WASHINGTON — 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.

In addition to supplying trade data, ATS in some cases also design the online applications used by broker-dealer firms.

MSRB officials say the use of electronic brokerage systems by retail investors has increased in recent years. But industry-wide data is scarce, partly because the board’s online Electronic Municipal Market Access, or EMMA, system does not distinguish electronic from other muni trades.

Tom Vales, chief executive of TMC Bonds, said the online retail muni business at several of his firms’ clients — companies that represent the bulk of the industry — increased more than 30% in 2011 from 2010.

Online retail muni bond trading accounted for 25% of Bonddesk’s trades in the first four months of 2012, down from roughly 30% in 2011, but up from 10% of its trades in 2006.

The increase occurred as trading of certificates of deposit and agency and Treasury bonds declined.

At Charles Schwab, 58% of retail muni and corporate bond trades occurred online last year, compared to roughly 40% a few years ago, according to a spokesperson.

The firm’s clients made around 160,000 muni-bond trades worth $9 billion in par value last year, many of which were electronic.

The MSRB wants to understand how the systems work and ensure firms provide online retail investors with adequate access to material-event notices and other material facts, as required under Rule G-17 on fair dealing, according to Ernesto Lanza, MSRB deputy executive director and chief legal officer.

The board also wants to ensure firms fulfill obligations under Rule G-30, which requires dealers to buy and sell munis at “fair and reasonable” prices for online retail customers.

Online investors frequently pay prices shown on their screens and usually do not negotiate prices through a bidding process.

In addition, the MSRB is examining whether bonds displayed online, based on clients’ search criteria, qualify as recommendations, which would trigger suitability requirements under Rule G-19.

The rule requires that dealers have “reasonable grounds” for the muni bond recommendations they make to retail customers.

MSRB staff could eventually recommend that the board issue additional guidance or rule changes, but no decisions have been made about how to proceed.

If the MSRB were to take action, it would probably start by issuing a “concept” release, a document designed to solicit feedback and make the public aware of the issues that could arise with electronic brokerage.

Some market participants argue that investors should not have any special protection if they choose to take the risk of buying bonds through electronic brokerage systems, rather than broker-dealers.

Previous MSRB notices have addressed ATS. The board issued guidance on sophisticated municipal market professionals, or SMMPs, in 2002 with the goal of not bogging down ATS with regulatory requirements. The board said that SMMPs trading over ATS have more investment knowledge and need less protection than other investors.

On Friday, the Securities and Exchange Commission approved an expanded definition of SMMP that for the first time includes certain individual investors.

Vales said the growing popularity of electronic brokerage systems has brought much-needed additional capital to the municipal bond market. He said additional regulations could create barriers to electronic retail trading, possibly restricting market liquidity.

“We need more participants in the market, not fewer,” he said.

Vales noted that the MSRB’s real-time reporting system and EMMA improvements mean retail investors have easy access to disclosures and pricing data.

Because that information is available, individual investors should be free to decide whether to hire a financial advisor or manage their portfolio themselves, he said.


The Bond Buyer requested interviews with several electronic brokerage firms. FMSbonds Inc. and the GMS Group LLC either declined to comment or did not return calls for comment.

But executives at Charles Schwab, Fidelity and TD Ameritrade all provided demonstrations of their websites. They said their systems give investors a range of information and educational resources, and stressed that the websites do not make recommendations because the systems display bonds that meet customers’ search criteria. They said the websites encourage customers who have questions or problems to call a representative for assistance.

The systems let investors search for bonds based on criteria such as the issuing state, rating, maturity date, quantity and type of bond, such as those issued for housing or education projects.

The firms’ websites show details about individual bonds pulled up by customers’ selection criteria, including ratings, the yield to maturity and prices.

Some also require customers check boxes to confirm they understand features of the bond.

The websites link to the MSRB’s EMMA system, where investors can find disclosures and other documents. Fidelity’s link pre-fills the EMMA search box with the bond’s CUSIP, bringing users straight to disclosures; Schwab’s website also provides customers with material event and other information from DPC Data.

TD Ameritrade links to a page called “How to read your results,” where investors can find definitions of terms like CUSIP, maturity and coupon rate. The site has a drop-down box of material events and links to the Financial Industry Regulatory Authority’s 11-point muni bond checklist, which is designed to help investors understand a bond.

TD Ameritrade’s site also flags recently downgraded bonds, and users can compare a muni bond’s yield to a corporate bond yield. Customers can access weekly outlook and default reports from Municipal Market Advisors.

“We make sure there are no features of the bond we feel the client may not understand,” said Donna Lemery, TD Ameritrade’s senior manager of fixed income.

Lemery said all online bond orders move through the company’s trading desks for review. If a bond has a unique feature, such as an unusual call, the firm routes the order to a fixed-income specialist, who may call the customer to discuss the order.

“All trades have a pair of eyes on them,” said Perry Guarracino, TD Ameritrade’s director of fixed income.

Fidelity’s website gives investors access to Standard & Poor’s reports, and lets them view a yield curve, which can help identify potentially risky bonds, such as those with uncommonly high yields, said Fidelity vice president of fixed-income securities Richard Carter. Fidelity provides what he calls “depth of book:” if two dealers are offering to sell the same bond, Fidelity will show both.

Chad Jones, vice president of fixed-income sales and service at Charles Schwab, said his firm offers roughly 20,000 municipal bond issues for sale on the Schwab website. Investors can also buy new-issue munis underwritten by JPMorgan Chase.

Jones said the site automatically displays the best quote, but investors have the option to view other quotes, if any are available. Roughly 97% of Schwab’s bond orders are filled within 30 seconds or less, though some are routed to the trading desk for review, he said.

Schwab lets customers see a bond’s trading history, including prices and yields of both inter-dealer and retail trades. It also gives customers access to Moody’s Investors Service rating reports. “An investor who learns how to read trade history can pull back the curtain on the bond market,” said Schwab’s senior manager of fixed-income product management Mark Moreci.

In addition to letting investors buy bonds, the websites of Fidelity and TD Ameritrade allow them to request quotes and sell bonds online.

Unique Challenges for Retail

Executives agree that online bond trading poses unique challenges for retail investors. To research bonds, investors must often pour over complicated financial and other disclosures, many of which contain legal jargon.

Moreci said Schwab’s customer surveys indicate many retail investors are unfamiliar with basic bond concepts.

“When asked about price, many do not have the context to answer the question,” he said.

Moreci said Schwab’s online resources are written in simple language, designed to be understood by investors with differing experience levels.

Investor advocates say individuals who trade bonds online should take extra precaution. Charles Rotblut, vice president at the American Association of Individual Investors, said that although finding information needed to fully access a municipal bond can be difficult, munis still tend to be safe investments. “To a large extent, investors can rest knowing that defaults are rare,” he said.

Bob Webster, director of communications for the North American Securities Administrators Association, an investor advocacy group,  said not too long ago most investors had personal relationships with their dealers. To place orders, investors needed to pick up the phone, or meet their dealer. 

That began changing in the late 1990s with the Internet revolution. Financial companies, which were among the first to take advantage of the Internet’s potential, led the online charge, Webster said.

Many of today’s leading online trading firms, such as Charles Schwab, E*Trade, TD Ameritrade and Scottrade, were early Internet adopters, he said.

And while online firms offer discount investment services, their do-it-yourself models mean “more responsibility has been placed on the shoulders of individual investors,” Webster said.


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