Client Supervision

Suitability Obligations

Suitability is a foundational obligation in the municipal securities industry. MSRB Rule G-19 requires that a broker-dealer, when recommending a municipal securities transaction to a customer, have reasonable grounds for believing the recommendation is suitable based on the customer's financial situation, investment objectives, and needs. The Municipal Securities Principal must establish and supervise a suitability framework that protects customers and ensures compliance.

The suitability obligation has evolved significantly over the years. While historically the standard focused on whether a particular bond was appropriate for a customer given their profile, modern suitability requirements are more comprehensive and are informed by both MSRB rules and FINRA standards. The principal must be familiar with both frameworks.

Customer Information Requirements

Under MSRB Rule G-19, before making a recommendation, the dealer must make reasonable efforts to obtain information about the customer, including:

• Financial Status: Income, net worth, liquid assets, and existing holdings
• Tax Status: Tax bracket, whether tax-exempt income is beneficial (this is particularly important for municipal securities, whose primary advantage is tax-exempt interest)
• Investment Objectives: Income, growth, preservation of capital, speculation, or a combination
• Risk Tolerance: The customer's ability and willingness to accept investment risk
• Time Horizon: How long the customer intends to hold the investment
• Liquidity Needs: Whether the customer may need access to funds before maturity
• Investment Experience: The customer's familiarity with municipal securities and other investments

Types of Suitability

Consistent with FINRA's suitability framework, municipal securities suitability has three components:

• Reasonable-Basis Suitability: The representative must have a reasonable basis for believing the recommendation is suitable for at least some investors. This requires the representative to understand the product and its risks.
• Customer-Specific Suitability: The recommendation must be suitable for the particular customer based on their specific investment profile. A bond suitable for one customer may be unsuitable for another.
• Quantitative Suitability: The representative must have a reasonable basis for believing that a series of recommended transactions, taken together, are not excessive in frequency or cost for the customer. This prevents churning.

Institutional Customer Exemptions

MSRB rules provide a modified suitability standard for institutional customers (sometimes called "sophisticated municipal market professionals" or SMMPs). When dealing with institutional customers that meet certain criteria, dealers may fulfill their suitability obligations with less extensive procedures, provided the institution has affirmed that it is exercising independent judgment in evaluating the recommendation.

An institutional customer generally includes banks, savings institutions, insurance companies, registered investment companies, registered investment advisers, and any entity with total assets of at least $50 million. However, even with institutional customers, the dealer must still have a reasonable basis to believe the recommendation is suitable.

Communications Supervision

The Municipal Securities Principal is responsible for supervising all communications related to the firm's municipal securities business. MSRB Rule G-21 governs advertising in the municipal securities area, while Rule G-27 requires supervisory procedures for communications with customers and the public.

Categories of Communications

Communications can be categorized in ways consistent with FINRA's framework:

• Institutional Communications: Written or electronic communications distributed only to institutional investors. These require review but may be reviewed after use rather than requiring pre-approval.
• Retail Communications: Written or electronic communications distributed to more than 25 retail investors within a 30-day period. These generally require pre-approval by a principal before first use.
• Correspondence: Written or electronic communications to 25 or fewer retail investors within a 30-day period. May be reviewed after sending but must be subject to supervisory procedures.

Advertising Standards Under Rule G-21

Rule G-21 sets specific standards for municipal securities advertising. All advertisements must:

• Be fair and balanced, presenting risks and benefits evenhandedly
• Not contain false, misleading, or exaggerated statements
• Not omit material facts that would make the communication misleading
• Be approved by a principal prior to first use
• Include the name of the dealer and any applicable disclosures

Customer Complaints

Handling customer complaints is a critical supervisory function. The Municipal Securities Principal must ensure that customer complaints are received, documented, investigated, and resolved in accordance with MSRB and FINRA requirements.

Complaint Handling Procedures

A "complaint" is generally defined as any written statement from a customer or person acting on behalf of a customer alleging a grievance involving the activities of the dealer or its associated persons. The principal must ensure the following procedures are in place:

• Receipt and Documentation: All complaints must be immediately forwarded to the compliance department and the designated principal for review. A complaint log must be maintained.
• Investigation: Each complaint must be promptly investigated. The principal must review relevant account records, trade confirmations, communications, and any other pertinent documentation.
• Response: The firm must respond to the customer in a timely manner. The response should address the specific allegations and explain any actions taken.
• Resolution: If the investigation reveals a violation or error, appropriate corrective action must be taken, which may include financial restitution, trade corrections, or disciplinary action against the representative.
• Reporting: Certain complaints must be reported to FINRA under Rule 4530 (formerly Rule 3070), particularly those involving theft, fraud, or unauthorized trading.

Complaint Recordkeeping

Under MSRB Rule G-8, dealers must maintain records of all customer complaints, including:

• The identity of the complainant
• The date the complaint was received
• The subject matter of the complaint
• The name of the associated person involved
• The disposition or resolution of the complaint
• The date of resolution

Gifts, Gratuities, and Non-Cash Compensation

MSRB Rule G-20 regulates gifts and gratuities in the municipal securities industry. The principal must supervise compliance with these rules to prevent improper influence and maintain the integrity of the market.

Rule G-20 Limits

Under Rule G-20, no dealer or associated person may give or permit to be given anything of value in excess of $100 per year to any person, other than an employee of the dealer, in relation to the municipal securities activities of the employer of the recipient. Key points include:

• The $100 annual limit applies per recipient, not per gift
• Normal business entertainment (meals, events) is excluded from the limit if the dealer's representative accompanies the recipient
• Promotional items of nominal value (such as pens or notepads) are generally excluded
• The rule covers gifts to employees of issuers, other dealers, and institutional investors
• Gifts given by the firm and gifts given by individual associated persons are aggregated