Manual on Close-Out Procedures. Third Edition January 1985

Transcription

1 Manual on Close-Out Procedures Third Edition January 1985

2 Manual on Close-Out Procedures Third Edition January 1985 Municipal Securities Rulemaking Board 1900 Duke Street, Suite 600 Alexandria, VA (703)

3 Table of Contents Preface... Close-Outs by Purchasers: The Basic Procedure Initiating a Close-Out: The Telephone Call... Initiating a Close-Out: The Written Notice... Executing a Close-Out: The Purchaser s Options... Executing a Close-Out: The Procedure... Deliveries During the Close-Out Period... Second or Later Notices... The Ninety Business Day Time Limit... Retransmittals: Close-Outs Involving Several s Notification... Subsequent Retransmittals... Deliveries on Retransmittals... Close-Out Executions on Retransmittals... Special Situations I: The Transfer Extension... Special Situations II: Close-Outs on Reclamations... A Last Word... Appendices Appendix A: Glossary of Terms... Appendix B: Rule... iv Municipal Securities Rulemaking Board First Edition published January Second Edition August Third Edition January iii

4 Preface This manual outlines in question-and-answer form the provisions of rule G-12(h) (i) governing the close-out procedures available to dealers purchasing municipal securities. The text of rule G-12(h)(i) is set forth in an appendix, with each sentence indexed with references to relevant questions; also included is a glossary of basic terms. The manual sets forth the procedure as in effect as of January 1, 1985; future editions of the manual will be revised to reflect subsequent changes to the procedure, if any, as well as future Board interpretations. The manual does not address the seller s close-out provisions of rule G-12(h)(i). Persons wishing to use this procedure should refer to the text of the rule. For explanation purposes the manual reviews the procedures from varying perspectives from the perspective of the purchaser when reviewing the basic procedures, and from the perspective of the seller when reviewing the retransmittal procedure. Readers should be mindful of the perspective from which individual questions are written. Chapter One Close-Outs by Purchasers: The Basic Procedure iv

5 Initiating a Close-Out: The Telephone Call 1. Q: What transactions are subject to a close-out procedure? A: Only transactions between municipal securities brokers or dealers are subject to a close-out procedure. The close-out procedure cannot be used with respect to a transaction between a customer and a municipal securities dealer. 2. Q: Can I issue a close-out notice on any transaction between myself and another dealer? A: To be able to issue a close-out notice on a transaction, you must have first compared the transaction with the other dealer; that is, you must have sent a confirmation of the trade to him, and received from him a matching confirmation, or some other acknowledgement that he knows about the trade. The close-out procedure cannot be used if only one party knows the trade. 3. Q: When can I begin a close-out? A: The earliest date for initiation of a close-out procedure is the 5th business day following the settlement date. A transaction must be in fail for at least 5 days before you can initiate a close-out on it. You can initiate a close-out at any time after that, up to the outside time limit, which is discussed later in questions Q: Should I be sending out notices on every trade that s open in fail on the 5th business day? A: Remember, we said the earliest date you can initiate is the 5th business day. You can issue a close-out notice on the 5th business day, if you want to, but you aren t required to issue a notice at that time, and, in fact, most firms and banks wait a longer period of time before considering a close-out. One practice which the Board believes should be avoided is the idea of automatically issuing a close-out notice as soon as a transaction is 5 business days old. Some dealers have considered computerizing the process of issuing notices, so that notices would be automatically printed and sent out on the 5th business day to the dealers failing to deliver the securities. The Board believes that this can be considered harassment of the failing dealer. The Board urges that you issue a close-out only when you have a serious intention of following through on it. Another factor to consider is that many transactions that are in fail on the 5th business day after the settlement date will clear within the next day or two. You may want to check informally on the status of the trade with the other dealer before deciding to take the step of issuing a close-out notice. 5. Q: How do I begin a close-out? A: Beginning the close-out procedure is a two-step process. First, if you re the purchaser, you must call the seller, and tell him that, if he does not deliver the securities involved in the transaction by a stated date and time, you intend to close out the transaction. You must also state the time period during which you intend to execute the close-out. 3

6 6. Q: When you say call the seller, what does that mean? Whom should I call? A: Every dealer has its own procedures to handle close-outs, so the Board doesn t require that a specific person, or a specific type of person, be contacted. You should call someone who will know what you re talking about, a person in municipal operations, for instance. A number of dealers have the trader who made the trade contact the person he or she bought the bonds from. Whomever you call, remember that you will have to obtain the name of the person to whom you are talking. You will have to identify this person when you send written notification of the close-out. While we re on this subject, remember that sometimes you will be the recipient of a close-out notice. People in your office should know who handles close-outs for you and that they re responsible for referring calls and notices on close-outs to these people. If a close-out is mishandled in your office and, due to this error, you inadvertently fail to meet certain requirements (for instance, not retransmitting the notice to another dealer on time), you will be exposed to some risk on the close-out. 8. Q: Do I have to specify the 10th business day? A: The 10th business day is the earliest date you can specify. You can specify any date later than that as the deadline for delivery, should you choose to do so. 9. Q: And then I m also supposed to state a time period during which I will execute the close-out if the securities aren t delivered? What should that be? A: The rule requires that you specify the day or days during which you intend to execute the close-out, and permits you to specify a period of up to 5 business days for that purpose. If you specified the 10th business day after the telephone notice as your delivery deadline, your execution period could then be the 11th through the 15th business days after the notice. To follow our example, if you call the seller on July 8, and you specify a delivery deadline of July 22, you can specify as your execution period July 23 through July 29. JULY Sunday Monday Tuesday Wednesday Thursday Friday Saturday Q: When I call the seller, I have to tell him a date and time by which he must deliver the securities if he wants to avoid a close-out. Can I tell him any date, or is there a specific date I must use? A: Let s presume for the moment that this is the first notice you are issuing on this transaction. In that case, you would not be able to specify a deadline earlier than the close of business of the 10th business day after the day you give the telephone notice. For instance, if you call the seller on July 8, you could not specify a delivery deadline earlier than July 22. JULY PHONE CALL DEADLINE Sunday Monday Tuesday Wednesday Thursday Friday Saturday EXECUTION PERIOD PHONE CALL Q: What happens if I specify as an execution period only one or two days? A: Then those are the only days on which you can execute that close-out notice DEADLINE It is important to be careful when specifying dates on close-out notices. Whatever dates or days you specify for the execution period are the only dates or days you will have available to you to act on the notice. If, through mistake or oversight, you specify only one or two days, you will be able to execute the notice only on those days. If you want the full 5 business days, you must make sure to specify the full 5 days. 4 5

7 11. Q: Don t you count July 22 (the 10th business day) as one of the days in the execution period? A: No. Remember that your deadline cannot be earlier than the close of business of the 10th business day after the telephone call. You could not execute the notice on the 10th day. 12. Q: You said earlier that you were assuming that this was the first notice I m issuing on the transaction. What happens if it s the second or third notice I m issuing? A: The time period you have to wait before the deadline is shorter. We ll discuss that later, in response to question Q: Let me review this. If I want to initiate a close-out procedure, the trade has to be with another dealer, and it must have been compared. I can start a close-out on the 5th business day after settlement date, and I do it by calling the seller and stating my intention to close out the trade. I have to tell him that if he doesn t deliver me the securities by a stated date (at least 10 business days after the day I m calling) I may execute a close-out. I also have to tell him the dates which I am reserving for this close-out execution, which can be up to 5 business days. Is that correct so far? A: Yes, that s right. Initiating a Close-Out: The Written Notice 14. Q: Once I ve called and given the notice over the telephone, what do I do? A: Once you ve called the seller, then you have to send a written notice confirming your intention to close out the trade. 15. Q: When do I have to send that? A: The rule says immediately after the telephone call. This is defined earlier in the rule to mean not later than the following business day. 16. Q: How do I have to send that? A: That notice has to be sent return receipt requested. That means that, if you send the notice by hand, the messenger should get a stamped or signed receipt when he delivers the notice to the seller. If you send the notice by mail you should use certified or registered mail, or something similar, on which you will receive a receipt card. 17. Q: Do I have to have possession of the receipt? Some services are available that deliver items and have the receiving party sign a receipt, but that receipt is retained by the service and not sent back to me as the sender. Can I send a notice by means of one of these services? A: The purpose of the receipt is, obviously, to substantiate that you delivered the written notice, should questions or problems subsequently arise. If the service is obtaining a receipt, and if you can get access to that receipt should you need to (e.g., if you can obtain a photocopy of the receipt upon request), then delivering close-out notices by means of the service would be acceptable. 18. Q: What has to be in the written close-out notice? A: The rule requires a number of items of information to be contained in the notice, as follows: 1. Your firm s or bank s name. 2. The name and address of the dealer you re sending the notice to. 3. The name of the person to whom you spoke when you provided the telephone notice of the close-out. 4. The date you gave the telephone notice. 5. A description (including the par value amount) of the securities involved in the transaction that you re giving the close-out notice on. 6. The trade date and settlement date of the transaction. 7. The price and total dollar amount of the transaction. 8. The deadline by which the seller will have to deliver you the securities if he wants to avert the close-out. 9. The date or dates during which you can execute the close-out. 10. Your name and telephone number, or the name and telephone of someone else the seller can contact about the close-out. 19. Q: Isn t there a standard form that I m required to use? A: No. The Board decided that establishing minimum requirements for the contents of the notice would be sufficient, and that it wasn t necessary to make everyone use the same form. A suggested form what you might want to use appears on the next page. 20. Q: Would it be acceptable to use a uniform form such as the NASD s Buyin form? A: Use of such a form would not be permissible unless references to the closeout rules of another self-regulatory organization are deleted or omitted from the form. If the notice which you use contains a statement that the close-out is being conducted in accordance with rules that don t apply to close-outs on municipal transactions, that notice is void, and you would have to reissue a new notice. A form modeled on the NASD form would be fine, as long as all of the required information is provided. 21. Q: I have a few questions on some of the items you mentioned. You said that notice should include the name and address of the dealer I m sending the notice to. If the dealer has several offices, what address should I send the notice to? The main office? A: Again, different dealers have different practices, so it s impossible to specify a hard-and-fast rule. As a general matter, though, you should assume that, unless you know otherwise, you want to get the written notice to the person you spoke to on the telephone. That person knows about the close-out, knows the written notice is coming, and presumably knows how it should be handled or to whom it should be directed. Therefore, unless you know that the notice should be sent 6 7

8 To: [Name and Address of Municipal Securities ] Attn: Re: Notice of Close-Out Date: (Quantity and Description of Security) (Interest Rate) (Maturity Date) which is due from you to the undersigned on a contract made on at for settlement (trade date) (contract price) vs.. (settlement date) (contract amount) We hereby notify you that unless you make delivery of the above-described securities before the close of business on we intend to close out this (date) transaction pursuant to the provisions of Municipal Securities Rulemaking Board rule G-12(h)(i) during the period from to. (date) of your organization was contacted on (name) regarding this notice. (date) (date) [Name of Municipal Securities ] by: telephone #: elsewhere, it s best to send it to the address or the office at which the person to whom you spoke is located. For instance, if you spoke to someone in the Dallas office, you should probably direct written notice there, even though the firm might be headquartered in Houston. 22. Q: You also mentioned a description of the security. Some municipal descriptions can get pretty detailed do I have to have all of the descriptive information that might be required for a confirmation, for example, duplicated on the close-out notice? A: Remember that you re issuing the close-out on a transaction that both you and the seller have already agreed on and compared. The information you provide about the transaction is intended to make sure that the seller can identify the transaction you re talking about. Therefore, you would have some flexibility to abbreviate this description, as long as you re providing sufficient information to identify the transaction. 23. Q: The deadline and the dates for execution of the notice you mentioned those are the dates I specified earlier, on the telephone, right? A: That s correct. Those are the dates we discussed in questions 7 and 9 earlier. 24. Q: Suppose I have problems in delivering the notice. Does that affect the timing of the close-out? A: No. The timing of the close-out procedure depends on the date of the telephone call, and not on the date the written notice is presented. Problems in delivery of the written notice would therefore not affect the procedure, presuming, of course, that both parties agree about the timing of the telephone call. In general, should you have problems in delivering a notice, it s best to contact the person you had previously spoken to (whose name is on the notice) and determine from him or her how the notice should be delivered. Sometimes it s sufficient simply to arrange that the notice be delivered directly to that person. 25. Q: One problem I ve experienced in the past when delivering notices is the seller refusing to accept the written notice when it s been presented to him at his office. For instance, if I have a messenger deliver the notice to him over the window, the person at the delivery window would refuse to take the notice from the messenger. This has happened when I put on the notice the name of the person I spoke to on the telephone, and they claim that they don t know anyone by that name. Is this proper? A: It is never proper to refuse to accept a written notice of close-out. If the seller believes that there is a deficiency in the notice he can call you and question that, but he should never refuse to accept the notice when it s presented. 26. Q: What about deficiencies in the notice? Suppose I figure the dates incorrectly, or make some other mistake. What should be done? A: Remember that you are confirming a close-out notification you have already given over the telephone. The written notice should be providing the seller with information confirming (1) what transaction is involved, and (2) what the terms 8 9

9 of the particular close-out procedure are. If a notice is missing some information about either of those terms, or if it is completely unclear about them, the seller can demand that he be provided with a satisfactory notice. 27. Q: Would that be true for minor mistakes like misspellings, etc.? A: If the mistakes were minor in nature, and didn t cause problems with identifying the transaction or understanding the notice, then the notice should be considered to be in proper form. 28. Q: If a seller thinks there is something wrong with a notice, does he have to let me know about that by any specific time? A: No, there is not specific time limit by which he would have to advise you of any problem. However, he should let you know about the problem within a reasonable period of time. He shouldn t delay until you are about to execute the close-out and then say, hold it; I don t think your notice meets the requirements. 29. Q: Should I keep a copy of my notice and the return receipt? A: Yes. You do have record retention requirements to meet (copies of written communications on close-outs must be retained three years) and, of course, you will need to keep track of each close-out procedure while it s still active. It s important that you monitor the status of a particular close-out procedure, to ensure that any time extension, which we ll discuss below, is properly recorded, and that you take action at the appropriate time. Many dealers are keeping track of procedures, both for notices they send out and notices they receive, by maintaining copies of the notices in tickler files by date, so that someone is alerted about a particular close-out several days before action needs to be taken on it. This assures that notices won t be overlooked. 30. Q: Let me summarize again. Not later than the business day after I ve given notification of close-out by telephone, I have to send a written notice confirming my telephone call. That notice has to have certain specified items of information on it. That notice has to be sent return receipt requested, and I have to keep a copy. A: That s right. Executing a Close-Out: The Purchaser s Options 31. Q: So far I ve called with my telephone notification of close-out, and I ve sent out my written notice. What s next? A: The rule recognizes three kinds of close-out situations. The first is the relatively simple situation where only two parties, a purchaser and a seller, are involved, and the seller s failure to deliver is caused by some factor other than the submission of the securities for transfer. The second is a more complicated situation in which three or more dealers are involved, and there is a string of related fails to deliver on the same securities. The third is an unusual variant of the two-party close-out, the special situation in which the securities which the seller has failed to deliver have been submitted to the transfer agent. Let s start by following the simple version of the two-party close-out first. Once we have the down we can take a look at the more complicated versions. In the simple two-party situation, once you as the purchaser have given the telephone and the written notice of close-out, the rule does not require anything further to happen until the deadline and the execution dates arrive. (As we ll see later, in question 157, this is the point at which the more complicated twoparty close-out situation, where the securities have been submitted for transfer, becomes different from the simple version.) 32. Q: Doesn t the seller have to come back to me and tell me what s going on, why he s failing to deliver? A: In most cases, no, the seller is not required to respond to you. Most industry members try to provide information on the status of fails, and, of course, dealers issuing close-out notices frequently delay taking further action on the notices if they are kept informed about what s happening on the delivery and why it is in fail. The Board wanted to keep the close-out procedure simple so it did not provide a specific requirement for this kind of response; it s always a good idea, though, for the seller to keep the purchaser informed on the status of the transaction. In the more complicated two-party close-out procedure, however, where the securities have been submitted for transfer, the seller is required to respond to you concerning the reason for the fail. This is reviewed in detail in questions Q: So we re now at the deadline for delivery and the seller hasn t come up with the bonds. What are my choices in executing the notice? A: The rule permits you to choose one of three ways of executing the notice, as follows: 1. purchase ( buy in ) all or part of the bonds at the current market price for the account and liability of the seller; 2. accept from the seller substitute securities agreeable to you, with the seller bearing any cost associated with substituting them; or 3. make the seller repurchase the bonds on terms that include accrued interest and that make him bear any market change. Note, also, that you have the choice of not executing the notice at all. If the seller advises you that he expects to deliver the securities in the next few days, or if, for some other reason, you feel that it would be appropriate to work with the seller to get delivery of the securities, you can permit the notice to lapse. 34. Q: What happens if I do that? A: We ll cover that later on, in questions 80 through Q: I d like to discuss each of the execution options in turn. How would the buy-in option work? A: Your traders would go into the market, find someone who has the bonds for sale, and purchase the bonds at the current market price. These bonds would be 10 11

10 used to satisfy your contract with the seller, and the seller would have to pay any costs you incurred on the transaction. 36. Q: Such as? A: Well, if the initial contract on the bonds was at 95, and the buy-in was executed at 100, the seller would pay the 5 points differential. He would also have to pay the difference in accrued interest. 37. Q: You said that I could buy in all or part of the bonds. Does this mean if I have a trade for 100 bonds, with 50 owed to a customer and 50 in trading inventory, my trader could buy in the 50 for the customer, and leave the fail open for the other 50? A: No. The language of the rule is all or any part of the securities necessary to complete the transaction. If you have a fail of 100 bonds your trader would have to buy in the full 100, or, if the seller can deliver you a partial of 50, you can accept his 50 and buy in the other 50 to complete the trade. 38. Q: Since you mention partials, do I have to accept his 50 in your example? A: No, you have the option of accepting the partial or executing a close-out for the full amount. If you can work with the seller and take the partial, it is, of course, preferable that you do so. You are not required to accept the partial, however. (Note, however, that in a multi-party close-out there might be circumstances in which you would be obliged to accept what you would consider a partial delivery. This is discussed in questions 155 and 156.) 39. Q: One last question on partials If I do accept a partial, and have some bonds left in fail, do I have to start the close-out process all over again for the remaining fail, or can I proceed on my original notice? A: You can proceed to buy in the remaining balance on the strength of your original notice. You don t have to start the process all over again. 40. Q: Are there any restrictions on the people from whom my trader can buy in the bonds? A: The rule expressly permits a buy-in on the bonds from long positions in customer accounts you maintain. If your trader buys in the bonds from the person to whom the bonds were sold, you have to get the seller s consent. Otherwise there are no restrictions on the party from whom you may buy them. 41. Q: The second option, substituting securities, is somewhat unusual. Do you mean I can tell the seller, I want X bonds, go buy them? A: No. This option requires negotiation between your trader and the seller. The option provides that you may accept substitute securities, so the seller has to agree on what securities are being substituted. 42. Q: And if the seller doesn t agree or my trader doesn t agree with what the seller wants to substitute? A: Without an agreement between the two parties the substitution option can t be used, and one of the other options must be selected. 43. Q: If we do agree on the securities to be substituted, how do we go about the substitution? A: A substitution of securities involves negotiation and agreement on all the details of the transaction securities, contract prices, settlement dates, etc. Confirmations should be exchanged on the substitution, and the original transaction should be concurrently cancelled. Any additional expenses or costs must be borne by the seller. 44. Q: The last option is a mandatory repurchase. How does that work? A: You require the seller to repurchase the securities from you on terms so that he (1) makes up the accrued interest, and (2) bears the burden of any change in the market. 45. Q: What does bear the burden of any change in the market mean? A: Well, as a practical matter, if you have a contract at 100, and the market is down to 95, you force the repurchase at 100, so that he bears the burden of the down market. Conversely, if you have a contract at 100, and the market is up to 105, you can force the repurchase at 105, so the seller again bears the burden of the market shift. 46. Q: Suppose, in your example of a down market, I had sold those bonds to a customer at 101 after buying them from the selling dealer at 100. Could I force the seller to repurchase the bonds at my 101 contract price to the customer? A: No. You can only put the bonds back at the inter-dealer contract price. The seller cannot be held liable for the amount of any retail mark-up. 47. Q: Suppose, again in the case of a down market, I am seeking to have the other dealer repurchase at the contract price securities that I bought from him at a yield price. Do I use the original dollar price on the trade, or do I use the original yield price figured to the new settlement date of the repurchase transaction? A: You can use the original yield price figured to the new settlement date. Note that in the case of a security trading at a premium the seller can force you to use the yield price figured to the new settlement date. 48. Q: One thing that could be a problem is the price at which the buy-in or the mandatory repurchase occurs. Is there any check that the price represents a fair market for the bonds? A: The rule provides that the purchaser must always be prepared to defend the price at which the close-out is executed, so if your trader executed a buy-in at a price that was high relative to the market, the seller could challenge you on the validity of that price. Note that, in the case of a forced repurchase in a down market, a demonstration that the repurchase was put through at the original contract price would be sufficient to meet this requirement. 49. Q: What happens if the seller challenges the price? A: Well, assuming that you cannot reach agreement on the price, the matter 12 13

11 would have to go to arbitration. 50. Q: Is that true of other disputes about aspects of a particular close-out procedure? I can take these to arbitration as well? A: Yes. Disputes where one of the parties to a close-out feels that it has been significantly injured can be taken to arbitration, if the party is unable to work out a suitable resolution of the problem with the other parties involved. Information about the Board s arbitration code can be obtained from the Board s office. 51. Q: Sometimes I just want to get the trade off my books, and I would be perfectly happy to cancel the transaction without any payment of funds, or perhaps only payment of an accrued interest differential. Can I do this? A: The last option, the mandatory repurchase, permits you to require the seller to buy the bonds back at the contract price plus accrued interest. This would be the equivalent of what you re suggesting. If you were willing to forego the accrued interest differential as well, that would also be permissible. The parties to a closeout can agree among themselves to cancel transactions at the original contract moneys, should they so desire. 52. Q: Suppose I have the bonds bought at 100 and sold to a customer at 101, and the market for the bonds has declined to 95. If I can locate the bonds elsewhere in the market, can I execute a close-out against the seller, and cover the bonds in at the lower price, retaining the differential for myself? A: Absolutely not. The close-out procedure is intended to provide a mechanism for speeding up deliveries and clearance of transactions, not for making additional profit on a trade. Besides, as we ll see in question 63, in that situation you would be considered to be executing a buy-in, and would have to send the differential between the two prices to the selling dealer. 53. Q: I think it s time for a review again. I have three options to execute a close-out: a buy-in, a substitution, and a mandatory repurchase. On a buy-in, I go into the market and buy the securities from another dealer, and the seller has to bear the additional expense involved. On a substitution, the seller and I negotiate on replacement securities, and the original contract is cancelled once the substitute transaction is put through. On a mandatory repurchase, I require the seller to reverse the transactions by buying the securities back from me at a price that makes him absorb whatever has happened to the market. The seller has the right to challenge the price at which I execute the close-out, and, if he does, I have to substantiate that the price is fair. A: That s correct. Executing a Close-Out: The Procedure 54. Q: Those are my choices in executing a close-out notice. What do I actually have to do? A: Once the specified day or days arrive, your trading desk or some managerial person at your firm or bank should determine which of the options you re going to use and what action should be taken on the trade. 55. Q: Do I have to tell the seller beforehand, when I send him the original notice, which option will be used? A: No. You don t have to select the option for execution of the close-out until the actual day for execution. 56. Q: Let s suppose it s decided to have the seller repurchase the bonds. What has to be done? A: 1. Your trader should put through a ticket selling back the bonds at the appropriate price. 2. Once the close-out has been executed, the seller must be notified by telephone of the fact that the execution has taken place, and the manner in which you executed the close-out. 3. You have to confirm this notification in writing by the next business day, and send that to the seller, return receipt requested. 4. You must also forward the seller a copy of the confirmation of the transaction you put through to close out the trade. 57. Q: Should that confirmation sent on the close-out be identified as an execution of a close-out? A: Yes. Board rules require that information necessary to ensure that both parties agree to the details of a transaction must be included on a confirmation of the transaction. Under this requirement the confirmation should be designated as a confirmation of a transaction to effect execution of a close-out. 58. Q: If these securities were brought in from a customer, the confirmation would obviously identify the customer. Could I block out or otherwise delete the customer s name from the copy of the confirmation sent to the seller? A: Yes. The confirmation is intended to evidence the terms of the transaction put through to execute the close-out. The customer s identity is not necessary for this purpose and therefore may be withheld. If the close-out is challenged in arbitration, however, the customer might have to be identified. 59. Q: If my trader puts through a buy-in trade or a repurchase trade, do I have to do it on a cash basis for settlement on the trade date? A: No. The Board recognizes that in many cases the securities will not be available for same day delivery, or it will be impossible to reinvest a customer s funds for same day settlement. Therefore there is no requirement to execute the close-out on a cash trade basis

12 60. Q: Does it have to be done on a guaranteed delivery basis that is, does the party who is selling me the securities on the close-out execution have to be able to guarantee me that he will deliver the bonds on the settlement date? A: No. Since the point of the close-out procedure is to obtain the securities, you may wish to execute a buy-in with this guaranteed-delivery stipulation. You are not required to obtain such a guarantee, however. 61. Q: What about the settlement on the money due? How is that figured? A: When you notify the seller that the transaction has been closed out, you also inform him of the way in which you closed out the transaction, for example, I brought you in a 95. This information is also provided in the written notice on the execution sent the following day. By comparing the price and dollar amount of the close-out execution to his original contract amount, the seller will be able to determine how much he owes on the close-out execution, if anything. For example, if the original contract was at 90, with 30 days of accrued interest, and the buy-in was executed at 95, with 90 days of accrued interest, the seller would owe you 5 points, plus 60 days of accrued interest. 62. Q: When must that be paid? A: The rule requires that any money balances due on close-outs or closed-out transactions must be sent to the appropriate party by 10 business days after the date of execution of the close-out. Therefore, if the seller owes you 5 points plus 60 days accrued interest, as in our example, he would have to send you a check for that amount within 10 business days. Conversely, if you owe the seller money, you would have to send it to him within 10 business days. 63. Q: If I owed the seller money? How could that happen? A: Remember that when you execute a buy-in, it s for the account and liability of the seller. That means that, if you have to pay more for the securities when you buy them in, the seller has to pay the differential. Conversely, though, if the market for the bonds has declined, and you buy the bonds in at a price that s cheaper than the original contract price, the seller gets the benefit of that, and the differential should be paid to him. Let s follow our example through. Assume you bought the securities from the seller at 95, with 30 days of accrued interest. If the market declines to 90, and you buy in the securities at that price, plus 90 days accrued interest, you would owe the seller 5 points, less the 60 days differential in accrued interest. 64. Q: That doesn t seem fair. A: It seems unfair only because you re forgetting that the seller is left with an inventory position in the securities that he had previously sold. The object of the rule is to facilitate clearance of transactions and deliveries of securities, and the rule tries to do that without causing any dealer to absorb costs or losses that aren t necessary. In the case we re discussing, when the contract was executed at 95 and the buy-in at 90, the seller will be left long securities which he had originally sold at 95 at the new market level of 90. The 5 point reimbursement, however, adjusts the cost basis at which he owns those securities to the current market level, and, therefore, he does not absorb any unnecessary loss. 65. Q: What about substitutions or mandatory repurchases? How does the money settlement work on those? A: Well, substitutions are negotiated, remember, so that if any money settlements were involved they should be agreed upon during the negotiation. Mandatory repurchases are handled in much the same way as a buy-in. The seller is advised of the price of the mandatory repurchase at the time of execution, compares that price to the price of his original contact, and pays the difference within 10 business days. 66. Q: Or he gets paid the difference, if the repurchase is at a lower price? A: That s unlikely to happen. Remember that the rule provides that the seller can be required to repurchase the securities at a price which makes him bear the burden of any change in the market. If the market has declined, he can be required to repurchase at the original contract rather than the lower price, so that he bears the burden of the decline. 67. Q: Doesn t that cause him to absorb a loss? A: Yes, it could. The rule tries to avoid causing the seller to absorb an unnecessary or avoidable loss, but it recognizes that sometimes the loss can t be avoided. Since many municipals aren t widely available in the market, and can t be bought in, other methods of completing close-outs have to be provided. These other methods can t always resolve the transaction as cleanly as a buy-in can. Sometimes, therefore, the seller will have to bear some loss on the close-out of the transaction. 68. Q: What happens if a dispute arises about the fairness of the close-out execution price? Am I still obliged to send out any moneys owed on the closeout execution within 10 business days? A: No. If the close-out execution price is disputed, the settlement of the money amounts due should be deferred until the dispute is resolved. 69. Q: Let s review again. When I execute a close-out, I have authorized people (traders, for instance) decide what to do, and put the execution transaction through. I have to tell the seller by telephone that I executed the close-out, and how I did so. Then I send him a written notice confirming the call, with a copy of my confirmation of the transaction executing the close-out. That notice has to be sent by the next business day, return receipt requested. Any money due on the close-out, from the seller to me or from me to the seller, has to be sent within 10 business days of the execution date. A: That s the actual procedure for executing the notice

13 Deliveries During The Close-Out Period 70. Q: Let s go back for a minute, before I ve actually executed a close-out. Suppose, as in your earlier example, the dates on which I could execute the notice are July 23 to July 29. On July 23 my traders go into the market and buy in the bonds. If the seller tries to deliver the securities on that morning, after we ve executed the buy-in, am I obliged to accept delivery? A: Not unless the seller has given prior notice of his intention to make delivery. If the seller can complete the transaction, he can provide you notice that he will deliver the securities within 2 business days. If he gives you such notice, that would suspend the close-out procedure for those 2 days. 2 days, the dates for execution of your notice are extended an equivalent 2 days. If he freezes your notice for July 28 and 29, your notice will be effective, and a close-out can be executed, during July 30 and 31, as is illustrated below. (Note also that if the seller calls to promise delivery on the last day of the execution period (July 29, in our example), the effective dates of your notice are extended by three business days (July 30, 31, August 3), so that you are sure to have time to execute the notice if he doesn t deliver). JULY Sunday Monday Tuesday Wednesday Thursday Friday Saturday Q: But if he doesn t give that notice, and I ve executed the close-out, my execution is valid and I can reject the delivery. A: That s correct Q: Suppose the seller delivered the bonds on July 23, but before I executed the notice. Should I accept the delivery? A: Yes, in that case you should Q: Suppose I ve just executed the close-out, and I call him to notify him that I ve executed it, as I m required to do. Can he say, Wait a minute, I ve got the securities, I ll deliver tomorrow, and suspend the close-out in that way? A: No. The rule permits the seller to suspend action on the close-out so that, if the securities finally become available just before or during the close-out execution period, he has the opportunity to avert the close-out and make the delivery. You have the right to take action on the close-out at any time during the execution period, however, so, if you have already executed the close-out, he is no longer able to freeze or suspend action on your notice. 74. Q: Suppose the seller calls and gives notice of delivery, and then doesn t deliver? A: The close-out notice still remains in force. If the seller has given notice of delivery, and then fails to deliver the securities during the stated delivery days, you could proceed with the close-out Q: Is that true even if the days he is reserving for delivery are not the last 2 days in my execution period? A: Yes. If your execution period is July 23 to July 29, and the seller promises delivery and freezes your notice on July 23 and 24, you still get the 2 day extension, and the notice is effective on July 30 and 31, as is shown on the next page. That way you always get the full number of days you specified for your execution period FREEZE PERIOD EXECUTION PERIOD EXTENDED EXECUTION PERIOD Q: Can he deliver at any time during the specified delivery days, or does he have to deliver during the standard delivery hours? A: If he delivers the securities on the second day you should still accept the delivery even though it may be after standard delivery hours. This is true even if delivery will occur late in the day. 76. Q: Let s say my execution dates are July 23 to July 29. On July 27 the seller calls me and tells me he will be delivering the securities sometime over the next 2 days, July 28 or July 29. Those are the last 2 days of my execution period if he doesn t deliver, can I still close him out under this notice? A: Yes. If the seller promises delivery and suspends action on your close-out for 18 19

14 Sunday Monday Tuesday Wednesday Thursday Friday Saturday JULY 78. Q: Can he freeze my notice more than once? A: No, the seller can suspend execution of a particular close-out notice only one time. If he does not deliver the securities during those 2 days, the notice becomes effective again, and he can t prevent your taking action on it EXECUTION PERIOD FREEZE PERIOD EXTENSION AUGUST 81. Q: That doesn t mean that I ve lost my chance to close out the transaction, does it? A: No, you can issue another notice or several more notices, if you wish. 82. Q: And I proceed with those in the same way? A: Pretty much the same, yes. The only major difference is that the waiting period between the day you give the telephone notice of the close-out and the delivery deadline you can specify for delivery of the securities is shorter. Remember we discussed earlier, in question 7, that, on the first notice, you could not specify a delivery deadline earlier than the 10th business day after the date of your telephone call about the close-out. On the second notice issued on a transaction, however, and any notice after that, you can specify a delivery deadline of 5 business days after your phone call. 83. Q: Can you give an example of that? A: Suppose you had issued your notice in July, as we had discussed earlier. For whatever reason, you let that notice expire without taking any action on it, but now you want to start up the close-out procedure again. If you call the seller on August 5, you can advise him that if he does not deliver the securities by the close of business on August 12, you will close the transaction out during the period August 13 to August 19. Sunday Monday Tuesday Wednesday Thursday Friday Saturday Q: Time for a review again. If the seller finally obtains the securities, he can freeze action on an outstanding close-out notice by calling me, as the purchaser, and advising me that he will deliver the securities during the next 2 business days. In that case I cannot take action on the notice during those days, and, if the seller delivers, the notice expires. The 2 business days also extends my period for executing the close-out, though, so if the seller doesn t deliver the securities during those days, I can proceed to close out the transaction. A: That s right. Remember, the seller can suspend action on the close-out only once on a particular notice ND PHONE CALL EXECUTION PERIOD DEADLINE Second or Later Notices 23/30 24/ Q: I don t absolutely have to execute the close-out though, do I? For instance, back in question 33 you said I could allow the notice to lapse. What happens if I don t execute the close-outs? A: As we said earlier, each notice is good only on its terms and for whatever day or days are specified on it. If, for example, your notice is good for the period of July 20 to July 24, you must take action during that time. If you don t, the notice lapses and is no longer valid. 84. Q: Whereas if this had been the first notice I would have had to wait until August 19 for the delivery deadline, and August 20 through August 26 for my execution period. A: That s correct. Since you had already issued a notice on this transaction and this is a second or subsequent notice, the notice becomes effective more quickly

15 85. Q: If my second notice becomes effective (on August 13, as in your example), can the seller put the 2-business-day freeze on its execution? A: If he can promise delivery of the securities within that time, yes. 86. Q: This business of second or later notices seems so simple, I don t know if we have to review it. A: That s right. Second or later notices can become effective at an earlier time than first notices (5 business days after the telephone call), but otherwise they should be handled in the same way. 92. Q: This time limit sounds serious. So after the 90th business day after settlement date on a transaction I generally will not be able to issue a closeout notice? A: That s right. Day 90 is your last day. The Ninety Business Day Time Limit 87. Q: And that s all there is to the basic procedure? A: There s one important item left. Under ordinary circumstances you cannot issue a close-out notice on a transaction after the 90th business day after the settlement date. After that time you generally lose the ability to issue close-out notices. 88. Q: That s only if I haven t issued a notice before that time, right? I can issue a second or third notice on a transaction after 90 business days, can t I? A: No, you cannot. The absolute last day you can issue a notice is that 90th business day. If you don t have a notice outstanding, and you don t issue a notice on that day, you lose your chance to close-out that transaction. 89. Q: Suppose I issue a notice on day 89, that won t become effective until day 95. Can I proceed on that notice, or is that notice void? A: The 90 business day time limit applies to the issuance of the notice. A notice that is issued on or prior to day 90, therefore, is issued within the time limit, and is valid, even though it may become effective after that time. 90. Q: But once the time limit is past, I can only proceed with a close-out if I have a notice outstanding? A: That s generally correct. Remember that you must state a deadline for delivery of the securities when you issue a close-out notice, and you must state the dates during which you may execute the notice. If you issue a second notice on day 90, then, with a delivery deadline of day 95, and effective dates of day 96 through day 100, that s your last chance. You will have to take action during that execution period if you want to close out that transaction. If you don t, and that notice lapses, you can no longer close out the trade. 91. Q: You said earlier that under ordinary circumstances the 90 business day time limit applies. Does that mean that there are situations in which a close-out can be issued after that time? A: There is one limited type of situation in which a close-out notice can be issued after the 90th business day following the settlement date of the transaction. That is the case where a delivery on a trade has to be reversed reclaimed is the usual term because of a problem with the securities delivered. This situation is discussed later on, in questions

16 Chapter Two Retransmittals: Close-Outs Involving Several s

17 Notification 93. Q: Let s look at the multi-party close-out now. When does this begin to differ from the procedure we just reviewed? A: The differences begin at the time the selling dealer receives the close-out and determines the reason for his failure to deliver. 94. Q: So the beginning of the procedure the telephone call by the purchaser, and his sending of the written notice of the close-out is the same as we ve discussed? A: Yes. The beginning of the procedure remains the same as described in questions 1 through 30. You ll remember that in question 31 we agreed to assume that only two dealers, a purchaser and a seller, were involved in the close-out. This would be the case, for example, if the selling dealer had the securities certificates out to have a mutilated coupon validated. It s not uncommon, however, for more than two dealers to be involved, with the seller who first receives the close-out having failed to deliver the securities because he hasn t yet received them from a dealer who had previously sold them to him. This is where the concept of retransmittal comes in. 95. Q: What is a retransmittal? A: A retransmittal is the way in which a selling dealer can pass along the potential exposure on a particular close-out to another dealer that owes him the securities. Obviously, if the seller has the securities owed to him by another dealer, he s not the party who is at fault he didn t cause the failure to deliver so he shouldn t have to suffer the consequences of the close-out. So the rule permits him to pass along, or retransmit, the notice to the dealer who s failing to him. 96. Q: How is that done? A: Let s set up an example and see how it operates in practice. Let s assume that a block of municipal bonds has been traded among five dealers, A, B, C, D, and E, for final settlement October 28. We ll make you dealer D in this example. A B C D E It s now November 4, settlement date plus 5 business days, and dealer E, the ultimate purchaser, has just issued you, dealer D, a close-out notice. He has told you that if you do not deliver him the bonds by November 18, he will execute a close-out during the period November 19 to November 25. You check what the problem is, and find out that you have a fail to receive on the bonds from dealer C. 97. Q: That is all happening on November 4? A: That s right. Let s keep a calendar in front of us also, so we can keep track of the dates. Once you have identified that you are failing to receive the bonds from dealer C, you can retransmit the close-out notice to him. 98. Q: How do I do that? A: Pretty much the same way you would originate a close-out notice. You make a telephone call to dealer C, advising him of your intent to retransmit the notice of close-out issued by E to him, and stating the deadline date for delivery of the bonds, and the dates on which the close-out can be executed

18 NOVEMBER Sunday Monday Tuesday Wednesday Thursday Friday Saturday E CALLS D delivery deadline, and November 19 to November 25 as the execution period. That produced the situation illustrated on the bottom of the page. When you retransmit to C, that extends the delivery deadline to November 25, and the execution period becomes November 27 to December 3. That is illustrated on the next page. NOVEMBER DEADLINE 25 EXECUTION PERIOD 26 THANKS- GIVING Sunday Monday Tuesday Wednesday Thursday Friday Saturday CALL 5 CALL 6 7 FROM TO E C Q: Any time limit on when I retransmit the notice? A: Yes, and it s a strict one. You must retransmit the notice to C, if you re going to do so, by the close of business on the business day following the day on which you received the telephone notice Q: So if, as in our example, I received the telephone notice from E on November 4? A: You must have retransmitted that notice to C by the close of business on November 5, as is shown at the top of the opposite page Q: But it s sufficient to give the telephone notice of the retransmittal by that November 5 time limit? A: That s right. The telephone call retransmitting the notice must be made within the required time frame. NOVEMBER Sunday Monday Tuesday Wednesday Thursday Friday Saturday E CALLS D Q: The dates that I specify in my call to C are those the same dates that E specified in his phone call to me? A: No. The major distinction between two-party close-outs and multi-party closeouts comes into play here. The first time a close-out notice is retransmitted all of the dates applying to that notice the deadline date for delivery of the securities, and the dates during which the close-out may be executed are extended by 5 business days. The selling dealer gets an additional 5 business days to deliver the bonds, and the execution period for the close-out begins 5 business days later than originally specified EXECUTION PERIOD DEADLINE 26 THANKS- GIVING Q: What does that mean in terms of our example? A: Well, when E initiated the close-out to you, he specified November 18 as the 28 29

19 Sunday Monday Tuesday Wednesday Thursday Friday Saturday E 5 D 6 7 CALLS CALLS D C A B NOVEMBER 25 NEW DEADLINE 26 THANKS- GIVING NEW EXECUTION PERIOD DECEMBER RETRANSMITTAL C D E NOTICE OF EXTENSION 104. Q: So C now has til November 25 to come up with the bonds and E can t do anything on the close-out until November 27, at the earliest. A: That s right Q: All right. So, by the close of business on November 5 I have to call C and tell him I m retransmitting, and the new dates for delivery and execution, as extended because of my retransmittal. Do I have to tell E of the extension of time? A: Of course. On the same day that you telephone C to notify him about the retransmittal, you must also telephone E and notify him of the extension of time. If you remember our transaction flow chart back at question 96, you can see on the left page how these two notifications would be diagrammed Q: Do I have to confirm any of this in writing? A: Yes. Both of these notifications must be confirmed in writing. The rule also specifies the minimum contents for each notice Q: What has to be in the notice of retransmittal to C? A: The rule requires the following information: 1. Your bank s or firm s name. 2. The name and address of the dealer who originated the closeout notice which you are retransmitting. 3. The name and address of the dealer you re sending the retransmittal notice to (remember our discussion in question 21 about addresses). 4. The name of the person to whom you spoke when you provided the telephone notice of the retransmittal. 5. The date you gave the telephone notice. 6. A description (including the par value amount) of the securities involved in the transaction that you re retransmitting the close-out notice on. 7. The trade date and settlement date of the transaction. 8. The price and total dollar amount of the transaction. 9. The deadline by which the securities must be delivered to the originator in order to avert the close-out (as extended due to the retransmittal). 10. The date or dates during which the close-out can be executed (as extended due to the retransmittal). 11. Your name and telephone number, or the name and telephone number of someone else the seller can contact about the retransmittal Q: Why do I have to put the originating dealer s name on? A: As we ll see below, if other dealers retransmit the notice, they will have to advise the originating dealer of the retransmittal. In addition, the dealers to whom the notice is retransmitted will need to know who the originator is in case a late delivery is made or in case someone has information about the status of the transaction which the originator should be informed of Q: When do I have to send that written notice out? A: Not later than the business day following the date of your telephone notification of the retransmittal. In terms of our example, if you telephone C on November 5, 30 31

20 you would have to send the written notice by November 6. Note also that it must be sent return receipt requested Q: What about the notification to the originating dealer about the extension of dates? A: That has to contain the following: 1. Your firm s or bank s name. 2. The name and address of the dealer originating the notice of close-out (and to whom you re sending the notice of extension of dates). 3. The name of the dealer to whom you retransmitted the notice. 4. The name of the person to whom you spoke when you provided the telephone notice of the extension of dates. 5. The date you gave the telephone notice. 6. A description (including the par value amount) of the securities involved in the transaction that you re giving the notice on. 7. The date specified by the originating dealer as the deadline date for delivery of the securities. 8. The new deadline date for the delivery of the securities, as extended due to the retransmittal. 9. The date or dates during which the close-out can be executed, as extended due to the retransmittal. 10. Your name and telephone number, or the name and telephone number of someone else the originator can contact about the close-out Q: When must that notice be sent? A: That notice must also be sent not later than the close of business on the business day following the date of your telephone call, and also must be sent return receipt requested Q: Do you have suggested forms for those notices also? A: Yes. They are reprinted on the following two pages. To: [Name and Address of Municipal Securities ] Notice of Retransmittal of Close-Out Attn: Re: Date: (Quantity and Description of Security) (Interest Rate) (Maturity Date) which is due from you to the undersigned on a contract made on at for settlement (trade date) (contract price) vs.. (settlement date) (total amount) Pursuant to MSRB rule G-12(h), we hereby advise you that we are retransmitting a notice of close-out received by us from. If the above-described (name of originator) securities are not delivered to them by, they have indicated that (extended delivery date) they intend to execute a close-out with respect to these securities during the period to. (extended date) (extended date) (name) of your office was contacted on regarding this retransmittal. (date) [Name of Municipal Securities ] by: telephone #: 32 33

21 To: [Name and Address of Municipal Securities ] Attn: Re: Notice of Extension of Dates Date: (Quantity and Description of Security) (Interest Rate) (Maturity Date) on which, pursuant to MSRB rule G-12(h), you have issued a close-out with a delivery deadline of. We hereby advise you that we have retransmitted such Notice of Close-Out to. (name of dealer) Since such retransmittal is an initial retransmittal, the dates of your notice are thereby extended the new delivery deadline is, and the new execution period is (date and time of deadline) from to. (date) (date) of your office was contacted on (name) (date) regarding this extension. [Name of Municipal Securities ] by: telephone #: 113. Q: Can I summarize so far? If I, as a selling dealer, receive a close-out notice from a purchaser, I must check to determine what my reason for failing to deliver the securities is. If I am failing to deliver for any reason other than that I m failing to receive from another dealer, we re in a two-party close-out, and we proceed as described in the earlier part of this booklet. A: That s generally true, except in the case of securities submitted for transfer, in which case you follow the procedure described in questions Q: But if I have a fail to receive from another dealer I can retransmit the notice to the other dealer. I do that by calling him, not later than the business day following the day I received the notice. I advise him that I am retransmitting a notice to him, that the notice is from such-and-such a dealer, and that the deadline date for delivery is x and the execution dates are y. I confirm that in a written notice, containing certain specified contents, and sent, return receipt requested, on the following business day. A: That s correct. And now the time extensions Q: If this is the first retransmittal, that applies a time extension of 5 business days to the delivery deadline and execution period specified by the originating dealer they get moved back 5 business days. Since I m the first retransmitting party I figure out the time extension and apply it when I m retransmitting. A: That s right. The x and y dates you mentioned in question 114 will be those extended dates Q: Right. After I transmit the notice by telephone, I advise the originator, also by telephone, that I ve retransmitted the notice and that the 5 business day time extension has been applied. I confirm that in a written notice, containing specified information, also sent return receipt requested on the following business day. A: Correct. Subsequent Retransmittals 117. Q: We set up our example so that there would be several retransmittals after mine. How would those subsequent retransmittals work? A: Let s recall where we left our example. On November 5 you had called C and E about your retransmittal. Your retransmittal extended the delivery deadline to November 25, and the execution period to November 17-December 3, as is shown on the next page

22 Sunday Monday Tuesday Wednesday Thursday Friday Saturday E 5 D 6 C 7 CALLS CALLS CALLS D C B NOVEMBER 25 NEW DEADLINE 26 THANKS- GIVING NEW EXECUTION PERIOD DECEMBER In terms of our transaction flow, that produced this: A B RETRANSMITTAL D E NOTICE OF EXTENSION call to B (by November 9, in the example) Q: Any difference in the telephone call he makes, or the written notice he sends? A: No. In the telephone call he has to mention the originator and the deadline and execution dates. The written notice is required to have the same items of information Q: Does he mention my name at all? A: No. He must advise the party to whom he is retransmitting only about the originator, since subsequent parties receiving notice will need to contact the originator about the retransmittals, and may want to advise him about the status of the delivery. Since there s really no need for you to get this information, you re not indentified Q: The deadline and execution dates C specifies to B are those the same dates that I specified to C, or are they extended again? A: They are the same dates you specified to C, which in this case were November 25, as the delivery deadline, and November 27-December 3, as the execution period. The only time extension that is ever applied because of retransmittals is the 5 business day extension caused by the first retransmittal. Any retransmittal after the first retransmittal will simply be passing along the same notice, with the same applicable dates. You can see that on the calendar, which now shows C s retransmittal to B, but doesn t show any change in the delivery deadline date or the execution period. NOVEMBER Sunday Monday Tuesday Wednesday Thursday Friday Saturday E 5 D 6 C 7 CALLS CALLS CALLS D C B C So on November 5 C receives your call concerning the retransmittal. He investigates why he is failing to deliver the securities, and finds out that he has a fail to receive from B. He then does essentially the same thing that you did, calling B to advise him of the retransmittal, and sending a written notice of retransmittal to him Q: What are the time limits on C s action? A: The same as the time limits applying to you. He must call B within one business day of your telephone call to him concerning the retransmittals (by November 6, in the example), and send B the written notice one business day after his telephone DEADLINE 26 THANKS- GIVING EXECUTION PERIOD DECEMBER 27 28

23 122. Q: What about E? Does C communicate with E at all? A: Yes, again in a fashion similar to the way that you did. C must call E and advise E of his retransmittal to B. That call must be made on the same day that C retransmits to B. C must also send E written notification of his retransmittal to B Q: Does the rule prescribe minimum content requirements for that notice to E? A: No. The rule contemplates that C will simply send E a photocopy of his retransmittal notice to B. Further, since there is no time extension involved, he does not have to send that return receipt requested, and can simply send it regular mail. Sunday Monday Tuesday Wednesday Thursday Friday Saturday 8 9 B CALLS A 15 NOVEMBER E 5 D 6 C 7 CALLS CALLS CALLS D C B The flow chart would show C s retransmittal to B as follows: A ADVICE OF RETRANSMITTAL E DEADLINE 26 THANKS- GIVING EXECUTION PERIOD DECEMBER B D The flow chart would diagram it as follows: RETRANSMITTAL C A ADVICE OF RETRANSMITTAL E 124. Q: And now B s retransmittal to A? A: B s retransmittal to A will be exactly the same as C s retransmittal to B. If C called B on November 6, B must call A by the close of business to November 9 (the next business day), and send out the written notice of retransmittal by November 10. B must call E on the same day he retransmits to A, to advise him of the retransmittal, and B must send E a copy of the retransmittal notice to A within one business day thereafter. The deadline for delivery remains at November 25, and the execution dates remain at November 27-December 3, throughout this retransmittal. RETRANSMITTAL B C D The calendar would show B s retransmittal as is shown opposite

24 125. Q: Reviewing second or subsequent retransmittals there is no extension of the delivery deadline or execution dates for a second or subsequent retransmittal. On these retransmittals the retransmitting party must give telephone notice of the retransmittal to the other dealer within one business day of his receipt of the close-out notice, and must send, return receipt requested, a written notice of retransmittal, containing specified information, within one business day thereafter. The retransmitting party must also give telephone notice of the retransmittal to the originator, on the same day he actually retransmits the notice by telephone, and must send the originator a copy of his notice of retransmittal within one business day thereafter; he can send this latter notice by regular mail, if he wishes. A: That s the procedure for second or later retransmittals Q: So A has provided E with notice that it s about to deliver the bonds. A then delivers to B. Does B call E, and obtain a further 2 business day freeze? A: No. Let s assume that A calls E on November 25 to promise delivery. That would suspend the close-out execution for 2 business days (November 27 and 30), as is shown below. NOVEMBER Sunday Monday Tuesday Wednesday Thursday Friday Saturday Deliveries on Retransmittals Q: Let s reverse the order this time and look at deliveries before we look at close-out executions. Does the seller have the right to invoke the 2 business day freeze on the close-out in a retransmittal situation? A: Yes. The rule provides that if the seller, or any subsequent selling party to whom a notice has been retransmitted can complete the transaction, he can suspend action on the close-out for 2 business days. As a practical matter, in most instances the only seller who would know that the securities can be delivered is the party who first sold the securities, dealer A in our example, since he is the dealer who knows what the problem is Q: If, in our example, A comes up with the bonds, should he call B and promise him the delivery, or should he go direct to E? A: He should go directly to E: A CALLS E 26 THANKS- GIVING FREEZE PERIOD EXECUTION PERIOD DECEMBER DELIVERY NOTIFICATION A E Those 2 business days are the only days that the close-out notice can be frozen. If B receives the delivery on November 27, he s still subject to that November 30 deadline, so he should redeliver those securities to C as quickly as he can. B C D 129. Q: That puts a lot of pressure on A to deliver out those securities early in the freeze period. Is this true? A: Remember that A is promising delivery to E within 2 days, not promising E that B will get them within 2 days. A has to be fairly sure that he will be able to deliver the securities early enough so that they will make their way through the transaction chain within that time. Remember that E is the party who originated the close-out, and E is the only party who can execute it. A therefore has to advise E that the freeze has been applied to prevent E from taking action on the close-out Q: What s to prevent someone from delaying on the delivery so that one of the parties in the middle gets stuck with the securities when the close-out execution takes place? A: Two things act to prevent this: 1. Each party must act expeditiously in processing the securities for 40 41

25 redelivery to protect himself. As long as that party is in possession of the securities involved in a close-out, he has total liability on the close-out (since the offsetting transaction on which he retransmitted the notice has been completed). 2. Disputes on close-out procedures, like other disputes on municipal securities transactions are subject to arbitration under the Board s arbitration code. If a dealer in the middle absorbs a loss on a close-out due to another dealer s delay in redelivering the securities, that matter could be arbitrated, and the dealer whose undue delay caused execution of the close-out might be held liable for the full amount of the loss Q: Should dealers make special arrangements for clearing these transactions if they feel that s necessary? A: Sometimes that would help ensure that the transaction is cleared through the transaction chain in time. In our previous example, if all of the dealers except C were located in Chicago, and C is located, and had requested delivery, in New York, C might want to make special arrangements to have someone in Chicago clear the transaction for him. This would help to ensure that the transaction can be cleared in time and would also avoid the time-consuming process of shipping the bonds to and from New York. In some special cases, where the retransmittal chains have involved a number of dealers located in several different cities, the parties involved have reached an agreement to have the securities delivered directly from the initial seller (A, in our example) to the ultimate purchaser (E), with the other contracts completed by a transfer of funds through bank wires or checks. This type of arrangement is fine, as long as all of the dealers agree to this procedure, and the procedures for payments and settlement on all of the contracts are understood and accepted by all parties Q: Reviewing again if there is a series of transactions on which a close-out notice has been retransmitted, the 2 business day freeze can be invoked, if delivery can be made. The notice of impending delivery should go from the ultimate seller of the securities to the originator of the closeout. The 2 day period applies to the entire sequence of deliveries through the transaction chain, however, so the dealers involved must process these deliveries expeditiously. A: Correct. confirm this notification in writing on the next business day, and forward you a copy of the confirmation of the transaction executing the close-out. You in turn must retransmit the notification of the execution to C by telephone on the same day that you received it, advising C of the manner in which the close-out was executed. You would send written notification of the execution to C on the following business day, and forward C a copy of the confirmation evidencing the execution as soon as possible. C in turn advises B in the same fashion, and B advises A Q: So that each of the retransmitting parties must advise the party to whom he retransmitted by telephone that the close-out has been executed A: That s right. That must happen on the date the execution takes place Q: and confirm that notice in writing on the next business day, forwarding a copy of the confirmation of the transaction executing the closeout. A: That s correct. Each of the retransmitting parties must take these actions on the same days Q: What confirmation are we forwarding, and why can t we just attach it to the written notice of execution? A: You are forwarding a copy of the confirmation evidencing the terms of execution of the close-out. If the close-out is executed by substitution or mandatory repurchase, the confirmation you are sending would be your own substitution or repurchase confirmation, and presumably you could provide that at the same time as the written notice of execution. In the case of a buy-in, however, you would have to forward a copy of the originator s confirmation executing the buy-in, and, in that case, you would most likely not have that confirmation at the time you send the written execution notice. Therefore it is only required that you forward a copy of that confirmation when it becomes available to you Q: Can we follow through on our example? A: Of course. Let s look at our transaction flow chart again. Note that this time we have marked prices on each of the transactions A has sold to B at 90, B to C at 91, C to D (that s you) at 92, and you ve sold to E at 93. We ll assume that all of those transactions were for the same settlement date, so that we don t have to worry about the accrued interest: Close-Out Executions on Retransmittals 133. Q: Now to the execution of the close-out notice. If delivery is not made, E can execute the close-out. How does the execution get retransmitted? A: E would communicate the fact of the close-out execution to you (as D) as he normally would. He would advise you of the execution, and of the manner in which he executed the notice, by telephone on the date of execution. He would 42 43

26 A AT 90 E 140. Q: How would the money settlements take place? A: In this case each of the parties would pay the differential between their transaction contract price and the execution price of 95. A therefore pays B 5 points (the difference between 90, A s contract price, and 95), B pays C 4 points, C pays you 3 points, and you pay E 2 points. B AT 91 D AT 93 A 5 PTS E C AT 92 B 4 PTS D 2 PTS Now, on November 27, E executes a mandatory repurchase at the current market price of 95. On that day E calls you and advises you I m executing a mandatory repurchase at 95. You then call C and advise him I m retransmitting a mandatory repurchase from E at 95. C 3 PTS 138. Q: So I specify the same execution price to C that E specified to me? A: Yes. If you make any change in this execution price, then it will become impossible to compute the money settlement correctly Q: And C specifies that price to B? A: Yes. C calls B on November 27 and advises B of the retransmitted execution at 95, and B calls A and advises A of the retransmittal at 95. The flow chart would show this as follows: Notice that each party in the middle of the chain receives a payment equal to (1) the amount of his profit on the transaction, plus (2) the amount he has to pay to the subsequent dealer. In most cases it will be easiest to pass all settlements through the transaction chain. This ensures that each party receives the amount that it is entitled to, and that all transactions are cleared through the settlement process. Settling directly between the ultimate seller (A) and the ultimate purchaser (E) can be done only if all parties agree to handle it this way, and if arrangements are made for settlement of the other transactions at the same time. A AT 95 E 141. Q: Does the time limit on money settlements apply to these payments also? A: Yes. All of these money amounts must be sent to the appropriate party within 10 business days of the execution date. B AT 95 C AT 95 D AT Q: What happens in the event that the ultimate seller (A) challenges the fairness of the execution price? Are all the other parties still obliged to settle the money amounts they owe within the 10 business days? A: No. As in the case of the two-party close-out, if the execution price is disputed, completion of the money settlements should be delayed until the dispute is resolved

27 143. Q: In these situations, though, some of the amounts owed will not be involved in the dispute for instance, the profit amounts for the parties in the middle of the transaction chain. Shouldn t those parties settle up on the undisputed amounts, and just defer payment on the portion that is the subject of the dispute? A: Undisputed amounts can be paid right away, and sometimes it might be desirable that this be done. The rule does not require it, though Q: A few more questions about executions on retransmittals can I, as a party in the middle of the retransmittal chain, execute E s notice? A: No. Only the dealer originating a close-out can execute it. A dealer who has retransmitted the notice can only retransmit the execution, he can t execute the notice itself Q: This next item is a point we ve covered before but I d like to check it again. Suppose when B receives the notification of the execution, he calls A to pass it on, and A says I ve got the bonds, and I m delivering within 2 business days. Does that nullify the execution? A: No, it doesn t. Once the execution period has started, the originator of the notice has the right to execute the notice at any time. Once he acts, the closeout has been executed with respect to all of the transactions. The transaction between B and A, therefore, is closed out by E s action. A can t forestall action on an execution that has already taken place Q: Suppose the dealers are in different time zones, and C, for example, gets the telephone notice of execution at 4:00 p.m., West Coast time. If he has to retransmit the notification of execution to B in New York, he s not going to be able to do so on the date the execution took place. Does that cause problems? A: Not really. The rule requires that notification of execution has to be retransmitted on the date execution actually takes place, and every effort should be made to meet that requirement. If unavoidable factors, like differing time zones, prevent a dealer from retransmitting the execution notification in time, that would not nullify the execution or cause similar difficulties. If, however, a dealer delays retransmitting a notice of execution without a good reason, that might present problems Q: Let me review and then come back for a few last questions on retransmittals. In executing a retransmittal notice, each of the parties must give telephone notice of the execution on the date the execution took place, and confirm that notice in writing on the following business day, with confirmation of the execution transaction forwarded when it s available. The terms of the transaction which actually executes the close-out should be retransmitted to each of the parties involved. All money settlements should be completed within 10 business days of the execution date. A: Correct Q: Often the settlement dates on the transactions in a particular retransmittal chain differ, sometimes significantly. Can I retransmit a notice to a dealer if my transaction with him has been in fail for less than 5 business days or more than 90 business days? A: No. The outside time constraints of the close-out procedure would apply to retransmittals as well. Therefore, you cannot retransmit a notice to a dealer who is failing to deliver you the securities if your transaction with him is less than 5 business days past settlement. You also could not retransmit if your transaction with him is more than 90 business days old Q: Can I retransmit a close-out notice I receive to any dealer who owes me securities on a transaction that is 5 or more business days old? Suppose I receive a notice on a transaction for one settlement date, and my only open fail to receive is for a transaction for a later settlement date. Can I retransmit the notice to my contra-side on that second transaction? A: Yes, as long as that second transaction is 5 or more business days old Q: What about second or subsequent close-out notices? Are there any differences in the handling of these? A: No. The shorter time period before the delivery deadline, which we covered in questions 82 through 84, would apply, but the remainder of the procedure would be the same. The 5 business day extension for the first retransmittal would apply to these notices as well Q: What would happen if the notice I am receiving is a second or subsequent notice (with the earlier delivery deadline and execution period dates) and I had never initiated or retransmitted a close-out on that second transaction, on which I am retransmitting the notice? In that case, the dealer to whom I retransmit the notice will be subject to a possible close-out five days earlier than he would have been if I were retransmitting a first notice. Can I still retransmit the notice to him? A: Yes. Once a transaction is 5 or more business days old, it is subject to a possible close-out. The fact that the other dealer has not previously received a close-out notice on the transaction does not affect your right to retransmit a second or subsequent notice to him Q: Can I retransmit one or more notices and issue my own notice on the same transaction? Suppose a dealer owes me 100 bonds that I have resold in two lots of 50. I can retransmit to him notices on each of my offsetting sale transactions. Can I initiate my own notice and send it to him on the same transaction? A: Yes, you can issue your own notice. Since close-out notices are intended to be used to facilitate the completion of transactions, however, and not for the purpose of harassing another dealer, you should consider whether your issuing your own notice serves any purpose

28 153. Q: Can I retransmit to another dealer notices for a total par value of securities greater than the amount of securities he owes me? For example, if he owes me 100 bonds, can I retransmit to him three notices for 50 bonds each? A: Yes. He would, of course, be subject only to an execution or executions for the amount of securities that he owes on the transaction. In your example, if you did retransmit the three notices for 50 bonds each, and all three were subsequently executed, the dealer to whom you retransmitted the notices would only be liable for moneys due on two of the notices, since he only sold you 100 bonds Q: Another question I have involves the situation where I as a seller receive a close-out notice on a sale of 50 bonds, let s say, which is offset by a larger block, say 100 bonds, on the purchase side. Can I retransmit this notice, and, if I can, do I retransmit for the 50 or for the full 100? A: You can retransmit this notice for the 50 bonds, in order to cover your potential liability. If it s executed by the originator, the trade would be split, the retransmittal would apply to 50, and the remaining 50 would be left to open in fail. You can, of course, initiate and follow through on a close-out procedure on this remaining 50 at any time Q: If I pass on a partial retransmittal to another dealer, and he can deliver me the securities which are the subject of the retransmitted notice, although he still cannot make delivery of the full amount of the securities owed to me, am I obliged to accept his delivery of the smaller amount of securities, even though, for my purposes, that s a partial delivery? A: You would be obliged to accept delivery of the smaller amount of securities that is the subject of the retransmittal if that was necessary to avert execution of the close-out on those securities. In this circumstance you would not have the discretion to choose to turn down the partial delivery. Chapter Three Special Situations I: The Transfer Extension 156. Q: Would I have to accept that partial delivery as soon as I retransmit the close-out notice? A: It would seem reasonable to do so, since the originator of the notice is seeking to obtain delivery of the securities. You are obliged, however, only to accept the delivery if that is necessary to avert execution of the close-out; that means that you would have to accept the delivery in sufficient time to permit the securities to be redelivered to the originating dealer on or before the delivery deadline date. 48

29 The Transfer Extension 157. Q: Now I guess we should deal with the more complicated version of the two-party close-out you mentioned earlier. You indicated in question 31 that, although the selling dealer s reason for his failure to deliver the securities owed on a transaction generally will not affect the way a close-out would proceed, it would cause a change in the procedure in one limited case. What is that? A: The rule provides a special time extension of the delivery deadline and execution period dates due to the seller s reason for his failure to deliver in one specific type of situation. If the selling dealer who receives the close-out notice has submitted the securities owed on the transaction to the issuer or its agent for transfer, the selling dealer can advise the dealer originating the close-out notice of that fact and thereby obtain an extension of the dates Q: Why did the Board feel that a special provision for a time extension was necessary in this situation? A: As you may know, a law passed by the U.S. Congress in 1982 had the effect of requiring that, as of July 1, 1983, most long-term new issues of municipal securities must be issued solely in registered form. Since this is such a big change for the municipal securities industry, and since many industry members are not familiar with the process of securities transfer (which will often be necessary on registered securities), the Board believed that some relief should be provided in the close-out rule to permit time for these persons to become comfortable with the transfer process. Also, many industry members and others are concerned that the transfer arrangements on new issues may not be as efficient as possible during the first period of time after the effective date of the registration requirement, and that the processing of transfer items may be somewhat slow initially. The Board shared this concern, and felt that providing in the close-out rule for a time extension in a transfer situation would minimize the possibility of executions of close-outs on transactions when the delay in delivery was attributable to delays in the transfer process Q: How much of a time extension does the rule provide? A: Let s say that you are the selling dealer and have submitted the securities for transfer. If you receive a close-out notice and respond to the originating dealer and advise him that the securities are in transfer, the delivery deadline and execution period dates are thereby extended for 10 business days from the dates specified by the originating dealer. For example, as is illustrated on the opposite page, if he issued a close-out notice with an original delivery deadline of January 5 and an original execution period of January 6 through January 12, your advice that the securities involved are in for transfer would extend those dates by 10 business days, to January 19 and January 20-26, respectively. 51

30 JANUARY Sunday Monday Tuesday Wednesday Thursday Friday Saturday ORIGINAL DEADLINE FEBRUARY Sunday Monday Tuesday Wednesday Thursday Friday Saturday ORIGINAL EXECUTION PERIOD PHONE PHONE WRITTEN NOTICE RESPONSE RESPONSE NEW DEADLINE EXECUTION PERIOD Q: Is there any time limit on my response? A: The rule requires that, if the securities are in transfer, you (as the seller) must advise the originating dealer by telephone of that fact by the close of business on the business day following the date you received the originator s telephone notice of close-out. You must then send a written confirmation of that advice, return receipt requested, not later than the next business day; the written advice must state the new delivery deadline and execution period dates, as extended due to the transfer. Note that, as a practical matter, when you receive a close-out notice you would have to determine the reason for your failure to deliver by the next business day, so that you know whether you should retransmit the notice. Therefore, the transfer extension provision doesn t really require you to act any earlier on a close-out notice you receive than you normally would have to Q: So if, to use a new example, the originating dealer gave me (as the seller) telephone notice of his intent to close out the trade on February 6? A: You would have to advise him by telephone that the securities are in transfer by the close of business on February 7, and send the written advice by February Q: Does the rule contain requirements for the contents of that written notice? A: No, the rule only states that the delivery deadline and execution period dates as extended by the advice of the transfer must be stated on the written notice. A suggested form to use for the response, however, is shown on the next page Q: Do I have to specifically ask for the extension? A: No. The extension is automatic as soon as you advise the purchaser that the securities are in transfer Q: Do I have to prove that I have the securities in for transfer? A: The rule does not formally require that you prove that you have submitted the securities for transfer. It would be helpful, however, if you did cite certificate numbers or provide a window ticket number, if available

31 165. Q: Is this extension available on any close-out notice that is issued on a transaction? Suppose, for example, that the originator lets the first notice lapse, and issues a second notice while the securities are still in transfer. Can I get another 10 business day extension on that second notice? A: No. The 10 business day transfer extension is available only on the first closeout notice issued on a transaction. If the purchasing dealer lets the first notice lapse, and then issues a second notice, you cannot apply the transfer extension to that second notice, and the dates on that notice remain as specified by the originator. Note also that even if you did not take the transfer extension on the first notice (if, for example, you didn t find out that the securities are in transfer until after the time for response has passed) you still cannot get the extension on a second or subsequent notice on the transaction Q: Suppose that I get the 10 business day extension, but the securities don t arrive back from the transfer agent until after the execution period has begun. Can I invoke the 2-business-day freeze period provision? A: Yes. The freeze provision would apply in the same way that it would to any other close-out situation Q: How does this transfer extension apply in the case of a notice that is retransmitted? A: It doesn t. The rule provides that the 10-business-day transfer extension is available only on close-out notices which are not retransmitted Q: Suppose that when I received the notice from the originator I retransmitted the notice to a third dealer, and that third dealer is the person who has submitted the securities for transfer. Isn t that third dealer entitled to the 10-business-day transfer extension? A: No. Any party to whom a close-out notice has been retransmitted cannot use the 10-business-day extension, even if he has the securities in for transfer Q: Why not? A: The Board felt that trying to provide that extension in the event of a retransmittal would make the close-out procedure far too complicated, and be the source of many mistakes in handling close-out notices. For the sake of simplicity and efficiency, therefore, the Board decided that the extension would not apply if a retransmittal occurred. Further, since the retransmittal itself causes a 5-businessday time extension, a party receiving a retransmitted notice already has additional time to resolve the problem, and doesn t really need an additional extension of time beyond that provided by the retransmittal Q: Is there anything else I need to know about the 10-business-day transfer extension? A: One more item as we discussed earlier, the basis for including the provision for the extension in the rule was the concern about industry members becoming familiar with the transfer process and about the possibility of inefficiencies in the transfer process during the initial implementation of the requirement that new issues be distributed solely in registered form. Since both of these are problems 54 55