevant to determining if the underwriter has met its fair pricing obligation are set forth in the UW Resource. For ease of reference, they are reproduced below and, on a case-by-case basis, may include one or more of the following:

• Market dynamics leading up to and at the time of pricing (which may include the pricing of comparable transactions or the impact of other transactions in the market at the same time);
• Movements of benchmark curves and corresponding impacts to any preliminary pricing scales;
• Whether the underwriting is solely managed or managed by a syndicate;
• Whether the underwriting is for a complex structure;
• Any unique or uncommon features of the underwriting;
• Any specific instructions or other communications related to pricing from the issuer or the issuer’s municipal advisor (such as specific limitations regarding price(s), coupon(s), or other characteristics of the issuance);
• Whether the underwriting is for a new and/or unknown credit;
• The type and nature of investor demand for the issuance (e.g., how price adjustments might alter demand on a maturity-by-maturity basis and/or as a whole); or
• The changing status of the order book as pricing evolves.

While the MSRB does not expect firms to fully document and recreate every aspect of the pricing process for supervisory and examination purposes, underwriters are expected to have WSPs (Rule G-27). The UW Resource makes clear that the WSP requirement is not one size fits all and the same can and should be tailored to a firm’s underwriting activities. Further, “while firms do not need to document every aspect of the pricing process, there is an expectation, consistent with Rules G-8 and G-9, that a dealer will maintain and preserve material records related to primary offerings” that will help “facilitate inspections and examinations of dealers and assist the examining authorities in evaluating a dealer’s compliance with Section 15B of the Exchange Act, the rules and regulations thereunder, and MSRB rules.” (Emphasis added).

The DIVER New Issue Pricing and Scales platform can be highly effective in supporting obligations and “facts and circumstances” referenced in the UW Resource and the referenced MSRB Rules. Using the structural and credit characteristics of the proposed or actual transaction, one can easily identify all relevant comparable issues and trades to form an objective baseline around a new issue. Moreover, one can easily incorporate relevant secondary trade activity to allow for consideration of market data up to the time of pricing. The latest tax-exempt benchmark curve, as well as real-time treasury rates for taxable deals, are available to quickly update an indicative curve in preparation for pricing. Additionally, all of the supporting evidence to justify a pricing yield curve can be safely and securely stored for subsequent retrieval or exported in a PDF report to support proper documentation.

As many of us know, recent SEC exams have included questions around new issue pricing and support for the same consistent with the rules. While the MSRB’s Compliance Resources are not a rule and it has not been filed with the SEC, one can infer that following the same will be beneficial should the SEC inquire.

A good starting point: MSRB Rule G-42 does not impose a specific obligation to provide new issue pricing advice and the municipal advisor and its client can agree that such pricing advice will not be part of the engagement.⁴ However, if the municipal advisor, “through its conduct … has effectively agreed to provide pricing-related services or does perform such services, the applicable standards of care (the duty of care and, if applicable, the duty of loyalty) will apply.” This is so even if the scope of services is silent or ambiguous.

MSRB Rule G-42 establishes the core standards of conduct and duties of municipal advisors. Among other things, Rule G-42 obligates a municipal advisor to “Act in a manner consistent with its duty of care to its client.” The duty of care is explained in Supplementary Material .01 of Rule G-42 and requires a municipal advisor to, among other things:

As it relates to new issue pricing, the municipal advisor must take affirmative steps to ensure it is meeting its G-42 obligations. To that end, the municipal advisor should have tools and resources to ensure they have a sense of the market for comparable transactions (think market segment, credit, structure and more) and where those transactions are trading post issuance should the market have moved since the time of issue. This allows the municipal advisor to engage in a constructive dialogue on behalf of and with their client to address its G-42 obligations. DIVER’s New Issue Pricing and Scales platform is one such tool to help access comprehensive information to support new issue pricing obligations.

Furthermore, if a municipal advisor is providing new issue pricing advice, it is expected to have WSPs that speak to the review and supervision of the activity. The MA Resource makes clear that the requirement is not one size fits all and can and should be tailored a firm’s activities. It also provides that “…there is an expectation … that a municipal advisor will maintain and preserve documents material to a recommendation or that memorialize the basis for the recommendation.” As many have heard, there has been some focus by examiners on new issue pricing and “[m]aintaining and preserving books and records facilitate inspections and examinations of municipal advisors and assist the examining authorities in evaluating a municipal advisor’s compliance with Section 15B of the Exchange Act, the rules and regulations thereunder, and MSRB rules.”

MSRB Compliance Resources are important and meaningful tools for those operating in the municipal market and, while not creating new requirements or having been filed with the SEC, should be a reminder that there are established legal requirements under existing MSRB rules that municipal advisors are expected to fulfill.