0001
 1   THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION 
 2   
 3   
 4                      MEETING OF THE 
 5               FIXED INCOME MARKET STRUCTURE 
 6                    ADVISORY COMMITTEE 
 7   
 8   
 9   
10   
11   
12                   Monday, July 29, 2019 
13                         9:30 a.m. 
14   
15   
16   
17   
18   
19   
20   
21   
22   
23          U.S. Securities and Exchange Commission 
24                     100 F Street, NE 
25                     Washington, D.C.                       
0002
 1   PARTICIPANTS: 
 2   
 3   Daniel Allen 
 4   Matt Andresen (Via Telephone) 
 5   John Bagley 
 6   Lizzie Baird 
 7   Horace Carter 
 8   Jay Clayton, SEC Chairman  
 9   Gilbert Garcia 
10   Tom Gira 
11   Lawrence Harris 
12   Michael Heaney 
13   S.P. Kothari 
14   Scott Krohn 
15   Allison Lee 
16   Lynn Martin 
17   Amy McGarrity 
18   Richard McVey 
19   Rebecca Olsen 
20   Brett Redfern 
21   Suzanna Shank (Via Telephone) 
22   David Shillman 
23   Lawrence Tabb 
24   Sonali Theisen 
25   Kumar Venkataraman (Via Telephone) 
0003
 1   PARTICIPANTS(CONT.)
 2   
 3   Rachel Wilson 
 4   Brad Winges (Via Telephone) 
 5   Mihir Worah 
 6   
 7   PANEL ONE 
 8   Susan Sheffield, GM Financial 
 9   Sarah Tucker, Raymond Jones 
10   Brian Walker, Incapital 
11   Brad Winges, Hilltop Securities 
12   
13   PANEL TWO 
14   
15   Jude Arena, Bank of America, Merrill Lynch 
16   John Bagley, MSRB 
17   John Cahalane, Tradeweb 
18   Chris Ferreri, Hartfield, Titus, and Donnelly 
19   Craig Noble, Wells Fargo Advisors 
20   
21   
22   
23   
24   
25   
0004
 1   PARTICIPANTS(CONT.): 
 2   
 3   PANEL THREE 
 4   
 5   Tom Doe, Municipal Market Analytics 
 6   Sheila May, GW&K Investment Management 
 7   Tom McLoughlin, UBS 
 8   Tim Schaefer, Office of the California State Treasurer 
 9   Kendel Taylor, City of Alexandria 
10   James Wallin, Alliance Bernstein 
11   
12   PANEL FOUR 
13   
14   Daniel Gates, Moody's Investors Service 
15   Yann Le Pallec, S&P Global 
16   Otis Otih, Mars 
17   Susan Sheffield, GM Financial 
18   Rachel Wilson, Iron Mountain 
19   
20   
21   
22   
23   
24   
25   
0005
 1                          C O N T E N T S 
 2                                                            PAGE 
 3   
 4   Welcome and Opening Remarks                                 6
 5   
 6   Draft Recommendation for Investor Education                19 
 7   Regarding Retail Notes 
 8   Break                                                      64 
 9   Draft Recommendation on Certain Principal                  65 
10   Transactions with Advisory Clients 
11   
12   Lunch                                                     104
13   
14   Updates from the Technology and Electronic                104 
15   Trading Subcommittee and ETFs and Bond Funds 
16   Subcommittee 
17   
18   Content and Timeliness of Municipal Issuer                109 
19   Disclosures  
20   
21   Break                                                     163 
22   
23   Credit Ratings: Future Modifications or Status Quo        163 
24   
25   Adjournment                                               210 
0006
 1                      P R O C E E D I N G S 
 2             MR. HEANEY:  Why don't we get started?  If people 
 3   could take their seats, please. 
 4             Good morning all.  I believe we have a quorum, so 
 5   I'll call the meeting to order. 
 6             Thank you for joining us today at the SEC's Fixed 
 7   Income Market Structure Advisory Committee meeting.  In 
 8   addition to the members here that we have in person, we also 
 9   have Kumar and Brad on the phone.  Good morning, gentleman. 
10             MR. WINGES:  Good morning. 
11             MR. VENKATARAMAN:  Good morning, Michael. 
12             MR. HEANEY:  Good morning, Kumar. 
13             Suzanne Shank will also be joining momentarily on 
14   the phone. 
15             At the outset of the meeting, I'd like to note 
16   that our esteemed colleagues, Carole Brown and Amar Kuchinad 
17   are no longer members of the committee. 
18             Carole, who recently left her position with the 
19   City of Chicago as a result of the transition of a new 
20   administration, provided the committee with important 
21   insights and views into the considerations of municipal 
22   issuers. 
23             Amar was an active contributor to our work, and 
24   his thoughtfulness and measured approach helped directly 
25   shape many of the recommendations that this committee 
0007
 1   approved and considered. 
 2             I would like to thank both of them for their hard 
 3   work, their efforts, and all their dedication to the 
 4   committee. 
 5             I'd like to welcome Chairman Clayton and turn it 
 6   over to him for his opening remarks. 
 7             CHAIRMAN CLAYTON:  Thank you, Michael.  And good 
 8   morning everyone.  Thank you for being here.  I want to 
 9   extend a warm welcome to our newest Commissioner, Allison 
10   Lee.  Welcome back to the Commission. 
11             COMMISSIONER LEE:  Thank you. 
12             CHAIRMAN CLAYTON:  And to your first FIMSAC 
13   meeting. 
14             COMMISSIONER LEE:  Thank you. 
15             CHAIRMAN CLAYTON:  We have a full agenda today 
16   with four panels, including recommendations from the 
17   Corporate Bond Transparency Subcommittee and the Municipal 
18   Securities Transparency Subcommittee.  We will also hear 
19   updates from the Technology and Electronic Trading 
20   Subcommittee and the ETFs and Bond Future Subcommittee. 
21             I will endeavor to be efficient with my opening 
22   remarks, but the length of the agenda somewhat constrains me 
23   in that. 
24             At the outset, I want to thank all of you for your 
25   service to FIMSAC.  You've done an excellent job, and the 
0008
 1   Commission greatly appreciates your informed and thoughtful 
 2   recommendations on, in many cases, very complex issues.  You 
 3   have not shied away from vexing and potentially contentious 
 4   matters, and at the same time have proceeded with rigor and 
 5   respect for each other's views.  This is greatly 
 6   appreciated. 
 7             I also want to join Michael in thanking Carole and 
 8   Amar for their work.  They've done a terrific job and have 
 9   been part of that, what I would call robust and fruitful 
10   dialogue. 
11             As my fellow Commissioners and I emphasized at the 
12   inaugural meeting of the FIMSAC, our aim is for this 
13   committee to be a valuable use of your time.  Now, one and a 
14   half years later, I can tell you that the issues you've 
15   raised and the recommendations that you've provided have 
16   indeed helped inform policy decisions and spur action by the 
17   Commission and FINRA. 
18             To that end, I'm pleased to announce that we are 
19   extending the committee's charter for one year to allow the 
20   committee to engage with FINRA, the Commission, and other 
21   interested parties as we consider and, to the extent deemed 
22   appropriate, implement the recommendations of the committee.  
23   We also would graciously appreciate it if you would continue 
24   to use this forum to keep the Commission apprised of 
25   developments in the fixed income market. 
0009
 1             Since the FIMSAC was created in November, 2017, 
 2   each meeting has been insightful and constructive.  FIMSAC 
 3   has issued eight recommendations on seven topics with two 
 4   more recommendations to be considered today.  That is 
 5   productive by any measure.  I'll deviate here.  Michael 
 6   asked me last night how many recommendations I thought you 
 7   would come up with in a two-year period, and I said I'm an 
 8   optimist so I thought four.  So you've at least doubled my 
 9   optimistic assessment at the outset. 
10             We appreciate these recommendations and want to 
11   move to the next phase, and I wanted to give you a sense of 
12   where we stand.  In response to two of FIMSAC's 
13   recommendation, FINRA has published for comment both a 
14   framework for a corporate bond block size pilot, and a rule 
15   proposal for new issue reference data for corporate bonds.  
16   Both of these plans explore challenging terrain, but we are 
17   better for the work to date.  I thank FINRA for their 
18   willingness to take a lead on these matters.  Our staff, 
19   many of whom are here today, stand ready to engage with 
20   FINRA and you on these topics. 
21             I'm going to make a personal comment here on this 
22   comment of challenging terrain.  Look, market structure, 
23   market function, liquidity, execution, these are areas where 
24   theory meets practice, and the limits of theory are exposed.  
25   I often summarize this by saying liquidity is not free.  
0010
 1   Another way to say it is that liquidity and execution are 
 2   not coextensive. 
 3             In other words, the real question is liquidity at 
 4   what price, that's the relevant question for our markets.  
 5   And as we look at our rule sets and try to explore these 
 6   important concepts of price discovery, liquidity, execution, 
 7   transparency are optimized for a fair market, we should 
 8   recognize that behavior will adjust to whatever rules we set 
 9   today or whatever rules we have set in the past.  And what 
10   that tells me is that with that behavior adjustment and 
11   technological developments, this is a constant exercise.  
12   Said another way, whatever we come up with today, there will 
13   be another group five or six years from now that needs to 
14   examine it.  That's just my view. 
15             Okay.  In response to other FIMSAC 
16   recommendations, the SEC is also actively considering the 
17   regulatory framework for fixed income electronic trading 
18   platforms as well as issues related to a classification 
19   scheme for exchange traded products.  Our staff is also 
20   engaging with FINRA to evaluate the practice known as 
21   pennying in the corporate bond market. 
22             This is just a short summary of the work being 
23   conducted in response to your efforts, and to be clear, we 
24   are also working on the recommendations I did not mention 
25   specifically. 
0011
 1             Turning to today's agenda, I'm especially looking 
 2   forward to the discussion on the content and timeliness of 
 3   municipal issuer disclosures.  This is an important topic 
 4   particularly for our Main Street investors that I have 
 5   addressed before. 
 6             The timeliness of municipal issuer financial 
 7   reporting is an area I believe can be improved.  It's also 
 8   an area where we've heard there are questions in the market 
 9   about the application of our Federal Securities laws and, in 
10   particular, how the anti-fraud provisions of the Federal 
11   Securities laws apply to information that is made publicly 
12   available by municipal issuers through various channels. 
13             It's not really a topic on today's agenda, but 
14   something that I want to address.  I've been informed 
15   recently that some issuers are receiving advice that in 
16   connection with the distribution of information that is 
17   material to an investment decision, disclosing that 
18   information to investors on the MSRB's EMMA system triggers 
19   a more rigorous liability standard for that information than 
20   disclosing the same information to investors through other 
21   means. 
22             While I intend to explore that matter further, and 
23   have not reached any definitive conclusions, there are 
24   various scenarios I can imagine where I have significant 
25   questions about this advice, and whether it is correct as a 
0012
 1   matter of law or policy.  Seems to me information is 
 2   distributed through one channel or through another channel, 
 3   you might want to have the same liability perspective. 
 4             I've directed our Municipal Securities -- Office 
 5   of Municipal Securities to put together a staff legal 
 6   bulletin summarizing the application of Federal Securities 
 7   laws to various disclosure scenarios, and thank them in 
 8   advance for their work on this important effort. 
 9             One of the two recommendations under discussion 
10   today relates to investor education around secondary market 
11   liquidity in the market for retail notes.  I am very glad 
12   you are tackling this specific issue where retail investors 
13   would benefit significantly from a better understanding of 
14   that market function.  More broadly, I understand the staff 
15   continues to work through your prior recommendation on 
16   investor education. 
17             I cannot overstate the importance of raising the 
18   level of understanding of our markets and retail investment 
19   services among our Main Street investors.  This is one 
20   reason why, in connection with the standard of conduct 
21   rulemaking package we recently passed, we launched a Main 
22   Street investor education campaign designed to help retail 
23   investors understand key differences between broker-dealers 
24   and investment advisors as well as the fees and costs they 
25   are incurring so that they can make better decisions based 
0013
 1   on their individual needs and circumstances. 
 2             This campaign will include a short -- will include 
 3   short educational videos, updates of our website, 
 4   investor.gov, and retail investor events around the country, 
 5   including taking into consideration your recommendation 
 6   today.  If investors don't understand that in the same name 
 7   there's different liquidity and notes, we should make sure 
 8   that they do. 
 9             Thank you, Michael. 
10             MR. HEANEY:  Thank you, Chairman Clayton. 
11             I'd also like to welcome Commissioner Lee to her 
12   first FIMSAC meeting.  And for those who don't know, she was 
13   sworn in, I believe, just three weeks ago.  So welcome to 
14   FIMSAC, and I turn it to you for opening comments. 
15             COMMISSIONER LEE:  Thank you.  Thank you, Chairman 
16   Clayton for the welcome, and thank you, Michael and the 
17   committee for having me today. 
18             This committee's work to enhance execution, 
19   access, and transparency in fixed income markets is critical 
20   to the Commission's efforts in this area. 
21             I'll be very brief this morning because I'm mainly 
22   hear to listen and to benefit from your expertise. 
23             Broadly, the fixed income markets have been 
24   traditionally the domain of institutional investors, 
25   government entities, corporations, and financial 
0014
 1   institutions, but these markets have been evolving, and 
 2   issuers have developed an ever-larger variety of products 
 3   sold directly to individual or retail investors.  And in 
 4   particular, we know these products can be attractive to 
 5   retirees.  Fixed income products can have different 
 6   characteristics from those that many retail investors may 
 7   typically be familiar with, and this means that both 
 8   investor education and clear understandable and timely 
 9   disclosure becomes paramount concerns. 
10             I very much appreciate your attention to this and 
11   all the other issues under consideration today.  I know how 
12   busy you all are with your day jobs, and I thank you very 
13   much for lending your expertise and your valuable time to 
14   supporting the SEC's mission.  I'm very impressed with eight 
15   recommendations.  That's a lot of work, and I appreciate it. 
16             And then lastly, I just have to say hello to my 
17   fellow-Coloradan, Amy McGarrity.  I happen to be a member of 
18   COPERA from years ago. 
19             So thank you.  Thanks to all of you. 
20             MR. HEANEY:  Thank you, Commissioner Lee. 
21             Next I'll turn it over to Brett Redfern, Director 
22   of the Division of Trading and Markets, and the committee's 
23   designated Federal officer. 
24             MR. REDFERN:  Thank you, Michael. 
25             And I would also like to welcome everybody today 
0015
 1   to today's FIMSAC meeting. 
 2             Well let me first briefly introduce my colleagues 
 3   to the right -- or with me here today.  So Lizzie Baird is 
 4   one of the deputies in the Division of Trading Markets.  And 
 5   to her right is Dave Shillman, Associate Director in the 
 6   Office of Market Supervision.  To the left side of the table 
 7   we have Rebecca Olsen, Director of the Office of Municipal 
 8   Securities, as well as SP Kothari, Chief Economist and 
 9   Director of the Division of Economic and Risk Analysis. 
10             Before we get started, I need to remind you that 
11   the views expressed here today by staff are those of the 
12   speaker and do not necessarily reflect those of the 
13   Commission, any Commissioners, or other members of the 
14   staff. 
15             I'd like to start also by thanking the members of 
16   FIMSAC for continuing to devote so much time to a very busy 
17   -- in light of very busy schedules to all of the issues that 
18   are before us.  Your continued willingness to display and 
19   thoughtfully engage on some of the truly challenging issues 
20   is just incredible.  So we really appreciate your continued 
21   engagement. 
22             Our fixed income markets, which are predominantly 
23   over-the-counter dealer markets, face a distinct set of 
24   challenges given the extensive number and variety of 
25   instruments available for trading, the growing impact of 
0016
 1   technology, and the involving role of intermediation.  
 2   Pursuing a policy agenda that improves market quality and 
 3   efficiency and provides important benefits to investors in 
 4   the face of these unique challenges is a difficult task. 
 5             The committee's input plays an increasingly 
 6   important role in our consideration of fixed income market 
 7   structure policies that advance this agency's mission to 
 8   protect investors, maintain fair, orderly, and efficient 
 9   markets, and facilitate capital formation.  We really 
10   appreciate your continued willingness to take on such 
11   challenging issues and candidly share your insights with us. 
12             I want to reiterate that all interested parties 
13   may submit comments on the work of the committee by the 
14   FIMSAC webpage and the SEC's website.  All preliminary 
15   recommendations brought to the committee for consideration 
16   and all of the recommendations approved by the committee are 
17   available on the FIMSAC webpage.  I encourage also members 
18   of the public to review these materials and participate in 
19   the policy making process by offering their input. 
20             In addition, I encourage market participants to 
21   come in and meet with us, in person, to discuss these and 
22   other important issues impacting our corporate bond and 
23   municipal securities markets.  Input and engagement from 
24   market participants is extremely helpful to our policy 
25   formation process. 
0017
 1             Moving to today's agenda, this morning you will 
 2   consider recommendations from the Corporate Bond 
 3   Transparency Subcommittee and the Municipal Securities 
 4   Transparency Subcommittee.  These recommendations reflect 
 5   the FIMSAC's subcommittees' continued focus on the issues 
 6   that particularly impact retail investors transacting in our 
 7   bond markets. 
 8             First, the Corporate Bond Transparency 
 9   Subcommittee will discuss a preliminary recommendation that 
10   seeks to ensure retail investors are educated about the 
11   uses, characteristics, and risks of retail notes.  These 
12   notes are a particular type of corporate bond that are often 
13   made directly available to retail investors. 
14             Second, the Municipal Securities Transparency 
15   Subcommittee will discuss a preliminary recommendation that 
16   would facilitate investment advisors trading in a principal 
17   capacity with advisory clients seeking to sell bonds.  As 
18   you recall, FIMSAC previously discussed this preliminary 
19   recommendation at the April 15th public meeting. 
20             I look forward to discussions on these 
21   recommendations as well as those of the panels this 
22   afternoon.  Again, thank you to all the FIMSAC members for 
23   continuing to devote so much of your time to this 
24   committee's important work.  I truly look forward to today's 
25   discussion. 
0018
 1             And with that, I turn it back over to you, 
 2   Michael. 
 3             MR. HEANEY:  Thank you, Brett. 
 4             As Brett just noted, we'll spend our morning 
 5   considering two preliminary recommendations.  Both of these 
 6   recommendations have been months in the making.  I remind 
 7   everyone, our role as a committee is to consider the 
 8   structure of our fixed income markets and identify areas for 
 9   potential improvement.  Notwithstanding the impressive 
10   collection of expertise around the table, we often consult 
11   outside experts who have particular perspectives on topics 
12   under discussion and include them in both subcommittee calls 
13   and at our public meetings. 
14             The two recommendations we will consider today 
15   have indeed benefited from the input of an array of market 
16   participants.  In addition to our members, I'd like to thank 
17   all those individuals, while not on the committee, have 
18   devoted their time over the last year and a half to 
19   meaningfully engage in FIMSAC's work and help us develop 
20   thoughtful actionable recommendations to the SEC. 
21             In addition to our considerations of the 
22   preliminary recommendations this morning, this afternoon 
23   we'll host two panel discussions.  The first panel, which 
24   Chairman Clayton referred to, will discuss the content and 
25   timeliness of disclosures by municipal issuers.  The second 
0019
 1   will include representatives from issuers, bond 
 2   underwriters, and credit rating agencies who will discuss 
 3   some of the key issues from the Credit Ratings Subcommittee 
 4   which have been considered over the past several weeks.  
 5   These include conflict of interest, the ratings payment 
 6   structure, and concentration in the market for credit 
 7   ratings. 
 8             As a reminder, during our discussions, please I'd 
 9   ask that people raise their nametags so that we can have a 
10   open and constructive dialogue and inclusive of everybody's 
11   points of view. 
12                 DRAFT RECOMMENDATION FOR INVESTOR 
13                  EDUCATION REGARDING RETAIL NOTES 
14             MR. HEANEY:  For our first panel, we will consider 
15   the recommendation from the Corporate Bond Transparency 
16   Subcommittee on developing an educational bulletin 
17   addressing retail notes.  The draft recommendation developed 
18   by the subcommittee describes some of the unique attributes 
19   of these notes as compared to those of the larger bond 
20   issuance that are typically sold to institutional investors. 
21             I'll turn it over to Mihir, Chair of the Corporate 
22   Bond Transparency Subcommittee to summarize the preliminary 
23   recommendation for us and moderate the panel.  Mihir. 
24             MR. WORAH:  Great.  Thanks, Michael.  And thanks 
25   to Jim, and Jay, and Brett, and other Commissioners. 
0020
 1             So today we have a recommendation concerning a 
 2   small but important part of the corporate bond market.  
 3   These are retail notes, and as Brett mentioned, these are 
 4   notes that corporate issuers sell directly to retail 
 5   investors.  There's many characteristics about these notes 
 6   that retail investors find attractive.  There's a regular 
 7   weekly issuance pattern.  They often have yield enhancement 
 8   features with embedded calls, and they have -- often have 
 9   something called a survival option where the beneficiaries 
10   of the note purchaser can put these back to the issuer at 
11   par. 
12             So while these have attractive features, we also 
13   found during research that they have, you know, some 
14   concerning aspects to them.  Primarily, the turnover and 
15   transaction costs in these notes compared to other notes 
16   issued by the same corporation or the same issuers are 
17   significantly higher. 
18             So we have a recommendation concerning that, but 
19   before I go into the details of the recommendation, we 
20   thought we'd have a panel of experts on these retail notes 
21   educate the rest of the FIMSAC as well as the SEC just like 
22   we were -- our subcommittee was educated on these retail 
23   notes. 
24             So as part of the panel we have a variety of 
25   participants in the retail note markets, and hopefully 
0021
 1   they'll educate us and shed some light for us on how these 
 2   markets work and why issuers use them, how you think 
 3   investors use them. 
 4             So sitting on the panel starting from the left, 
 5   Susan Sheffield from GM Financial.  Sarah Tucker from 
 6   Raymond James.  Brian Walker from Incapital, which is one of 
 7   the largest underwriters of these retail notes.  And on the 
 8   phone we have Brad Winges from Hilltop Securities, who is a 
 9   FIMSAC member. 
10             So before I turn it over to the panel with some 
11   questions, why don't we take a couple minutes for each of 
12   the panelists to introduce themselves, and their firm, and 
13   what they do.  So let's start with Susan. 
14             MS. SHEFFIELD:  Okay, thank you.  I'm really 
15   pleased to be here, and thank you for the invitation to come 
16   participant on the panel. 
17             My name is Susan Sheffield, I'm the Chief 
18   Financial Officer at GM Financial, and we are GM's captive 
19   finance company.  We're based in Fort Worth, Texas.  And as 
20   a finance company, we are obviously very regular issuers of 
21   the debt markets both on the unsecured side and the ABS 
22   side, and retail notes is a very important part of our 
23   funding platform from diversification, and it's our way to 
24   reach retail investors directly through using capital. 
25             MS. TUCKER:  Good morning.  This is Sarah Tucker, 
0022
 1   I'm with Raymond James Financial in St. Petersburg, Florida.  
 2   We're an investment firm that serves private clients with 
 3   over 7,800 advisors whose clients are individual Main Street 
 4   investors, many of whom purchase these so-called retail 
 5   notes and other fixed income securities. 
 6             MR. WALKER:  I'm Brian Walker, I'm with Incapital.  
 7   Incapital is the main underwriter of retail notes.  The 
 8   product that we offer through a number of issuers is called 
 9   InterNotes.  As Mihir had said, the -- it contains several 
10   unique features that a retail investor finds uniquely 
11   beneficial.  Things like the survivor option feature allows 
12   the estate to put it back to the issuer at par should there 
13   be a death of a noteholder.  And also an extended offering 
14   period.  They don't have to make a decision in a day, the 
15   notes are offered for a week, so it's pretty much a 
16   consultative kind of a situation. 
17             But the history, I'll give you just a brief 
18   history on the note program itself.  It actually started 
19   back in 1996, so it's been 23 years since retail notes have 
20   been offered to the public.  There's been over 278 billion 
21   dollars worth of the product offered, so it's widely 
22   distributed through virtually every member on the -- on Wall 
23   Street. 
24             Last year there was about 16 issuers issuing about 
25   1.6 billion in notes into the retail note market.  You know, 
0023
 1   it's very similar to a corporate note in that everything's 
 2   SEC registered.  There's a prospectus, prospectus 
 3   supplement.  There's a pricing supplement, all the terms are 
 4   fully disclosed.  And within those documents are a full 
 5   disclosure of the different risks involved to the issuer -- 
 6   or I'm sorry, to the investor, including liquidity risk, 
 7   interest rate risk, credit risk, tax implications.  So there 
 8   -- and all -- and we've also produced quite a few materials, 
 9   as Sarah would probably also buttress with her, educational 
10   materials that gets into retail hands are all FINRA-
11   reviewed. 
12             So there's been quite a bit of disclosure, there's 
13   quite a bit of transparency, there's quite a bit of 
14   liquidity.  And I was going to say also similar to 
15   institutional notes, all the notes are TRACE reported, so 
16   every trade, whether it's a five bond, or 50 bond, or 
17   whatever the size, it all gets reported into the TRACE and 
18   all fully disseminated. 
19             So it's been a very attractive product for retail 
20   because they can actually participate in a new issue whereas 
21   they can't on an institutional deal.  And they're largely 
22   buy and hold investors anyway that are seeking coupon return 
23   rather than total return as an institutional investor would.  
24   So I think it's been a good product over all those years for 
25   both the issuer side and for the retail side to participate 
0024
 1   directly in a direct issuance of fixed income. 
 2             MR. WORAH:  Thanks, Brian.  And we'll get back to 
 3   some of those same issues as we discuss further. 
 4             Brad's on the phone.  I think most of us know 
 5   Brad.  Brad, do you want to do a quick introduction for some 
 6   -- maybe for some of the panelists who may not know you? 
 7             MR. WINGES:  Yes.  Thank you. 
 8             I'm Brad Winges, President and CO of Hilltop 
 9   Securities.  I am an active FIMSAC member.  You know, one of 
10   the comments I'll make, I'm glad that we're having this 
11   conversation about market transparency and structure, as 
12   Commissioner Clayton's indicated.  That's the purpose of our 
13   panel and discussion is making sure that investors of all 
14   kinds, institutional and retail, get the transparency and 
15   the education they need to understand liquidity and market 
16   structure. 
17             So as it relates to this particular topic, I want 
18   to highlight that, as was indicated by Incapital, it is a 
19   good product for both retail investors and institutional 
20   investors at times -- or issuers, excuse me -- have 
21   different needs and the uniqueness of this product has been 
22   very beneficial to a lot of retail investors over the years, 
23   and as well as to corporate issuers. 
24             With that said, there's also, though, an 
25   increasing amount of true structured notes being issued out 
0025
 1   into the market, not just the Internote program, but you can 
 2   go out and pick your coupon, pick your structure, pick your 
 3   call, and through electronic exchanges that are out there, 
 4   issue as little as 25 bonds with an individual CUSIP.  And 
 5   the uniqueness of those individual CUSIPs, it's my opinion, 
 6   is not necessarily understood, and that's a lot different 
 7   than the Internote program that we're going to be talking 
 8   about today. 
 9             So there's really three levels of the corporate 
10   bond market that exists, and that are continuing to grow.  
11   One is the institutional market, one is the Internote market 
12   that's been around since the late 1990s, as was indicated, 
13   and now the increasing ability using technology and the 
14   electronic exchanges for corporations and advisors to 
15   connect and issue their own corporate security that may or 
16   may not fit necessarily the individual investor's needs.  
17   But at the end of the day, the liquidity on that security 
18   could vary pretty vastly in a little bit more volatile 
19   environment, and that's I think the main topic that we're 
20   talking about today. 
21             MR. WORAH:  So Brad, just to stick with you, you 
22   highlighted this to us around October.  So your big concern 
23   is the liquidity and whether retail investors understand 
24   what they're getting or not.  Any other issues?  What's been 
25   your experience, have you been personally involved in these 
0026
 1   markets, either on the broker-dealer side or on the advisor 
 2   side? 
 3             MR. WINGES:  We have advisors that do own these in 
 4   their various investor accounts, and we have seen them trade 
 5   out in the open market.  I would not claim that we're -- our 
 6   firm is an expert, nor would I claim I'm an expert in it.  
 7   It's a product that is growing significantly over the last 
 8   number of years, and I think several other panel members and 
 9   FIMSAC members recognize as well the institutional market is 
10   different than the retail market in the sense that option 
11   adjusted spread, and callability, and items like that, you 
12   know, vary widely. 
13             And it was indicated earlier by one of the panel 
14   members, most retail investors, and this is an important 
15   distinction that everyone needs to recognize, do tend to be 
16   buy and hold.  So they're yield seekers, and they're willing 
17   to give up some optionality and some other items in order to 
18   pick up that yield that an institution might not be willing 
19   to do because they tend to be more total return buyers, and 
20   they need daily or weekly liquidity on securities, depending 
21   on how they're managing their portfolio. 
22             So there is a distinction in those two markets 
23   based on liquidity and the need of the individual versus the 
24   need of the liquidity of an institutional money manager 
25   investor. 
0027
 1             MR. WORAH:  Thanks, Brad.  I think that's an 
 2   important point.  Many of us appreciate it and along with -- 
 3   I think we all, you included, also understand that as long 
 4   as the investors are fully aware of the liquidity 
 5   characteristics of what they're buying, and then it's their 
 6   choice whether they're buy and hold investors, and they're 
 7   willing to give up liquidity for the yield. 
 8             So let's turn to our other panelists now.  Let's 
 9   start with Susan.  As you said, GM Financial issues these 
10   retail notes along with other notes that large institutional 
11   investors buy.  Retail investors can also buy these larger 
12   notes in the secondary market.  So how do these retail notes 
13   fit into your overall capital structure?  How you think 
14   about them?  How's the program been going?  What's your 
15   issue and size?  Just give us some insights from an issuer's 
16   perspective. 
17             MS. SHEFFIELD:  Okay, sure. 
18             We started our program two years ago in August of 
19   '17, and we've issued about 558 million to date, and so far 
20   this year we've issued 205 million.  And we typically target 
21   tenors, you know, of two to 10 years given our asset base is 
22   auto finance products, which are typically shorter dated.  
23   And so that tenor scale fits nicely into how we manage our 
24   assets and liabilities. 
25             Again, it's not a huge part of our program.  We'll 
0028
 1   issue anywhere from say 10 to 12 billion in unsecured debt.  
 2   And so this is a small part of that, but it's an important 
 3   part from a diversification standpoint.  And while we would 
 4   like to do more, it's just the market, one, is fairly 
 5   competitive.  There are other options obviously for retail 
 6   investors to invest in.  Equity markets have obviously been 
 7   very strong.  And other avenues for them to look at. 
 8             So we believe education is really important and, 
 9   as many have mentioned already, there are some very 
10   attractive features of these bonds for retail investors like 
11   the survivor option.  And they can buy them at par as 
12   opposed to buying them -- an institutional bond, which they 
13   would not be able to buy on the primary market. 
14             So we like the product.  It's a nice part of the 
15   funding platform, and we'd like to do more of it, and we're 
16   committed to the platform. 
17             MR. WORAH:  Thanks a lot. 
18             And while we're on the issue of perspective, 
19   perhaps Scott, who is a FIMSAC member and wears the same hat 
20   at Verizon, can you give us your perspective?  I know 
21   Verizon issues these as well. 
22             MR. KROHN:  That's right.  So just to give some 
23   perspective, Verizon has about a hundred billion dollars of 
24   total unsecured debt outstanding.  The retail notes program 
25   for us is just over a billion dollars, so it's one percent 
0029
 1   of our total funding program.  But as Susan mentioned, it's 
 2   value diversification.  And, you know, I think it's been 
 3   mentioned, but I just want to emphasize it again, if you're 
 4   a retail investor on the primary side, retail notes has some 
 5   very good advantages.  You buy it at par, and you can buy it 
 6   in increments as low as $1,000.  So if you're a ma and pa 
 7   investor, and you're thinking about doing a CD, you know, 
 8   the retail notes could be an alternative to that. 
 9             When we get to the recommendation on further 
10   education, we spent a lot of time in the subcommittee 
11   looking at bid/ask spreads on retail notes versus, for 
12   example, a -- you know, and maybe on a given week Verizon 
13   will issue, you know, five or 10 million, and you compare 
14   that to a CUSIP, or an issuance that has two, or three, or 
15   four billion dollars, there's going to be a lot more trading 
16   in that much larger institutional bond. 
17             So I think it was pretty clear that, you know, 
18   liquidity is available on the retail notes, but the bid/ask 
19   spreads were wider than what you would find on a comparable 
20   institutional bond.  So I think that's part of what we're 
21   recommending as the -- as part of the bulletin is you could 
22   always source an institutional bond on the secondary market 
23   that might have better liquidity features in terms of 
24   bid/ask spread versus if you're not a buy and hold investor 
25   on the retail note and you decide to sell that bond. 
0030
 1             But as Susan mentioned, you know, the disadvantage 
 2   of trying to source in the secondary market is then you're 
 3   dealing with discounts, premiums, and some retail investors 
 4   aren't necessarily able to associate the coupon and the 
 5   yield of a on-the-run secondary institutional issuance 
 6   versus the very straightforward primary issuance of a retail 
 7   note. 
 8             So I am completely in support of the bulletin, but 
 9   there is -- if you're a buy and hold investor, I think the 
10   retail notes is quite advantageous and like GM Financial, we 
11   don't do any of the structured offerings, it's all plain 
12   vanilla unsecured maturities.  And in our case, because 
13   we're investing in cell towers and things that have very 
14   long lives, we're actually offering the retail market 
15   oftentimes between 10 and 30 years so there's a little bit 
16   of a variety depending on issuers and depending on what 
17   their funding needs are as to the tenor of the bonds that 
18   are offered. 
19             MR. WORAH:  Thanks, Scott. 
20             And before we turn to Sarah, everyone talks about 
21   the retail investor, I think Sara knows the most about the 
22   retail investor. 
23             Let's actually move to Brian.  He already gave us 
24   a bit of a flavor for the program, but how you guys -- you 
25   know, you guys are one of the largest underwriters of these, 
0031
 1   how you guys think about them?  What's the plumbing that an 
 2   issuer goes through before it gets directly?  Does it go 
 3   through a broker-dealer?  Does it go through you?  Just 
 4   educate us on the plumbing of this market and the creation 
 5   of these notes. 
 6             MR. WALKER:  Sure.  Yeah, absolutely.  So I -- as 
 7   I said before, so we're the main underwriter of new retail 
 8   notes that we call InterNotes, and that's just the 
 9   registered brand name that we give it.  But it's a primary 
10   note market, and they were designed to make investing for 
11   retail investors very easy to participate in new issue 
12   notes, because they never really had that opportunity 
13   before.  They might have some exposure through bond funds 
14   back in the day, and now maybe through ETFs.  And they might 
15   have exposure to, you know, fixed income per se, but they 
16   really don't have a note -- or ownership in a note that 
17   comes due at par. 
18             When you invest in a bond fund or an ETF, you just 
19   always have perpetual exposure to the duration of that fund.  
20   So this gives them an opportunity to actually participate, 
21   express a view, and an individual credit at some point along 
22   the curve for where the issuer issues the notes, and then by 
23   that note make a decision over a one week period of time, 
24   and then have the note come due at par. 
25             And so the other thing is that, as Mihir had said, 
0032
 1   it also has some -- a unique feature that's the survivor 
 2   option I mentioned before.  You can't get that in an 
 3   institutional note of any size, but it gives them liquidity 
 4   similar to what they would have experienced sometimes when 
 5   they buy a CD.  That gives some kind of liquidity back to 
 6   the CD buyer.  So that's a valuable benefit for them. 
 7             But the way it works is that each week we consult 
 8   with the issuer to decide what -- where on the curve, what 
 9   maturity note they want to issue, and where that spread 
10   would be.  At the end of the day, we end up being price 
11   takers to where their notes trade in the secondary market, 
12   and that's our cue for how to price the new note.  So we 
13   look to see where they trade, what -- if they want to be on 
14   the short end of the curve or the longer end of the curve, 
15   and we price the retail note accordingly. 
16             So -- and we offer the note in two ways, either at 
17   par, where it's sold through a commissioned account where 
18   the retail broker gets paid a commission to sell it.  Retail 
19   brokers, you know, have a higher percentage fee than an 
20   institutional salesman would have so the cost of having that 
21   distributed through a retail broker is reflected in the 
22   coupon, which is why you see notes of similar tenors for 
23   even a given issuer.  For example, in Verizon's case or any 
24   other issuer, they might have an exact same final maturity 
25   with an institutional note to a retail note, and the coupons 
0033
 1   would be slightly different because you have to pay for the 
 2   distribution cost. 
 3             So that's the main driver of the difference 
 4   between coupons that you might see on a given maturity 
 5   within a given issuer. 
 6             But we don't have any direct customers, we just 
 7   connect the dots between the issuer and then act as a funnel 
 8   aggregating all the orders that are sold by brokers through 
 9   their reps to their clients throughout the week.  So we'll 
10   typically price the note on a Monday, do the SEC filings, 
11   and then it's sold for the week to the retail investor.  
12   Orders are aggregated for that week, and then at the end of 
13   the week, one week later, we terminate the offering period, 
14   determine the notional amount, generate another final 
15   pricing supplement that gets filed with the SEC, and then 
16   that's the amount that gets settled up with the issuer every 
17   week.  So it's super efficient for them.  They have access 
18   to 600, 700 dealers, and thousands of brokers and, you know, 
19   tens of hundreds of thousands of clients, but yet they just 
20   have to settle one note with one amount through DTC. 
21             So it's very efficient.  It raises a lot of money 
22   for them that way.  And it's -- as we said earlier, it's 
23   very good for the retail customer, too, because they never 
24   had an ability to purchase. 
25             And as far as the liquidity, to Scott's point, 
0034
 1   too, if they average a notional size on these trades it's 
 2   between $5,000 and $10,000.  You're not going to see a lot 
 3   of trading like you would on a two billion dollar note, it -
 4   - they're just buying whole, you just don't see the 
 5   activity.  But when there is activity on any given day, you 
 6   could have up to 20 different market makers making a market.  
 7   They're traded on the ECNs, Tradeweb, and MarketAxess.  
 8   Everybody -- the platforms are all out there digitally 
 9   showing different bid and ask and aggregating supply from 
10   different brokers out there.  So it's very liquid, the 
11   prices are there. 
12             I think the price differences that we recognize 
13   between small trades and what I'd call institutional trades 
14   is merely based on the fact that it is a small trade.  So I 
15   think even a retail investor that buys a non-InterNote, but 
16   just buys a small piece of an institutional note is going to 
17   get the same kind of pricing as they would on an InterNote.  
18   So it's not unique to the InterNote product, but it is 
19   unique to the small size of the trade they're trying to 
20   execute. 
21             MR. WORAH:  Thanks, Brian. 
22             I think -- 
23             MR. KROHN:  Brian -- can I just ask Brian to make 
24   a comment on what's the -- as we think about protecting the 
25   retail investor, what's the composition of high yield 
0035
 1   issuers on your platform versus investment grade? 
 2             MR. WALKER:  So all the issuers are investment 
 3   grade on our platform.  The only exception is Ally 
 4   Financial, but every other issuer is an investment grade on 
 5   both sides. 
 6             MR. WORAH:  Thanks. 
 7             And so everyone's been talking about the retail 
 8   investor, let's go to Sarah who has firsthand experience.  
 9   Just tell us how your client base, do they -- what are the 
10   reasons they might be buying these notes, if they do, and 
11   what have you found in terms of secondary market liquidity, 
12   the motivations that are mostly buy and hold?  So educate us 
13   on your investor base. 
14             MS. TUCKER:  Sure.  So I've actually been working 
15   with advisors who give advice to the Main Street investor 
16   for almost 22 years, and my sole focus as the head of our 
17   taxable retail trading desk is to serve individual 
18   investors, working with those advisors.  
19             There are many of their clients, certainly the 
20   most obvious client that would want to buy true fixed 
21   income, and when I say true fixed income, what I'm talking 
22   about is not an exposure to fixed income held in some kind 
23   of package, or a proxy, or ETF, or something like that.  But 
24   I'm talking about an individual bond with a stated payment 
25   rate with an issuer that that client knows and can learn 
0036
 1   about through their advisor and through the various rating 
 2   services and trading that's reported.  It's got a stated 
 3   income that's predictable to them, and a final maturity.  
 4   And that final maturity generally is the true liquidity upon 
 5   which Main Street investors rely. 
 6             So if they're in retirement, this is an obvious 
 7   choice.  They seek a predictable cash flow to replace the 
 8   income that they used to earn working, and so that makes it 
 9   very attractive to them.  If they're nearing retirement, or 
10   really anyone who has significant assets to invest, and 
11   they're heavily weighted, if for no other reason than the 
12   longest recovery in the history of the equity market, 
13   they're heavily weighted to stock ownership, they sometimes 
14   want to take some of that risk off the table and diversify.  
15   And asset allocation has proven to be a very strong way to 
16   mitigate volatility in portfolios and to protect return of 
17   principal, not just return on their principal. 
18             And then some of our investors are folks that have 
19   a specific targeted goal for money that they want to know 
20   when they're getting that money back.  It may be college 
21   education for a child or a grandchild, some other specific 
22   targeted goal.  It's pretty easy for them to access these 
23   new issue notes that are being called retail notes because 
24   the platforms that we now use, the technology that has 
25   evolved over the last multiple years, allows an advisor to 
0037
 1   see these new issue offerings at par, that come once a week, 
 2   alongside the secondary notes from the same issuers.  And 
 3   why we love that is that it allows the advisor to share with 
 4   the individual Main Street investor all the attributes of 
 5   those different investment choices when we're speaking about 
 6   individual fixed income bonds, to compare them and contrast 
 7   them.  And these platforms that we use allow a really nice 
 8   tool to tee it up and let those clients compare those 
 9   things. 
10             Now usually they don't just buy an individual 
11   bond, okay.  This is not something you do with one dollar 
12   amount and one maturity.  The most common way that these fit 
13   into an investment portfolio is part of a very well 
14   diversified and staggered maturity bond portfolio or bond 
15   ladder.  And the ladder is truly a buy and hold strategy.  
16   But what is ideal for many investors is that it builds in 
17   liquidity.  So by laddering you might be laddering 
18   maturities of one year, two year, three year, four year, 
19   five year with your fixed income allocation, two, four, six, 
20   eight, ten years.  But with those various stated maturities, 
21   at which time you get the return of your par value, subject 
22   to the credit worthiness of the issuer, it builds in an 
23   opportunity for liquidity. 
24             What I noticed when I reviewed some of the 
25   materials that the subcommittee gathered and prepared to 
0038
 1   help with this examination is that there is a low percentage 
 2   of what they call liquidity, and liquidity is defined by 
 3   individual retail investors selling their bonds, their 
 4   InterNotes, their retail notes prior to maturity.  It's a 
 5   very low percentage of the time compared to the 
 6   institutional market.  Now I'm not at all surprised because 
 7   again, I think it represents that they do understand that 
 8   this is a buy and hold product. 
 9             These investors, these Main Street investors, are 
10   not flippers, they are not traders.  They are designing a 
11   portfolio that they're working out that specifically aligns 
12   with their individual needs, and so one would not expect to 
13   see a high volume of trading.  Not to mention the fact that 
14   the nominal amounts of these bonds and these issue sizes are 
15   indeed so much smaller, and therefore not suited for the 
16   institutional entities that must flip and trade regularly in 
17   large size, partially because if it's an open-end mutual 
18   fund, they've got to manage to a benchmark, or they've got 
19   inflows and outflows that mandate that they sell or buy 
20   bonds, sometimes at the worst possible time. 
21             Also I want to make sure that we cover -- there's 
22   a talk about transaction cost, and that the percentage of 
23   the transaction cost sometimes appears to be higher for an 
24   individual investor.  Some of the supporting material used a 
25   hundred thousand dollar trade.  Most of our investors don't 
0039
 1   invest a hundred thousand dollars on each individual issue.  
 2   But let's say it's 25 or 30 thousand dollars.  The 
 3   percentage of the transaction cost, that upfront cost, is 
 4   indeed a higher percentage than someone buying a million or 
 5   10 million bonds at a time.  No question, and no one should 
 6   be surprised at that. 
 7             But the difference here is that it's not just the 
 8   transaction cost that reflects the cost to the investor, but 
 9   rather the cost of ownership over time.  And if you look at 
10   the cost of ownership over time, if I'm an investor, and 
11   let's say I just invest $10,000 for a five year bond.  
12   $10,000, my advisor, if I'm paying him a commission or her a 
13   commission will get a $75 commission amount.  $75 one time, 
14   and I will not pay another dime for that five year time -- 
15   period of time.  So cost effectively, whether we're talking 
16   about the new issues that we're talking about here, or 
17   secondary issues, paying that upfront cost and holding to 
18   maturity gives you a prorated amount, gives you a better 
19   idea of what the true cost of ownership of fixed income is. 
20             There are other alternatives for income investing, 
21   some of which include exposure to bonds.  But none of those 
22   other alternatives can you get the guarantees of choosing 
23   your own maturity schedule and liquidity schedule knowing 
24   what you own and controlling the buy/seller hold position, 
25   and at such a cost-effective level. 
0040
 1             MR. WORAH:  Thanks, Sarah 
 2             I had one follow-up question, and then we can open 
 3   it up to the rest of the group for -- 
 4             MS. TUCKER:  Sure. 
 5             MR. WORAH:  -- questions of our panelists as well. 
 6             So my follow-up was for Brian in general and Susan 
 7   and Scott as it applies to GM or Verizon.  These notes have 
 8   -- you know, they're callable by -- how often is this call 
 9   exercised?  How often do you see the survivor option being 
10   exercised? 
11             MS. SHEFFIELD:  Our platform is pretty young, and 
12   so far we have seen hardly any survivor option opportunity 
13   taken yet.  I would imagine that we will at some point, 
14   obviously as it ages, and that's -- obviously we've talked 
15   about it attractive for the retail -- 
16             MR. WORAH:  Would GM efficiently exercise the call 
17   option if you were getting more? 
18             MS. SHEFFIELD:  I mean, we could.  We have not yet 
19   to date. 
20             MR. KROHN:  Yeah, on our side we would look, you 
21   know, at the going yield curve, an issuance curve for, you 
22   know, Verizon's bonds, and compare that to the retail notes 
23   to determine whether to call. 
24             MR. WALKER:  Sure.  On the survivor option 
25   question, we generally see per issuer the amount put back in 
0041
 1   any calendar year is usually less than one percent, but 
 2   always usually less than two percent of the total amount 
 3   outstanding for that issuer.  So they have the right but, 
 4   you know, it has to be submitted by the estate on the death.  
 5   So it doesn't happen that often, but it does give them that 
 6   additional liquidity. 
 7             On the call side of it, most of the notes have a 
 8   call feature embedded in them which allows the issuer to 
 9   call the note prior to maturity.  And with the last cycle 
10   downward in interest rates, we saw quite a few bonds being 
11   called, which is not unusual.  So as I said, there's been 
12   two hundred and almost eighty billion issued.  There's still 
13   22 billion outstanding.  That's a combination of bonds that 
14   have matured and those that have been called. 
15             And the issuers -- or I should say the investors 
16   seem to fully understand it.  It's fully disclosed that it's 
17   the issuer's right to do it.  It's all described in the 
18   prospectus in terms of call period ability, when they call, 
19   and how frequently, and how much notification they need to 
20   give. 
21             So but, you know, we're currently at 22 billion 
22   out of the total amount that's been sold. 
23             MR. WORAH:  Great, thanks. 
24             Let me turn it over to the rest of the group.  
25   Chairman Clayton first. 
0042
 1             CHAIRMAN CLAYTON:  Terrific that you're here, and 
 2   boy my mind is buzzing here with a bunch of questions, 
 3   including like what's the value of the call option to the 
 4   issuer, and what's the cost of the survivor option to the 
 5   issuer, and how do those balance out? 
 6             What -- I -- one narrow question.  What's the 
 7   typical non-call feature or is there any non-call period on 
 8   this? 
 9             MR. WALKER:  I think the general rule of thumb is 
10   to try to have the call period to be about 20 percent of the 
11   final maturity.  So quite often you'd think of that as a 
12   five no-call one, or a 10 no-call two, or a 15 no-call 
13   three. 
14             CHAIRMAN CLAYTON:  Okay.  So there is a no-call. 
15             I do -- let me put it this way, I'm just as 
16   concerned that advisors understand the costs and benefits of 
17   these features as retail investors.  You know, if I do think 
18   that -- let me put it this way, I think your average advisor 
19   can understand a call feature, no-call period, a survivor 
20   option, but once you start going beyond that, I think we get 
21   into the more sophisticated advisors being able to 
22   understand those features.  That's just one person's view of 
23   the world. 
24             In terms of understanding what the costs of these 
25   are, is there any disclosure in the market about the 
0043
 1   difference in issuance, like do purchasers say okay, XYZ 
 2   bond is -- at an institutional market is three and a 
 3   quarter, and in this market it's three, and does that 
 4   disclosure take place? 
 5             MR. WALKER:  There's not a formal discussion of 
 6   any kind of subcomponent of the bond or what the valuation 
 7   theoretically might be so -- 
 8             CHAIRMAN CLAYTON:  No, I'm saying just from -- 
 9   what's the discount to the institutional bond?  Is that 
10   disclosed? 
11             MR. WALKER:  Well generally -- yeah.  They can -- 
12   you can make the comparison based on where TRACE is 
13   reported. 
14             CHAIRMAN CLAYTON:  Yeah. 
15             MR. WALKER:  But in terms of saying an 
16   institutional note trades at X level here, and this bond 
17   trades -- the retail note trades here, there's not a direct 
18   single page kind of comparison that would show that.  And it 
19   is a -- and I would say it is kind of a -- it's a market 
20   discussion between issuer and us.  And even among traders 
21   you can have difference, variance, and discussion about what 
22   is the right level across the curve, because quite often 
23   you'll have notes in the secondary market that have a very 
24   high coupon, and so they naturally want to trade above par, 
25   but there's a lot of resistance to truly trade fully above 
0044
 1   par, so they seem to trade cheap on our yield basis. 
 2             So an issuer's new issue curve is not always 
 3   reflective of where their secondary -- 
 4             CHAIRMAN CLAYTON:  I understand all that.  I just 
 5   -- 
 6             MR. WALKER:  All that kind of stuff.  And so the 
 7   big debate is -- 
 8             CHAIRMAN CLAYTON:  I'm just trying to -- you know, 
 9   my people, retail investors, I'm trying to say, okay,  
10   here's how much you're paying vis a vis what an 
11   institutional investor would pay for the fact the 
12   distribution costs more, and you've got a survivor option, 
13   and maybe the call option will offset that or not, depending 
14   on where it's at.  How do you have that conversation with 
15   the customer? 
16             MS. TUCKER:  May I speak to that? 
17             CHAIRMAN CLAYTON:  Yeah. 
18             MS. TUCKER:  So our advisors, when they show an 
19   offering to their clients, do have access to compare and 
20   contrast quite easily.  There is -- there are tools in the 
21   offering platform that you check a box next to -- let's say 
22   you did a Verizon or a GM bond with a comparable maturity 
23   that might be a global issue versus the new issue, and it's 
24   going to show whether there's a yield pickup on one or the 
25   other. 
0045
 1             What's nice is it's kind of an apples to apples 
 2   comparison because they can do it with the same compensation 
 3   so that you really can see the difference.  And in those 
 4   instances where the yield is better on one or the other, 
 5   guess what, it's very easy for them to make that decision 
 6   and have that guidance. 
 7             It's a transparent marketplace.  Just to give you 
 8   an idea on this trading platform because some people who 
 9   haven't seen it face to face firsthand are surprised.  But 
10   on any given day, in investment grade offerings, our 
11   advisors have over 85 to 100 dealer's offerings comingled 
12   alongside one another with significant depth of market in 
13   some of the larger issue sizes.  And for any specific 
14   maturity range, they might have hundreds of line items from 
15   which to choose. 
16             Now we can filter that down based on do they 
17   already own enough exposure to telecom or bank and finance, 
18   but it's very easy for the advisor to tee up a nice 
19   comparison in a client facing piece to show those tradeoffs 
20   and make that decision. 
21             CHAIRMAN CLAYTON:  Yeah, but my -- I mean, the 
22   motivation for my comments is both on issuance and trading.  
23   How do you explain the delta to the institutional market to 
24   a retail investor in a way that they can capture it?  If 
25   that's discount and spread on issuance, and if it's discount 
0046
 1   on trading.  Are people able to explain that in kind of 
 2   plain English? 
 3             MS. TUCKER:  Well, I don't think my retail 
 4   investors talk in spread at all.  They talk about yield, and 
 5   maturity, and issuer, and really generally that's the 
 6   comparison that's made to the Main Street investor is what 
 7   is the yield, what is the maturity, does this align? 
 8             CHAIRMAN CLAYTON:  Yeah.  And the one more thing 
 9   is, the -- for a comparable maturity your yield is 25 BPS 
10   below what an institution would pay, or five BPS, or 
11   whatever it is.  I mean, that's -- that to me is interesting 
12   information, but maybe I'm not your typical Main Street 
13   investor. 
14             MS. TUCKER:  No.  Well, probably not. 
15             (Laughter.) 
16             MS. TUCKER:  Probably not.  But do understand, 
17   what we have to compare it to is what do they really have 
18   access to. 
19             CHAIRMAN CLAYTON:  Yeah. 
20             MS. TUCKER:  Because they don't have a million or 
21   10 million to put down. 
22             CHAIRMAN CLAYTON:  Oh, I get it. 
23             MS. TUCKER:  And so -- 
24             CHAIRMAN CLAYTON:  And look, we're giving -- look, 
25   I kind of like it.  I just want to make sure they're making 
0047
 1   good choices. 
 2             MS. TUCKER:  Right. 
 3             CHAIRMAN CLAYTON:  And then the last comment I'll 
 4   make is a self-serving one, which is the way you said it 
 5   that this is an example.  We've had debates around here 
 6   about Commission-based pricing or, you know, what I will say 
 7   is kind of continuous pricing.  This type of buy and hold 
 8   ladder strategy is a clear example where a commission-based 
 9   pricing is likely to be more beneficial to a client than 
10   another pricing model.  I'll just leave it that. 
11             MR. WORAH:  Thanks, Chairman. 
12             And I think our educational questions were exactly 
13   around those lines. 
14             CHAIRMAN CLAYTON:  Sorry. 
15             MR. WORAH:  The end investor probably sees a 
16   static yield to maturity, yield to call, and not, you know, 
17   the -- what is the price of the option.  That's exactly part 
18   of the education that we are recommending. 
19             But let's move on.  Gilbert. 
20             MR. GARCIA:  Yeah.  This is sort of a related 
21   question.  So what roughly is the yield differential between 
22   -- or coupon differential between a retail note and a 
23   institutional note?  And if you could just give me some 
24   sense for, are retail investors, are they aware of TRACE, do 
25   they know about TRACE, do they have TRACE data?  I mean, is 
0048
 1   that common for them? 
 2             MR. WALKER:  Yeah, I'll speak to the first part, 
 3   and I think Sarah can address the second part. 
 4             So to put the note into a commissioned account 
 5   where the broker is paid a commission to sell that note to 
 6   his customer, the difference is going to be about 20 to 25 
 7   basis points in just the coupon differential.  So -- and 
 8   that would be pretty much equivalent to if Sarah or any of 
 9   the other dealers go out and source a note, even an 
10   institutional note, and want to put that into a commissioned 
11   retail account.  They're going to have to buy that note, 
12   mark it up to pay for the commission, which would be similar 
13   to what we're doing on a brand new issue note. 
14             The only difference is we're doing it at par and 
15   it comes due at par.  In the secondary they might be going 
16   out and buying it at 99 and marking it up to 101, or 100 and 
17   a half, or something like that. 
18             So the fee to get it into the retail customer's 
19   hand in a commissioned account is going to be the same 
20   whether it's the primary retail note or a secondary note, 
21   even if it's an institutional note, global note, a two 
22   billion dollar note, they're still going to mark it up to 
23   put it into the retail customer's hands.  So that's the 
24   equivalent in the primary or secondary market. 
25             What we've done in the primary market, though, now 
0049
 1   additionally in the last couple of years is to include some 
 2   language that allows that note to be sold into a fiduciary 
 3   account or to a fee-based account where they can buy it 
 4   below par, they don't have to pay a thousand dollars at the 
 5   offering date, they can pay something slightly below so that 
 6   they don't have to incur a commission and pay their fee-
 7   based account in conjunction.  They just have to put the 
 8   account -- a note will go into their account and they'll 
 9   just have their regular fee-based fee that goes on the 
10   account. 
11             MR. GARCIA:  And on the TRACE data.  Sarah, you 
12   were going to talk about TRACE. 
13             And one more related question, if you could. 
14             MS. TUCKER:  Sure, sure. 
15             MR. GARCIA:  On the trading desk themselves, are 
16   they traded separately from the institutional traders or are 
17   they the same book? 
18             MS. TUCKER:  Okay.  So let's go first to TRACE and 
19   price discovery.  It's really so different from when I first 
20   entered the bond business years ago when everything was kind 
21   of voodoo, and even from trader to trader you didn't know 
22   where things traded and how much they were marked up. 
23             The Main Street Investor's fully aware of TRACE, 
24   and MSRB for that matter.  It is on confirmations when they 
25   purchase.  It is disclosed to them by their advisors that 
0050
 1   they have access to this information.  So -- 
 2             MR. GARCIA:  What do you mean it's disclosed, the 
 3   TRACE is disclosed?  Do you mean recent bids and offers or -
 4   - 
 5             MS. TUCKER:  Oh, actually, the confirmation -- no, 
 6   the confirmation actually gives them a link to TRACE.  The 
 7   confirmation also these days posts the prevailing market 
 8   price disclosure changes that took effect in 2018 also gives 
 9   them a really terrific access to the bond facts website that 
10   shows where you've got TRACE reporting, so you can see 
11   actually the prices at which bonds have traded.  But you 
12   also get links to the offering documents, the details of the 
13   issue, and questions that you as an investor should ask your 
14   advisor or ask yourself before buying the bond to make sure 
15   that you have those considerations brought to your 
16   attention. 
17             So it's -- there's some really good resources out 
18   there for individual investors that years past didn't exist.  
19   So that's terrific and really helpful. 
20             We also train our advisors on fixed income.  I 
21   personally have been doing that for the better part of 15 or 
22   20 years, specifically about this. 
23             And the other question is trading, where does that 
24   trading occur?  So the traders that work in our retail group 
25   at Raymond James trade both the institutional size global 
0051
 1   issues and the medium term notes alongside.  And, in fact, 
 2   as we elect to show through an offering of the new issues, 
 3   the trader that has expertise in that sector is evaluating 
 4   that that offering is in market context before showing it 
 5   through to our investors -- to our advisors to share with 
 6   their investors, and we monitor that. 
 7             So they've got the expertise for those sectors of 
 8   bonds, they've got the ability beyond just allowing an 
 9   advisor to see them alongside, but also to get that second 
10   set of eyes.  And actually their phone number and their name 
11   is put on our offerings so that an advisor can call directly 
12   to the trader and say, you know, this looks to be a little 
13   lower yielding, or higher yielding, or what have you.  
14   What's your perspective? 
15             MR. HARRIS:  The institutional bonds that we've 
16   been putting up as, in some cases, the foil to these bonds 
17   are actually quite frequently traded by retail clients as 
18   well.  The advantage that the retail client obtains when 
19   trading these normal issues or more common issues is that 
20   there are other people who are constantly pricing them, and 
21   so that the prices that you see are liable to be the result 
22   of deep analyses that are well beyond the capacity of the 
23   retail clients and even their advisors.  And so there's an 
24   advantage there. 
25             The protections that a investor into the 
0052
 1   InterNotes would obtain is that the issuers, if they're 
 2   competing with each other on a common basis, that is that 
 3   they're all selling similar bonds, will be competing to get 
 4   the attention of the investment advisors and ultimately the 
 5   retail clients.  And so I think it's very important that 
 6   these bonds have fairly similar terms across the various 
 7   issuers. 
 8             Now we are not here to specify that that be the 
 9   case, but my sense is if we're to try to prevent deeper 
10   problems and try to keep from returning to this point, it 
11   would be really useful if the calls were standardized to be 
12   the -- say five on one or whatever the notion is and so 
13   forth, so that these bonds were comparable across issuers.  
14   And then if there are plenty of issuers, then we'll get the 
15   type of protections that we'd otherwise need. 
16             I had one specific question, though, that I wanted 
17   to ask Brian, and this just reflects my lack of knowledge 
18   about these issues.  What happens to the survivor option 
19   upon a secondary transfer?  So you got a trade.  Does the 
20   survivor option go to the new purchaser, or is it still 
21   conditioned on that person's life? 
22             MR. WALKER:  So if the primary noteholder dies and 
23   they don't exercise the option and -- 
24             MR. HARRIS:  No, no, no.  If -- so the primary 
25   note holder decides that they want to sell it, and they've 
0053
 1   got essentially some condition on their life, does that 
 2   condition stay with the original primary noteholder, or does 
 3   it go to the next one? 
 4             MR. WALKER:  No, it passes to the next one. 
 5             MR. HARRIS:  Oh, that's interesting. 
 6             MS. TUCKER:  That's true on the InterNote 
 7   structure for the most part, although there have been other 
 8   issuers using different shelves that had different 
 9   limitations and requirements, and we make sure that that's 
10   pointed out to our advisors and our clients.  But for the 
11   most part, yes, if you buy it in the secondary market, it's 
12   now your lifespan that determines whether or not the 
13   survivor option is available to your beneficial owners. 
14             MR. HARRIS:  One final quick question.  Has the 
15   insurance regulators in the various states ever been -- 
16   become interested in this issue?  It's essentially a -- has 
17   elements of being a life insurance product. 
18             MR. WALKER:  Yeah, there's definitely an actuarial 
19   element to it because you are basing it on the demographics 
20   of the buyer, which aren't really known to the issuer or to 
21   us.  The insurance companies used to be big issuers of it, 
22   and it did go through an analysis, and it was -- wasn't an 
23   issue for them.  So insurance companies in the past that 
24   have issued have been Prudential, Protective, Hancock.  
25   They've all issued the notes and all gone through the same 
0054
 1   analysis. 
 2             MR. HARRIS:  And the issuers are protected by the 
 3   call so that they probably don't have too much exposure, 
 4   right?  So their fear is that -- the fear would be that the 
 5   interest rates rise, bond values drop, the clever person 
 6   transfers this into the name of somebody ready to die, and 
 7   the issuers get hurt. 
 8             MR. WALKER:  Yeah.  There could be an adverse 
 9   selection if somebody were to try to go down that path. 
10             MR. HARRIS:  Yeah.  Thanks. 
11             MR. WORAH:  There's a number of questions, but in 
12   the interest of time, let me turn it over to Michael. 
13             MR. HEANEY:  I just want to bring it back to think 
14   about the evolution of this market.  This -- the medium term 
15   note market started in the '80s, and that was really driven 
16   not by retail but by institutions, and it was really driven 
17   by the insurance companies who were trying to match assets 
18   and liabilities.  And so you had desks that were creating 
19   bespoke products, GM was a very big issuer of this back in 
20   the day, where insurance companies said, I need to match at 
21   this liability date, I'm looking for XYZ yield.  And it was 
22   a flourishing business because of the demand from the 
23   buyers. 
24             This became on offshoot for retail of exactly 
25   that.  And so you can think about how you standardize it, 
0055
 1   but actually this is about as bespoke demand as you will 
 2   see.  People want -- my kid's going to college in 10 years, 
 3   I want a 10-year maturity.  Now the call features, again, 
 4   can vary because that's going to determine how much extra 
 5   yield or not you'll receive.  So I don't think you want to 
 6   standardize this. 
 7             This goes back to the theory and in practice.  In 
 8   practice this works, and there are people who want to buy it 
 9   because you can tailor-make a product for them.  And I think 
10   this is -- I don't think we're really debating whether this 
11   is good or bad, it's really just the specifications around 
12   education and knowledge around it. 
13             Let's not forget, and everyone around this table 
14   will know, a two billion dollar underwritten deal has a heck 
15   of a lot more liquidity than a 200 million dollar 
16   underwritten deal.  Same issuer.  It's down the trickle to 
17   the smallest size of why you would see bit offer spreads, 
18   and the subcommittee has gone through this in detail, wider 
19   bid offer spreads.  For the rest of those FIMSAC members not 
20   on that -- this subcommittee. 
21             So I just throw those points outs. 
22             MR. WORAH:  Clearly this is a very interesting 
23   topic.  There's a lot of questions.  Let me do a time check 
24   with Michael.  We were supposed to end at 10:45, we have to 
25   get the recommendation in as well.  What do you -- 
0056
 1             MR. HEANEY:  We have another five -- I'd say 
 2   another five minutes of -- 
 3             MR. WORAH:  Five minutes of Q&A, and then we go to 
 4   the recommendation? 
 5             MR. HEANEY:  Yeah, please. 
 6             MR. WORAH:  Okay. 
 7             Lynn, I think you were -- yeah. 
 8             MS. MARTIN:  Sure, great.  Sarah, you gave a 
 9   pretty good overview of the educational policies you 
10   currently have in place today. 
11             Brian, I was wondering from your perspective, is 
12   that pretty common throughout the financial advisor network 
13   to have these standards in place today?  And if so or if 
14   not, from an issuer perspective, are there additional 
15   educational items, elements that you take under your own 
16   process when bringing something to issue. 
17             MR. WALKER:  Right.  So from our standpoint, we 
18   obviously have to rely on the dealers to apply all the know 
19   your customer rules, and educate the brokers, and make sure 
20   the customers are informed of the risk.  But Incapital also 
21   is taking kind of the mantel so to speak and created our own 
22   marketing materials that we make available to every dealer 
23   that reiterates the same risks that are described in the 
24   prospectus that's filed with the SEC.  And so the dealers 
25   can either use those for their own purposes or repurpose 
0057
 1   them and get their own internal approvals and go through 
 2   FINRA on their own and do all that, too. 
 3             So we've definitely tried to take the forefront 
 4   and make it in as plain English as possible, and update the 
 5   materials on a regular basis, and make them available to 
 6   every dealer that wants to use them. 
 7             MR. WORAH:  In the interest of time I'm going to 
 8   go in the order that I saw the questions come up.  Horace.  
 9   And Larry and Gilbert, I'm going to skip you guys since you 
10   went once already. 
11             MR. CARTER:  Thanks. 
12             I've got a question for Brad.  Hey, Brad, it's 
13   Horace.  You mentioned in your opening comments -- 
14             (Phone static.) 
15             MR. CARTER:  Can you hear me? 
16             (No response.) 
17             MR. CARTER:  Yeah, you mentioned in your opening 
18   comment something that sounded quite a bite different from 
19   the InterNote program, some of the programs that we've been 
20   discussing.  Would you mind just elaborating a little bit on 
21   what those types of issues are and whether or not you feel 
22   like those particular instruments have been addressed in 
23   this conversation? 
24             MR. WINGES:  Yeah, thank you, Horace. 
25             It's not just the InterNote program and, you know, 
0058
 1   we've spent a lot of time talking about specifically the 
 2   InterNote program and certainly, as I mentioned, there's 
 3   been a lot of education around that.  But there are ways in 
 4   the open market right now that are occurring and more and 
 5   more electronic trading platforms are enabling people to -- 
 6   and advisors to go online and issue securities and 
 7   essentially you could do a hundred bonds with any coupon 
 8   structure that you want, any cost structure you want, and 
 9   there's open-ended issue platforms out there that you can go 
10   in and put your own commission in, and click away. 
11             And that's really been the genesis of the major 
12   concern is the consistency.  If at the end of the day we're 
13   only the InterNote program and only the global institutional 
14   network, which it has been for many, many years up until 
15   about the last three or four years, then the concern would 
16   just be, you know, is that education material that Incapital 
17   and others, you know, have been providing, getting all the 
18   way to the advisor and to the retail investor. 
19             But there's this other element that still is 
20   getting missed, and even on some of the subcommittee 
21   discussions I think it kept looping back to the InterNote 
22   market, but it's the other market that's continuing to grow.  
23   And even last year we saw a Triple A rated corporate issuer 
24   that had been down rated by Moody's, and in one day their 
25   global notes were down -- a five year global note was down 
0059
 1   two points, the InterNotes that we're talking about here 
 2   were down anywhere from three to three and a half, and their 
 3   structured note, MTNs, that had varying calls on it, were 
 4   down anywhere from 10 to 12 points. 
 5             So that was a little alarming in that there isn't 
 6   a lot of consistency around the education, around anything 
 7   outside of the institutional corporate issuance market.  And 
 8   I think that's gotten missed here, and I want to make sure 
 9   that people understand that, that if -- again, if there were 
10   only the InterNote market or the global institutional 
11   market, you know, certainly we could manage, you know, the 
12   education around that. 
13             But there is another market that's continuing to 
14   grow, and it's become much more readily available due to the 
15   advancement of all these electronic trading platforms, and 
16   the ease of execution, and the transparency of brokers being 
17   able to really create their own bonds. 
18             MR. WORAH:  Okay.  One last question.  Rich. 
19             MR. MCVEY:  So just thank you for your input this 
20   morning.  Very valuable to the committee's understanding. 
21             One quick question.  Do you see any downside to 
22   the recommendation we're making to enhance education for 
23   retail investors? 
24             MS. TUCKER:  Okay.  This is Sarah.  I -- the 
25   downside is not to educate investors.  It's always -- an 
0060
 1   informed investor is generally a happier and more successful 
 2   investor.  But the downside is if it's not properly framed.  
 3   And I would suggest that anytime you add additional 
 4   requirements or limitations in different investment choices, 
 5   you drive certain investors away from those to other 
 6   alternatives. 
 7             And in the case of income generation, there is no 
 8   other investment alternative that gives a client a defined 
 9   price of liquidity at par and a defined date of liquidity at 
10   maturity.  And so care should be taken to frame the 
11   education more broadly encompassing other income investments 
12   and their commensurate risk rather than focusing on 
13   something that's, at least by behavior, not demonstrated 
14   that it's often used. 
15             It -- by behavior, the percentage of time that the 
16   Main Street investor sells one of these smaller issues prior 
17   to maturity is quite small as a percentage of the total.  
18   And I think that proves that they're aware that's it more of 
19   a buy and hold general guideline.  But if we make it harder 
20   for them to buy the thing that's most closely aligned with 
21   what they're trying to achieve and that can personally align 
22   with their needs for liquidity, for stability, and 
23   predictability, they may be driven to other investments that 
24   are perpetual, lower in standing in a corporation, stock, 
25   packages or proxies for which they have no flexibility of 
0061
 1   control of the buy, hold, or sell decisions. 
 2             So I would be very cautious on how we put this out 
 3   to the investing public to make sure that we don't drive 
 4   them away from something that might be a more cost effective 
 5   and more directly true benefit to their investing 
 6   experience. 
 7             MR. HEANEY:  I'm sorry, I'm just going to 
 8   piggyback that really quickly. 
 9             Brian, do you have a different answer? 
10             MR. WALKER:  No, I would concur.  I just -- it -- 
11   you know, it just needs to be balanced so that there's not 
12   an onus that discourages them from looking at a product 
13   that's worked for so well so long.  And not understanding in 
14   comparison the other risks of all their alternative fixed 
15   income products that also have fees somewhere in the chain 
16   of distribution through the origination structuring 
17   management and distribution. 
18             MR. HEANEY:  Okay. 
19             Brett. 
20             MR. REDFERN:  Try to be quick.  Just a quick 
21   question.  As you probably know, we recently passed our 
22   regulation best interest rule, and that talks about not only 
23   disclosure of cost but it also talks about during the time 
24   that you're meeting with a potential customer, for dual-
25   hatted advisors they have to make these decisions about 
0062
 1   whether or not they're best suited for a brokerage account 
 2   or an advisor's account.  For this product, given the fact 
 3   that you were talking about it being largely a buy and hold 
 4   type of customer, and I guess there you also mentioned that 
 5   typically just one fee upfront. 
 6             I'm just wondering for the dual-hatted advisor, to 
 7   what extent do you feel like they understand the product 
 8   well enough to be able to make the determination if either, 
 9   a, then therefore that belongs in the brokerage account; or 
10   b, that client belongs in a certain type of account?  Or it 
11   may be that the cost, the way that they're bought and sold 
12   might map out so it's less relevant.  I'm just wondering 
13   your thoughts on that. 
14             MS. TUCKER:  Thank you.  I'm kind of looking 
15   forward to our implementation of a reg best interest because 
16   I do think it will allow perhaps the pendulum to swing to 
17   making sure that advisors decide the advice model that's 
18   best suited for a client based on their behavior and their 
19   needs.  And so oftentimes, if it is a buy and hold laddered 
20   portfolio of bonds, there isn't as much activity and advice 
21   on an ongoing basis needed from an advisor, and so they may 
22   elect to do it on a transactional or brokerage advice 
23   agreement.  And I would not be surprised to see that being 
24   more prevalent. 
25             But there is still some active advice, monitoring 
0063
 1   of the -- quality monitoring of the maturities, making sure 
 2   that nothing changes in that client's personal circumstances 
 3   that would change the decision whether to buy, sell, or 
 4   hold. 
 5             But there are also, as Brian had mentioned, many 
 6   of the selling group agreements today do allow for two 
 7   different issuances.  One at the full par value with the 
 8   upfront transaction cost, and the other geared toward an 
 9   advisory advice model that would be offered at par less the 
10   concession, and done only on an agency basis. 
11             So what's really good about the way this 
12   marketplace and these platforms has evolved is that it does 
13   give the client choice of what is the best advice, model, 
14   and compensation for their advisor based on their personal 
15   individual circumstances. 
16             MR. WORAH:  All right.  Thanks a lot.  Let's move 
17   real fast to the recommendation. 
18             MR. HEANEY:  Yeah, I'll entertain a motion to vote 
19   on the recommendation. 
20             MR. GIRA:  I make a motion (away from mic). 
21             MR. HEANEY:  Okay.  All voting members in favor of 
22   the recommendation, please raise your hands. 
23             (Hands raised.) 
24             MR. HEANEY:  All opposed raise your hand, please.  
25   Anyone? 
0064
 1             (No response.) 
 2             MR. HEANEY:  Any abstentions? 
 3             (No response.) 
 4             MR. WORAH:  And we have Kumar and Brad on the 
 5   phone. 
 6             MR. HEANEY:  Yeah.  Kumar, can I ask you to vote, 
 7   please? 
 8             MR. VENKATARAMAN:  Michael, I'm in favor. 
 9             MR. HEANEY:  Thank you. 
10             Brad? 
11             MR. WINGES:  I'm in favor. 
12             MR. HEANEY:  Thank you. 
13             Suzanne Shank, are you on the phone? 
14             MS. SHANK:  Yes.  I'm in favor. 
15             MR. HEANEY:  Thank you, Suzanne. 
16             So the recommendation has been approved 
17   unanimously, 16 votes for and none against. 
18             Mihir, thank you, and to the subcommittee.  And 
19   thank you very much to the panelists for taking the time to 
20   come to DC and assist us in the recommendation process. 
21             It's a little past 10:45, so we'll take a short 
22   15-minute break and then come back. 
23             Thank you.           
24             (Whereupon, at 10:51 a.m., a brief recess was 
25   taken.) 
0065
 1             DRAFT RECOMMENDATION ON CERTAIN PRINCIPAL 
 2                 TRANSACTIONS WITH ADVISORY CLIENTS 
 3             MR. HEANEY:  Okay.  Welcome back. 
 4             We'll now turn our considerations to the 
 5   preliminary recommendation from the Municipal Securities 
 6   Transparency Subcommittee on principal trading with advisory 
 7   clients. 
 8             As you all may recall, we previously discussed 
 9   this recommendation at our April meeting.  I'll turn it over 
10   to Lynn who chairs this subcommittee, but before I do I 
11   thought it would be helpful just to provide a little bit of 
12   background once again. 
13             The subcommittee over a period of several months 
14   developed a preliminary recommendation and presented it to 
15   the full committee in April.  As part of our discussion of 
16   that recommendation, we had a panel of experts that included 
17   members of the subcommittee as well as other market 
18   participants. 
19             The discussion in April largely focused on the 
20   recommendation's blind bidding requirement.  After 
21   considering what we had heard in April and engaging in 
22   further discussion on these issues, the subcommittee 
23   determined to keep the recommendation's blind bidding 
24   requirement and re-present the preliminary recommendation 
25   for consideration by FIMSAC at this meeting. 
0066
 1             Again I'd like to thank Lynn and the subcommittee 
 2   members for their perseverance and diligence in staying 
 3   engaged on the topic. 
 4             Lynn will walk us through the recommendation, take 
 5   us through some of the key points that we discussed in April 
 6   before turning to our panelists.  I look forward -- thank 
 7   you to the panelist for joining.  I look forward to an 
 8   interesting and fruitful debate, and I will turn it over to 
 9   Lynn. 
10             MS. MARTIN:  Thank you, Michael, and thank you to 
11   our panelists. 
12             As Michael said at our meeting in April, the Muni 
13   Transparency Subcommittee put forward a preliminary 
14   recommendation for the SEC to consider a rule that would 
15   allow a broker-dealer affiliate of an investment advisor to 
16   trade as principal with its advisory clients who are looking 
17   to sell bonds, so long as the dealer submitted the 
18   information as a blind bid. 
19             I'd like to -- given the emails from last evening, 
20   I'd like to remind everyone what blind is defined in the 
21   recommendation.  Specifically blind is defined as without 
22   having access to the bids from other dealers and requiring 
23   the dealer who initiates the auction submitting their best 
24   price to that auction at that time. 
25             We put forward this recommendation under the 
0067
 1   premise that we continue to look for ways, as a 
 2   subcommittee, to improve transparency and liquidity in muni 
 3   markets.  As Michael said at our least meeting, there's been 
 4   a lot of conversation around this topic and following last 
 5   meeting in the subcommittee, I'll tell you this has been 
 6   quite the vociferously debated topic, particularly around 
 7   the concept of blind bidding. 
 8             Some of the concerns expressed, both at the April 
 9   meeting as well as within the various subcommittees, are the 
10   technology and other operational work that would be required 
11   to implement the concept of blind bidding processes, both by 
12   the dealers and the bid wanted venues they utilize. 
13             So moving over to the panel.  Joining us today, we 
14   are privileged to have representatives from two retail 
15   wealth management firms, specifically Jude Arena from Bank 
16   of America Merrill Lynch and Craig Noble from Wells Fargo 
17   Advisors.  We have two infrastructure providers with us 
18   today as well, specifically John Cahalane from Tradeweb and 
19   Chris Ferreri from HTD.  And our very own John Bagley has 
20   joined us on the panel today to provide the regulatory 
21   perspective.  Thank you again. 
22             I hope everyone on the broader FIMSAC committee 
23   joins us in what should be a very spirited debate and 
24   discussion around these issues. 
25             So with that, let's kick things off.  I'm going to 
0068
 1   structure the panel in three different parts.  I'm going to 
 2   direct the questions to certain individuals, but as always, 
 3   if you've got an opinion, feel free to voice your opinion. 
 4             I'm going to start with the retail wealth 
 5   advisors, specifically Jude and Craig.  Both your firms 
 6   service retail investors directly through advisory and 
 7   brokerage offerings.  Could you broadly discuss whether you 
 8   believe that this preliminary recommendation would benefit 
 9   retail investors and, if so, how? 
10             I'll turn it over to either Jude or Craig, whoever 
11   wants to give it a start. 
12             MR. ARENA:  I'll give it a go here. 
13             So I think that there are parts of the 
14   recommendation that I think would be helpful.  I think that 
15   there are parts that I think would not be helpful. 
16             So broadly speaking, I think that having advisory 
17   clients be able to avail themselves more easily to the bid 
18   of affiliated dealers I think is a good thing.  So the 
19   discussion around does relaxing some of the consent 
20   disclosure requirements there pave an easier path for 
21   advisory clients. 
22             So some background there.  I think that large 
23   dealers in particular will reserve their best bid for their 
24   institutional clients and their retail clients.  So if you 
25   are a large dealer and are not able to bid on an advisory 
0069
 1   client, you might take out somewhere between 10 or 20 
 2   percent of market share of a market maker, so I think that's 
 3   an obvious negative. 
 4             Secondly, in particular in volatile markets, 
 5   dealers will reserve their bid for their best clients.  So 
 6   when you have advisory clients that are entering into a pool 
 7   of liquidity, there is no one that will prioritize them as 
 8   they don't have an affiliated dealer to bid on their bonds.  
 9   So in a normal market I would say the difference, if we're 
10   bidding on a retail client versus submitting a bid into the 
11   market, either into the inter-dealer broker market or into 
12   an ATS where it's not our client, the difference in a normal 
13   market might be somewhere between three to five basis 
14   points.  In a volatile market, we generally would not bid on 
15   bonds, so it would be the difference between providing a bid 
16   and not providing a bid. 
17             So I think that allowing advisory clients to 
18   access those bids in a more easy manner I think is a good 
19   thing.  So I see it as a disclosure and consent issue that I 
20   think could solve this problem very easily, either allowing 
21   a blanket waiver or another factor that would be kind of 
22   like the old exemption that allowed it to happen.  And then 
23   we could get more data, see what that looks like.  But I 
24   think that that solves the problem. 
25             Adding in a different market structure, adding in 
0070
 1   blind bidding I think at best is unnecessary confusion and 
 2   potential cost.  At worse, it could potentially lead to a 
 3   bifurcated market where liquidity's actually worse. 
 4             So I think that's more of a price issue.  There's 
 5   robust pricing in place now with best ex, fair dealing, fair 
 6   and reasonable.  I think that there's a lot of things that 
 7   have improved liquidity in the market and have been 
 8   effective in providing the best price.  And obviously the -- 
 9   leaving that regime in place for advisory clients, I think 
10   to participate in the normal course of business I think 
11   would be of benefit to them. 
12             MS. MARTIN:  Craig. 
13             MR. NOBLE:  So Wells Fargo from a perspective has 
14   looked at this over the years, and we actually use the 
15   individual exemption for the Rule 206 for our client-advised 
16   accounts starting back in '07.  And until 2016 when the rule 
17   was sunset, we actually went in and asked for an individual 
18   exemption to the rule and was granted an individual 
19   exemption to the rule.  And I would recommend that the 
20   subcommittee look at the documents that we provided during 
21   that time to show how it helped our clients. 
22             When you look at the average bid wanted in a 
23   municipal security for a managed account, we looked at 
24   around 25 bonds.  When you put those bonds out for the bid 
25   in a competitive bid wanted situation, as we know, a lot of 
0071
 1   times that misses the mark for a lot of trading desks. 
 2             A blind bidding -- from what I understand, looking 
 3   at a blind bidding process does not exempt us from knowing 
 4   that it is our bid, we just have to present the bid at the 
 5   time all the other bids are put in. 
 6             MS. MARTIN:  That's right. 
 7             MR. NOBLE:  So that still gives every trading desk 
 8   the ability to know what bonds are out there for the bid, 
 9   know that they're coming from one of your customer's managed 
10   accounts, which we don't have the ability to do now, have 
11   those bonds bid in our normal bid process, and we put it out 
12   for the bid, have the competitive marketplace act as it is 
13   now.  But it gives us one more bid, which is usually a 
14   strong, either in Merrill Lynch's or Wells Fargo's, a very 
15   strong retail system, and allows us to have one more 
16   opportunity or one more at least retail bid person put a bid 
17   on those bonds. 
18             I think it's -- I think the rule is -- number one, 
19   the rule is in existence for client-advised accounts before.  
20   That was for actually all securities, not just municipals at 
21   the time.  And we're a firm believer that this would help 
22   the liquidity in the marketplace, and we think it should be 
23   acted upon. 
24             MS. MARTIN:  Okay, great. 
25             So obviously we've been talking a lot about blind 
0072
 1   bid, both at the subcommittee level, and we will continue to 
 2   discuss it on today's panel.  In April we heard from one of 
 3   the ATS operators who indicated that they could implement 
 4   technology configurations, whatever the case may be, who 
 5   could ease the operational and technology burden that the 
 6   additional workflow may impose on firms. 
 7             I want to turn it over to the infrastructure 
 8   providers now, John and Chris, to give their perspective on 
 9   what you would need to build in order to, if the 
10   recommendation moves forward, implement a blind bidding 
11   protocol for this area.  And then I'm going to turn it back 
12   to Jude and Craig for their perspective. 
13             So John, do you want to take us out? 
14             MR. CAHALANE:  Sure, happy to.  First I'd like say 
15   Tradeweb, you know, as a wealth management platform 
16   liquidity and transparency being two pillars of electronic 
17   trading, we absolutely think more liquidity is obviously 
18   better for the individual investor.  From a functional 
19   perspective, our platform already has the functionality 
20   existing for dealers who use the entire stack of Tradeweb 
21   technology to bid in the blind or to wait as we're defining 
22   it until all of the bids are received. 
23             MS. MARTIN:  So today you could offer a solution 
24   that allows someone to bid on an affiliate bases, on a blind 
25   basis? 
0073
 1             MR. CAHALANE:  For any customer that uses our 
 2   entire stacks, our order management system through to our 
 3   financial advisor frontend.  For customers who connect to us 
 4   via API, there may be additional work for those customers in 
 5   their order management systems to potentially have to be 
 6   done to bid in the blind. 
 7             And then from a compliance perspective, from a 
 8   pre-trade perspective, there may be work that the individual 
 9   dealers need to do from an account coding perspective, which 
10   we would read pre-trade, to know that, you know, the firm is 
11   allowed to bid on those particular auctions.  But the 
12   technical work to be done is very, very little.  Obviously 
13   we want to test with all of our clients, but to bid in the 
14   blind, that functionality exists today. 
15             MS. MARTIN:  Okay. 
16             Chris. 
17             MR. FERRERI:  Thanks.  And thanks to the committee 
18   for inviting me here today. 
19             When I started in this business, getting in the 
20   workflow of my customer was getting a direct line, right.  
21   If I had a direct line to a client, I was in their workflow, 
22   and I did business.  Hartfield, Titus, and Donnelly in 2014 
23   separated our business -- our broker business from our 
24   technology business and created muni brokers, and we 
25   licensed that to our competitors.  So today every -- 97 
0074
 1   percent of every broker's broker's business flows through 
 2   muni brokers. 
 3             We benefit -- a nod to John, we benefit from a 
 4   regulator in the MSRB that recognizes the role of a broker's 
 5   broker and defines, this is what you do, this is how you 
 6   act, these are the rules of your business.  We can certainly 
 7   add a flag to say this is an affiliate, unless you submit a 
 8   bid with the bid wanted, you won't see the bids.  All 
 9   workflow is straightforward.  And once we did that in muni 
10   brokers, every broker's broker on the platform would have 
11   that ability.  So our part of the work is relatively 
12   straightforward. 
13             Getting into the workflow of every OMS and every 
14   EMS system that's in use, clearly is going to take time.  We 
15   have a frontend GUI that clients can log into.  That GUI 
16   would provide all of that functionality.  The reality is 
17   today fewer and fewer firms log into GUIs, log into 
18   websites, right.  They send their flow through their OMSs, 
19   whether it's Toms or other third-party providers.  So you 
20   need to be part of that workflow. 
21             So I wouldn't minimize the effort on the part of 
22   the OMSs and EMSs to even add that one flag and say okay, 
23   now that my rep has put an order in, this one identifies an 
24   affiliate, that affiliate flowed through, and all the 
25   regulations follow. 
0075
 1             So from the -- from our perspective, it's 
 2   straightforward.  That doesn't mean it's necessarily 
 3   straightforward for everyone else. 
 4             MS. MARTIN:  Yeah, that's a good point.  I want to 
 5   actually turn it over to Jude and Craig to -- obviously when 
 6   you're an infrastructure provider you have one perspective, 
 7   but that's not taking into effect your own workflow that you 
 8   would need to implement.  So I'd love to hear your 
 9   perspective on what the operational burden would be on your 
10   side to effectuate this, if it did move forward in this 
11   fashion. 
12             MR. ARENA:  I think that there's a couple of 
13   different ways.  I know that the recommendation doesn't 
14   require an ATS so I think some of the large dealers would 
15   determine whether they wanted to be a part of it at all and 
16   would provide the service on their own to not have to be 
17   beholden to the ATSs to provide that service.  I think some 
18   of the smaller dealers I think would not have that choice.  
19   They would be forced to participate. 
20             I think part of the difficult here for us lies in 
21   the process being different from our normal process where we 
22   have various price duties that we need to fulfill.  So doing 
23   that on a blind bases by clicking a flag.  Our duty to 
24   provide best ex doesn't change because, you know, we clicked 
25   a protocol that allowed us to be blind.  So I think that 
0076
 1   technologically I don't see this as really being the issue 
 2   here. 
 3             I think the issue is changing -- having dual 
 4   processes where certain flow goes one direction, certain 
 5   flows goes another direction, but at the end of the day the 
 6   ATS isn't the one that's warranting the price that's given 
 7   to the end client, the dealer is.  So I think that we would 
 8   -- we'd be likely to go through our own process and not, you 
 9   know, hook into whatever protocol just allowed us to 
10   potentially rely on the ATSs. 
11             MS. MARTIN:  Okay. 
12             Craig. 
13             MR. NOBLE:  We have a little different problem.  
14   Since we already use it for client advised, and we --- and 
15   it's -- any my biggest issue with this is it will be only 
16   for municipals, because now you're doing it on a security 
17   basis.  Normally our accounts would be coded on a -- as a 
18   managed account like our client advisory accounts are coded 
19   as a managed account allowing those accounts to be able to 
20   put out bid wanteds for those accounts. 
21             But now that if you limit it to just municipal 
22   securities, we then have to go through additional coding 
23   just for muni securities on all other, you know, managed 
24   accounts, which that's actually more of the technology 
25   problem that I foresee.  It's the individual security. 
0077
 1             So you have the accounts.  The bid wanted would 
 2   come in from the account.  It would normally be a managed 
 3   account, but now you've got to subdivide it.  You can't put 
 4   your corporates out, you can only put out your munis.  So 
 5   now you got to just look at those securities.  So that 
 6   becomes the layering effect that I think that will become 
 7   part of the problems you're going to have with this rule. 
 8             Like I said, I'm for the rule.  I'm just trying to 
 9   figure out how we're going to identify those individual 
10   bonds that will have to be sent out. 
11             MS. MARTIN:  Okay.  That's a good point. 
12             And just to clarify what FIMSAC would be putting 
13   forward is a recommendation.  There would obviously be a lot 
14   more details, which Brett and the SEC could speak to around 
15   the whole rulemaking process that folks would be able to 
16   comment on. 
17             So John, over to you.  You've been sitting quietly 
18   there, for the moment.  At the last meeting you expressed 
19   your belief that being a relatively reasonable technological 
20   change, blind bidding would be important for protecting 
21   investors, as ultimately it could lead to additional 
22   liquidity of municipal securities. 
23             Could you discuss your thoughts as to why blind 
24   bidding is important if affiliated dealers were to be able 
25   to bid on bid wanteds from advisory clients? 
0078
 1             MR. BAGLEY:  Sure.  I think the subcommittee -- 
 2   obviously getting more -- another bid in, especially a bid 
 3   that cares about the client, is important.  But there was a 
 4   conversation about, you know, the general feeling is that 
 5   the managed account business was more profitable than 
 6   traditional brokerage business and that, you know, we're 
 7   talking about trying to let them put -- the dealers put more 
 8   liquidity in here, but do we do something to -- where they 
 9   don't own the process, where they do on the brokerage side. 
10             And so people were concerned about, does it make 
11   it so much more profitable to do managed account business?  
12   That maybe some people get put into managed accounts that 
13   shouldn't.  And there's certainly rules in place to do that.  
14   But I think the thought process was, this is a major change 
15   in adding liquidity, so what about putting something in 
16   where the dealer is just another provider of liquidity, they 
17   don't control the entire process. 
18             MS. MARTIN:  Okay.  If this preliminary 
19   recommendation was put into effect, what are some of the 
20   things that you'd be looking for as a regulator? 
21             MR. BAGLEY:  Well, I'll speak for myself.  To be 
22   clear, we don't do enforcement. 
23             MS. MARTIN:  Fine. 
24             MR. BAGLEY:  But, you know, if I was look at this, 
25   right.  One, you got to think firms are going to have 
0079
 1   policies and procedures on how they handle this and whatever 
 2   they do.  And it doesn't have a lot of concern to me because 
 3   I think John and Chris can talk about, there's an audit 
 4   trail on any of these bid wanteds that go through, even in 
 5   internal bid wanteds, right.  So everybody knows -- you 
 6   know, you know when the bids came in, when they were 
 7   released, who had it, when they bid, et cetera, et cetera. 
 8             So I think if there was anyone trying to get 
 9   around whatever the rule was, it would show up fairly 
10   quickly whenever someone came in to do an audit or, you 
11   know, as their enforcement. 
12             So the rule doesn't give me a lot concern as a 
13   regulator.  I mean, I think the end -- the intent is to 
14   provide liquidity for somebody that really cares about this 
15   client.  So to me it's going to be a positive, and anything 
16   that might change from it I think can be handled pretty 
17   easily. 
18             MS. MARTIN:  Yeah.  John and Chris, would you mind 
19   just refreshing FIMSAC as to what protections are in place 
20   from your perspective? 
21             MR. CAHALANE:  Sure. 
22             And before I get there, I think we at Tradeweb 
23   have a little concern, not necessarily about whether the 
24   bid's coming in the blind or not, but having two separate 
25   protocols for a managed account versus a principal account. 
0080
 1             You know, both in my time here at Tradeweb and my 
 2   previous life at Morgan Stanley, market participants 
 3   potentially will go out of their way to try and figure out 
 4   are, you know, RFQs coming from a managed account versus a 
 5   principal, knowing they're potentially not, you know, 
 6   competing with the principal desk on the managed side versus 
 7   the principal side. 
 8             I think, you know, if we've got two separate 
 9   protocols here, the blind versus the not, we potentially set 
10   a precedent for liquidity providers to look to be more 
11   aggressive when they're bidding against the blind than they 
12   potentially would be if they were bidding in a, you know, 
13   last look scenario. 
14             I don't think one protocol's better than the 
15   other.  I think I'm in agreement with Jude that it really 
16   just needs to be one or the other and not separate the 
17   protocols.  In terms of, you know, audit trails, and data, 
18   and compliance solutions.  I mean, we provide all of that.  
19   Pre-trade, post-trade for firms to be able to manage this 
20   process for both compliance officers, trading desk heads, 
21   right, to see any trades that may potentially stand out. 
22             From an audit trail's perspective, we keep 
23   everything.  We keep every click that is taken on our 
24   platform, every price that's received, the timing of that 
25   price.  Again, if the users are in our full technology 
0081
 1   stack, the individual that took the action, we have all of 
 2   that information, and we keep it all, despite the fact that 
 3   I think as an ATS we're only required to save it for seven 
 4   years.  We have every click, every price update going back 
 5   from when the platforms were started in our database.  So 
 6   from a regulatory perspective, we can provide all the 
 7   information that's necessary to prove when firms took action 
 8   on an RFQ. 
 9             MS. MARTIN:  Chris. 
10             MR. FERRERI:  So this is sort of my Ikea Furniture 
11   answer, right.  We can all put Ikea furniture together, but 
12   it's easier if you follow the instructions.  We have very 
13   clear instructions in G43 in terms of what we have to do as 
14   broker's brokers, what we have to retain, what reports we 
15   have to generate. 
16             Our system maps to those rules, so it's a very, 
17   very direct relationship.  I go into our systems on a daily 
18   basis, look for exception reporting for institution 
19   exceptions, for price exceptions.  Our commissions are 
20   published.  If a customer pays a higher commission because 
21   they thought the broker did a good job, that's noted in the 
22   system.  The trader's name, the reason why the extra 
23   commission was paid. 
24             Surprisingly, I'll speak as a non-management 
25   broker, brokers actually welcomed that opportunity because 
0082
 1   they saw it as a way to protect them in doing their 
 2   business, right.  So you give me the tools to do this, and I 
 3   can just type this in when I do the ticket?  Yes, you do.  
 4   There's a notation on the ticket.  There's any number of 
 5   ways that we map back to the rule. 
 6             So again, and I'll speak as an infrastructure 
 7   provider, fully recognizing the guys on either end of this 
 8   panel, that they have much different obligations and 
 9   problems to solve, we can map to this rule as well. 
10             MS. MARTIN:  Okay, Jude, you had mentioned a 
11   couple of the protections that exist in the market today 
12   where you had already evidence, best execution, and things 
13   of that nature which would obviate the need to bifurcate 
14   your workflow.  Would you mind just touching on those again? 
15             MR. ARENA:  Yeah, sure.  I do think that there's 
16   one underlying notion here that I want to talk about that 
17   this blind process somehow leads to a better bid.  I think 
18   that the best ex and the fair and reasonable requirement 
19   that we go through, we go through that process now.  I think 
20   that the blind issue is back to the last look pennying, 
21   whereas the last look is the panel in April we discussed is 
22   something that dealers need to make the warrant on price 
23   that they are making, and that pennying is an act that may 
24   go on, I don't think it happens at larger dealers, that is 
25   an act that should be prohibited. 
0083
 1             So I think that bifurcating markets into two 
 2   different paths is bad, but I think that there should be 
 3   some explicit prohibition on the act of pennying.  I think 
 4   that might improve perceived integrity of the market.  So 
 5   here I think easier disclosure consent process to allow the 
 6   path for advisory clients to access bid of affiliated 
 7   dealer, but have the process the same.  You still get best 
 8   ex, you still get fair and reasonable, you get best 
 9   interest, and then maybe a prohibition on the act of 
10   pennying, which may occur.  I don't think it occurs at large 
11   firms. 
12             MS. MARTIN:  Okay. 
13             Craig, you had something to add, and then John, I 
14   know you've got some thoughts as well. 
15             MR. NOBLE:  I don't want to disagree, but I 
16   disagree.  The process -- the problem with the process now 
17   and -- is the fact that most large retail desks -- to your 
18   point, there's a difference between pennying and bidding in 
19   comp blind.  And this is what we're talking about.  I want 
20   to be in competition with the rest of the street for my bid 
21   wanted to be able to give the best price.  Put it in when 
22   the rest of the bids are due, not know who -- what another 
23   bid is, and get the -- and hopefully I am the best price.  
24   If I'm not the best price, it goes to whoever.  And that's 
25   all I'm asking to do.  Right now I can't do that. 
0084
 1             And when I have a problem is usually when it's the 
 2   five or 10 bond bid wanted on a new issue that was issued 20 
 3   years ago that now the person decides -- the manager decides 
 4   they need the cash, and they want the five bonds sold, and 
 5   the market's not there.  Or if it's there, best execution 
 6   and -- doesn't provide me with a bid if I put it out with 
 7   Tradeweb, you know, Hartfield, or anybody else.  They can 
 8   search it among the street, and it's still not going to get 
 9   me a bid.  I might be a bid for it because I know it's my 
10   customer, and I'll put it out to the street.  The question 
11   hums in bidding blind if there are no other bids. 
12             So that's part of the whole process of what we'll 
13   have to do if I am the only bid, which may or may not 
14   happen, I don't know.  So that's part of the rule regulation 
15   of what happens there, and where I am.  But I am a firm 
16   believer that this will help our retail clients get better 
17   executions because we have an investment in that client. 
18             I'm not saying that we don't now, but I don't -- 
19   for a managed account I don't.  I have to deal with the 
20   street as the street gives me that bid.  And that bid, I can 
21   tell the manager that that bid is four or five points off 
22   the market, but in reality if the manager makes a decision 
23   to sell it, I have 13 other bid wanteds, maybe, and that 
24   will be best execution in this marketplace. 
25             MS. MARTIN:  John. 
0085
 1             MR. BAGLEY:  So I was just going to add, the 
 2   subcommittee conversations around blind bidding had a lot to 
 3   do with pennying because the FIMSAC as a whole has passed a 
 4   recommendation that has gone to the SEC, but we all know 
 5   that process takes time, right.  There's not -- if 
 6   anything's going to happen, it's not going to happen in 
 7   three months.  There will be a process, you know, for 
 8   comments and everything else. 
 9             So one of the conversations was should we just we 
10   wait on this until whatever happens with pennying and 
11   corporates and munis happens?  So we thought, well that 
12   doesn't seem to make sense.  So what if we put guiderails on 
13   it a little bit, and you require this? 
14             Now it may mean sometimes the dealer can't get the 
15   bid in because they didn't get it in on our time, et cetera, 
16   but at least they have the opportunity now to try to get it 
17   in.  And then where pennying ends up, if anywhere, in 
18   corporates and/or munis, then it could be looked at in this 
19   context as well. 
20             But the real process was trying to move this along 
21   faster than saying wait for pennying to go, and if it's a 
22   year-long rulemaking process, and then you have to let 
23   people -- if something comes out of it, people have to 
24   implement, you got to give them six or 12 months.  So the 
25   thought was should we wait a year, year and a half before 
0086
 1   this even has an opportunity, or do we try to put something 
 2   else in? 
 3             And the other thing I'll say is, right, all this -
 4   - this was a recommendation that will go through a 
 5   rulemaking process and SEC, you know -- talk to me if I'm 
 6   wrong, but in that process, all of these type of comments 
 7   can come out.  Should it be blind, should it not be blind, 
 8   why shouldn't it be, should it be all products, not just 
 9   muni, should it be all fixed income? 
10             So to me it's about advancing something that's 
11   going to provide more liquidity for clients and allowing 
12   dealers to know it's their client.  And how it actually all 
13   ends up, to me it would happen through a rulemaking process. 
14             MR. REDFERN:  Just quickly, just to make sure that 
15   everybody's clear in terms of process here.  Any of the 
16   recommendations that come out of FIMSAC or advisory 
17   committees like this, these are things that ultimately do go 
18   out for public notice and comment process.  And so there's a 
19   -- you know, this helps to direct in terms of areas where we 
20   should focus.  But there are no guarantees coming out of any 
21   recommendations, and there ultimately becomes a much more 
22   fulsome and rigorous public review and comment process 
23   before anything is ultimately implemented and approved. 
24             MS. MARTIN:  So at this point I'd like to open 
25   FIMSAC for questions. 
0087
 1             Horace, it looks like you're the first to go, so 
 2   have at it. 
 3             MR. CARTER:  Thank you, Lynn. 
 4             John, it's a question for you.  You made a comment 
 5   earlier that you thought that it would be superior to have 
 6   one process rather than running a dual process.  My question 
 7   is, preferable to have one, yes.  Is it possible to have 
 8   two? 
 9             MR. CAHALANE:  Absolutely.  And our -- we have 
10   market participants today who run separate process for 
11   managed versus principal.  As I said, all this functionality 
12   exists already so we have clients who are already using that 
13   functionality to bid in the blind. 
14             My comments around a single process is more the 
15   concern around liquidity providers and their attempts to try 
16   to figure out where they're going to compete or not with a 
17   principal desk in a bifurcated process where they know 
18   they're competing versus a last look versus a blind bid. 
19             You know, I think if we're going to allow this 
20   activity it should either be all in the blind or it should 
21   all be with a last look.  And I think Jude's point to, you 
22   know, our hope around pennying and the rules that are going 
23   to be passed there, you know, should solve for some of the 
24   concerns around last look.  But we can handle both processes 
25   in our platform. 
0088
 1             MS. MARTIN:  Okay.  Larry -- I saw these first, 
 2   and then I'll come back to you, Larry. 
 3             MR. TABB:  Yeah, I'm assuming, and I could be 
 4   wrong, that some of the prohibitions around this is around 
 5   charging the client twice.  There was some sort of 
 6   commission or some sort of, you know, principal.  Is -- will 
 7   this be an issue if we wind up enabling this process or -- 
 8             MR. NOBLE:  No.  If you have a -- at least in our 
 9   world, if you have a managed account, the trade would have 
10   no commission on it.  It can't -- it's not allowed.  So it 
11   doesn't change that parameter of what happens now.  So I 
12   just can't bid on it, now I can bid on it.  It doesn't 
13   change what happens at the end result. 
14             MS. MARTIN:  Sonali. 
15             MS. THEISEN:  Thank you all.  I -- clearly like a 
16   very interesting and intricate topic and issue.  And I guess 
17   listening to all of the comments here and thinking about 
18   also kind of our duty to take into account sort of cost 
19   benefit analysis of making these changes, wanted to 
20   understand, you know, there was comments about like not 
21   minimizing the effort for OMS, EMS integration and also just 
22   the additional coding with munis. 
23             Would -- if the pennying recommendation gets to 
24   the right point, would that in combination with not 
25   unsunsetting, if you will, 206(3)-3T, whatever, it sounds 
0089
 1   like the panelists, please correct me if I'm wrong, seemed 
 2   like it worked fairly well.  Would those two things together 
 3   be from a cost benefit perspective an easier solution, or 
 4   are there risks to considering that alternative? 
 5             MR. BAGLEY:  Well I think the risk is we just 
 6   don't know what's going to happen with pennying, right?  I 
 7   mean, there is a recommendation.  The MSRB has been -- has 
 8   gone through a comment period.  FINRA has not yet.  But we 
 9   don't know what the outcome of that is.  Is there going to 
10   be a rule, is there not going to be a rule?  We don't know.  
11   So -- and there's certainly no timeframe on that.  And if 
12   FINRA's going to -- if FINRA gets engaged in this and 
13   starts, they're starting from scratch.  They're going to 
14   need to do economic analysis and everything else. 
15             So I think one of the questions (sic) is there is 
16   just not a defined timeframe for when or if anything would 
17   change with pennying. 
18             MS. THEISEN:  That I completely understand, and I 
19   appreciate it.  I guess my question was just in a world 
20   where the old rule was non-unsunsetted, and we went back to 
21   that, would that substantively accomplish the same goals, or 
22   what would be the risks?  Like so if we went back to pre-
23   2016, I think is when the last rule sunsetted, would we get 
24   the same thing?  And also, would that take into 
25   consideration some of Jude's concerns and other's concerns 
0090
 1   around bifurcating liquidity, or market manipulation, or 
 2   unwanted behavior of knowing, you know, that certain things 
 3   are coming in blind and not.  So I just want to kind of 
 4   weigh the two options against each other to understand which 
 5   is the easier approach. 
 6             MR. NOBLE:  Well the original -- from what I 
 7   understand, and I am not a managed account rule person, the 
 8   206 Rule is -- I read it but -- just coming into this 
 9   meeting I wanted to review what we actually had sunset.  For 
10   Wells Fargo, it was only if you had a client advised.  That 
11   means if you -- if the client wanted a managed account, so 
12   it was a fee in lieu of -- a managed account in lieu of fee.  
13   So basically you would be able to charge a fee instead of 
14   individual commissions, and that allowed us to do those 
15   trades because we had already told the client that if you 
16   made a selection, that we could act as principal during that 
17   transaction. 
18             The problem that I understand with that rule is 
19   you had to inform the client on every transaction that you 
20   were going to act as principal, which then becomes a problem 
21   with every trade we do now in every managed account, trying 
22   to do that on a -- now only on municipal sells, why we are 
23   only doing it that way, I think it becomes more confusing 
24   for the client.  I think this will kind of streamline it a 
25   little. 
0091
 1             The pennying rule I think has -- is a different 
 2   conversation.  That's not really having to do -- number one, 
 3   that's not going to change -- if we don't change the rule, 
 4   it's not going to change anything that happens with managed 
 5   account bid wanteds.  So that's -- pennying's not going to 
 6   change that.  So I don't see how the two are tied together. 
 7             I understand your question.  Would it be -- should 
 8   we just go back to the Rule 206, put it back in place, and 
 9   then also go to pennying, would that help?  I don't think it 
10   helps one way or the other.  I think it -- have to look at 
11   the two separately. 
12             MR. ARENA:  I think you get most of the benefit if 
13   you relax the requirement of transaction by transaction.  If 
14   you allow a blanket waiver, then you allow the advisory 
15   clients to get access to those bids without making 
16   substantive changes to market structure, blind versus not 
17   blind, different protocols, et cetera.  So I think that 
18   would be the correct thing to do.  I think, in my opinion, 
19   that would be the thing that would guarantee most benefit 
20   with least amount of cost, allow transaction by -- allow a 
21   blanket waiver, and then allow the rule process to play out 
22   on pennying separately. 
23             MS. MARTIN:  Rachel. 
24             MS. WILSON:  Sonali basically had my question.  
25   But -- and you actually started to answer, which is there 
0092
 1   seems to be -- we don't want to have distinct protocols or 
 2   bifurcating workflows.  I think we all feel getting that 
 3   liquidity and getting that bid in is a benefit.  And so when 
 4   you stitch that together, what is the easiest best path to 
 5   get there?  And I was going to say is it relaxing, you know, 
 6   going back and re-unsetting that rule, or is it something 
 7   else? 
 8             And so, Jude, I think you started to answer.  It 
 9   is that plus a blanket waiver?  I'd be curious -- Craig, I 
10   also heard you saying like Wells had an exception already 
11   granted to that.  So I don't know if you're already doing 
12   something like this, but curious to get the panel's view 
13   since we are lucky enough to have you with us. 
14             MR. NOBLE:  Well again, like I said, our 
15   individual exemption to the Rule 206 now stands that we can 
16   do it for our client advised managed accounts, okay.  So 
17   that's a subset of our managed accounts.  We have over a 
18   million managed accounts -- about 260,000 managed accounts, 
19   so it's a little different. 
20             I think Jude makes a good point.  I think that if 
21   we could get a more general exemption, if a -- but then it 
22   becomes a client by client decision, okay.  So you -- so 
23   let's say we do away with the client advised process, but 
24   any managed account can opt in for principal transactions, 
25   becomes a disclosure issue, I guess, and a client education 
0093
 1   issue.  And then, of course, you will have differences of 
 2   opinion since now how would we manage that process. 
 3             I think that's not -- that's a fair thought 
 4   process if you could do that.  I think it would definitely 
 5   help.  And especially then we wouldn't have it by just 
 6   municipal securities, which a large amount of our 
 7   transactions on the client advised accounts are not 
 8   municipals, it's other securities.  It's different 
 9   securities that they decide to purchase.  So I think it's a 
10   good idea.  I think the blanket exemption I would agree 
11   could be a different process. 
12             MR. FERRERI:  So now you're agreeing with her? 
13             MR. NOBLE:  I'm agreeing with her. 
14             MR. FERRERI:  Okay.  Just what I thought. 
15             MR. NOBLE:  Different ends of the table, but the 
16   same thought process. 
17             MS. MARTIN:  Larry. 
18             MR. HARRIS:  So I'm still a little confused.  If 
19   the pennying recommendation that we made is adopted, then 
20   this would appear to be a technical fix to ensure that in 
21   these special cases that we can get another bid in.  And so 
22   that would seem to be a sensible thing. 
23             If the pennying recommendation doesn't go, then we 
24   have to ask what's going on here.  So the underlying issue 
25   is that we're concerned that people who are acting as in 
0094
 1   some senses fiduciaries, or in the latest language, best 
 2   interest of their clients, that they don't be conflicted by 
 3   their principal trading. 
 4             And so we have this rule that was established to 
 5   prevent that problem.  And now we observe that the markets 
 6   have grown and become more mature, and there's a mechanism 
 7   that would appear to provide protection to those clients.  
 8   That is to say if there's a true auction, and there's lots 
 9   of dealers competing, then our fears about the agent 
10   representing the client -- ripping off the client by doing a 
11   principal bid under -- in dark places are alleviated. 
12             So then -- so in which case I think I'm pretty 
13   supportive of this proposal, but it all turns on the notion 
14   that the auction is a legitimate auction.  And the question 
15   then is to try to figure out how -- what constitutes a 
16   legitimate auction, and are we potentially creating a 
17   situation where -- so I've got agency relationship with my 
18   client, a managed client or something, or a rav client, or 
19   something, and I promised I'm not going to profit except for 
20   the annual fee. 
21             But now SEC's given us this exemption, or MSRB as 
22   well, that says I can go out and collect a bunch of bids.  
23   But I know where I -- I'll use a vendor who collects the 
24   stupid bid and allowing me to step in front of that with my 
25   blind bid that is also weak, and I profit. 
0095
 1             And so we want to make sure that we don't create a 
 2   little subindustry of people who are catering to broker-
 3   dealers who want to ensure that we'll give you the coverage 
 4   to put in your low bid because everybody else sort of has a 
 5   reputation for low bidding.  And that, of course, would not 
 6   be in the public interest. 
 7             So the question is is how do we prevent that 
 8   latter scenario from forming?  That you have venues that are 
 9   sort of known for just providing quotes that aren't really 
10   all that aggressive, and then the broker-dealers go to those 
11   venues because they know it's going to give them enough 
12   flexibility to accomplish what, you know, they may otherwise 
13   might want to accomplish. 
14             None of this, of course, is in the customer's best 
15   interest, and we believe that the broker-dealers are always 
16   acting in the customer's best interest, but the truth is is 
17   that the Commission exists largely in response to the fact 
18   that they don't always do so. 
19             So I'd say the scenario is, if we pass this and it 
20   gets adopted, how do we ensure that we don't have, you know, 
21   ATSs that are created that -- where there's -- where they 
22   are sort of under -- where they manage to collect bids from 
23   dealers who aren't aggressive? 
24             MR. FERRERI:  I'll just speak as a broker's broker 
25   that reports as an ATS, right.  Hartfield is both.  I'm not 
0096
 1   suggesting that bad people don't do bad things, but I'm not 
 2   sure I could operate a business that only takes bad bids.  I 
 3   think you'd have to execute trades to remain in business, 
 4   and I think that's a function of getting our prices out to 
 5   as many people.  As in interdealer broker in treasuries we 
 6   had a hundred accounts.  As broker's brokers in munis we 
 7   have 600 accounts.  We have SMMPs on our platform.  We have 
 8   home offices on our platforms. 
 9             Our job is to get the bid wanted out as quickly as 
10   possible, get as many bids back as quickly as possible 
11   because we get paid when we do a trade. 
12             MR. HARRIS:  So here's where I'm afraid for your 
13   business. 
14             MR. FERRERI:  Okay. 
15             MR. HARRIS:  If -- you're going to do all the 
16   right things, and I'm really delighted to hear that, but 
17   broker-dealer who wants to trade this thing on an 
18   advantageous basis is going to look at you and say hey, this 
19   guy's a really good guy in the business, but there's this 
20   other guy who doesn't have such a thick book of dealers, and 
21   I'm always going to go to him instead of go to you because 
22   the best bid in that book is probably going to be worse than 
23   the best bid that you could get.  And so now we have broker-
24   dealers looking for the worst instead of the best. 
25             MR. NOBLE:  So if I can jump in here also. 
0097
 1             MR. FERRERI:  I can jump in, too. 
 2             MR. NOBLE:  Yeah, I mean, that's a fine thought 
 3   process if you're dealing in a principal business where I'm 
 4   going to own the bonds to make money.  But when we go with 
 5   the best execution rule, okay, and the audit trail that I 
 6   have to follow. 
 7             So it would be one thing that if I'm buying bonds 
 8   five points below the market and then trying to mark them up 
 9   five points and sell them to another customer, which can't 
10   happen in my world, it may happen in other places, to your 
11   point, I think, and I don't know if that can still happen.  
12   We still have a very tight regulatory framework that I have 
13   to maintain best interest now and best execution.  So if I'm 
14   hunting out the worst bid provider, it's going to basically 
15   come out to bite me some point down the line. 
16             Jude, I -- going with that either. 
17             MR. ARENA:  Yeah, the fact pattern you described 
18   would be a rules violation.  So the burden isn't on the ATS, 
19   the burden is on the dealer to provide reasonable diligence 
20   to get best ex.  So that would not be reasonable diligence, 
21   and that would be a clear rules violation.  We have 
22   compliance around it.  We have frequent meetings to make 
23   sure that our process and best ex is meeting the requirement 
24   of the rule. 
25             MR. BAGLEY:  Yeah, dealers have to have a reason 
0098
 1   why they're using various platforms to meet their best 
 2   execution requirement, and it's in their policies and 
 3   procedures.  And most of them do some type of regular 
 4   evaluation of who they're going to.  So I think it would be 
 5   very difficult for a dealer to be one of five people that go 
 6   to this platform for these bids and be able to justify it. 
 7             So I don't think that's a long-term concern.  I 
 8   think that people are going to have to meet their best 
 9   execution and fair and reasonable requirements, and here -- 
10   their fiduciary requirements.  So I think that's not a very 
11   likely scenario in the scheme of things. 
12             MR. HARRIS:  So the tradeoff -- very quickly.  The 
13   tradeoff is the hope of getting a slightly better bid or 
14   maybe a substantially better bid from one entity versus the 
15   potential conflicts of interest that are associated with 
16   dual trading. 
17             The proposal is to change from a system that 
18   prohibits dual trading to a system that permits it.  Unless 
19   I hear something that changes me, I think I'll be voting 
20   against because frankly the agency problems associated with 
21   dual trading are very significant.  And in a market that has 
22   a number of participants, and this one does, you have 
23   basically most of the protection. 
24             So the business that you lose because you can't 
25   dual trade with your client is business you pick up because 
0099
 1   your competitor can't dual trade with his own client.  So in 
 2   the end I don't think it's -- the prohibition against dual 
 3   trading is all that damaging to the clients. 
 4             MR. HEANEY:  All right, Larry, we're not -- we're 
 5   holding off for the vote for now. 
 6             But Lynn, why don't we get to the others so we can 
 7   get through this? 
 8             MS. MARTIN:  Rick, you've been waiting a bit. 
 9             MR. MCVEY:  Yeah, I'll just say in advance, this 
10   may be a really dumb question, but if blind bidding is good 
11   for competition and liquidity in retail orders, why is that 
12   not also the case with blind offers?  Why is this all 
13   focused on one side of the market? 
14             MR. BAGLEY:  From conversations we had with 
15   dealers, they thought this was the biggest gap in the 
16   managed account side, trying to get a bid.  If you look at 
17   it, you know -- if you go to a platform -- you know, John, 
18   you guys must have a hundred thousand offerings, so the 
19   thought was there's a lot of offerings coming in, it's a 
20   harder thing to say we're going to be that much better. 
21             But on a bid side, the dealers tend to buy a lot 
22   of their own client bid wanteds, and they thought that was 
23   the biggest gap.  And their biggest concern was when the -- 
24   especially if the market's not behaving and it's kind of -- 
25   you know, it's all over the place, they'd like to be able to 
0100
 1   provide a bid, because sometimes the bids they see are not 
 2   there. 
 3             So it was just the thought that that was a much 
 4   more significant hole in the marketplace.  And I also think 
 5   that if you go to the offered side, it's -- it becomes a 
 6   much bigger question. 
 7             MR. NOBLE:  It is a bigger question.  On the offer 
 8   side, most outside money managers, that's the people that 
 9   are directing the trades, are usually using new issues as 
10   the primary market because it's easier for them to prove 
11   what they're buying in that marketplace, so you see a lot of 
12   new issues.  The problem that we have with new issues is 
13   they'll end up buying a million bonds and then basically 
14   putting it in a hundred different accounts.  That's where we 
15   end up with the 10-bond piece.  They got a great execution 
16   going in because they bought a million, but now their client 
17   owns a 10-bond piece, and now I have to get that 10-bond 
18   piece out of the account.  That's been the whole 
19   conversation.  It's usually they buy large blocks, split it 
20   10 to a hundred different ways, and then you end up with the 
21   odd lot pieces that you have to bid on. 
22             So the offer side has always been pretty much a 
23   new issue, sometimes a secondary market, but it's going to 
24   be in large blocks because that's what the money managers 
25   deal with.  But then when the client or the money manager 
0101
 1   decides they want to reinvest, they have to go to each 
 2   individual account now, and that has to happen on a multi 
 3   basis.  And it's usually -- they're not trying to sell five 
 4   accounts with a hundred bonds, they're trying to sell five 
 5   accounts with five bonds. 
 6             MS. MARTIN:  I think we have time for one more 
 7   question. 
 8             Tom. 
 9             MR. GIRA:  Just to echo what Jude said about sort 
10   of the best execution aspects of it.  There is -- there are 
11   rules that require regular and rigorous assessment of how 
12   firms how are routing their order flow.  So I think Larry 
13   raises a good point, but we -- there is a rule that's on -- 
14   and that is something we actively look at in our exams. 
15             But I -- just going back to the pilot, and the 
16   fact that it was allowed to sunset.  I heard sort of two 
17   reasons that might have explained that.  One was the trade-
18   by-trade and the difficulties created by that, as well as 
19   sort of wanting to have an alignment of procedures.  Was 
20   there any other reason why the pilot expired?  Because it 
21   seemed like that was maybe a good thing to have in place to 
22   sort of thread the needle here, and I was just curious if 
23   there were other reasons why that went away? 
24             MR. NOBLE:  I don't really know why it went away.  
25   I mean, in December of 2016 it did go away, and I think they 
0102
 1   informed everybody in the beginning of October or something 
 2   that it was going to sunset out.  And I don't know the 
 3   reason.  I would look to -- it was an SEC rule.  Look to 
 4   somebody in the SEC to tell me why it went away. Can't tell 
 5   you. 
 6             MR. CARTER:  It was originally supposed to sunset 
 7   in '09, I think, and then they kept extending it, and then 
 8   they just didn't in 2016. 
 9             MR. HEANEY:  You stumped us. 
10             (Laughter.) 
11             MS. MARTIN:  So Michael, I'll turn it over to you. 
12             MR. HEANEY:  Thank you. 
13             This has been a great discussion, and I don't want 
14   to use the word debate, but it's been a really good 
15   discussion. 
16             Before we move further, I know there's people on 
17   the phone, I just want to see if anyone on the phone has 
18   anything to add to the discussion. 
19             (No response.) 
20             MR. HEANEY:  Okay. 
21             At this point I'll entertain a motion to vote on 
22   the recommendation. 
23             MR. CARTER:  So moved. 
24             MR. HEANEY:  Thank you, Horace. 
25             All voting members in favor please raise their 
0103
 1   hands. 
 2             (Hands raised.) 
 3             MR. ANDRESEN:  Michael, this is Matt Andresen, I'm 
 4   on the phone for the vote. 
 5             MR. HEANEY:  Any opposed please raise their hand. 
 6             (Hands raised.) 
 7             MR. HEANEY:  Abstentions in the room? 
 8             (No response.) 
 9             MR. HEANEY:  All right. 
10             Matt, I'll take your vote. 
11             MR. ANDRESEN:  No. 
12             MR. HEANEY:  Kumar? 
13             MR. VENKATARAMAN:  I'm in favor. 
14             MR. HEANEY:  I beg your pardon?  Kumar, can you -- 
15             MR. VENKATARAMAN:  I'm in favor. 
16             MR. HEANEY:  In favor.  Thank you. 
17             Brad, I'm not sure if you're on. 
18             (No response.) 
19             MR. HEANEY:  Suzanne? 
20             MS. SHANK:  In favor. 
21             MR. HEANEY:  Thank you. 
22             Okay, the vote has passed 12 to 4. 
23             Again, I want to thank Lynn for your leadership on 
24   this and the persistence again for something that has taken 
25   a few months and a few meetings.  I'd love to thank the 
0104
 1   panelists, many of whom have come back twice to DC, but for 
 2   your insights on this as well. 
 3             And we will now break for lunch.  We'll be back at 
 4   12:45.  Thank you. 
 5             (Whereupon, at 12:00 p.m., a luncheon recess was 
 6   taken.) 
 7             MR. HEANEY:  Okay, why don't we get started? 
 8             UPDATES FROM THE TECHNOLOCY AND ELECTRONIC  
 9                 TRADING SUBCOMMITTEE AND ETFS AND 
10                       BOND FUNDS SUBCOMMITTE 
11             MR. HEANEY:  We'll begin the afternoon session 
12   with two updates from our subcommittees on the work they've 
13   done since the April meeting.  We'll start by hearing from 
14   Rick McVey, Chair of the Technology and Electronic Trading 
15   Subcommittee.  As all of you know, in June we held a 
16   telephonic meeting to consider two recommendations developed 
17   by the subcommittee. 
18             I want to once again thank Rick for his leadership 
19   and hard work in getting these initiatives in front of the 
20   committee and doing it in such a fashion on the phone as 
21   well. 
22             If you could provide, Rick, a brief update with 
23   what the subcommittee has been working on and considering 
24   since the April meeting, please. 
25             MR. MCVEY:  Sure, be happy to.  Thanks, Michael. 
0105
 1             And thanks to all the members of the Technology 
 2   and E Trading Subcommittee.  We have been doing quite a bit 
 3   of work during the quarter and specifically on two issues, 
 4   one of which Michael mentioned was revising the 
 5   recommendation to the full committee on pennying. 
 6             And we did respond to the comments that we 
 7   received during the April meeting from a variety of 
 8   different committee members.  We worked that language into 
 9   the recommendation and specifically worked to clarify the 
10   intended difference between practices in pennying versus 
11   legitimate last look.  And we did then present that as all 
12   of you know at the June conference call, and that 
13   recommendation was approved by the committee. 
14             The second work that we conducted around the same 
15   time was really reviewing the comment letters that came into 
16   FINRA on the proposed corporate bond new issue reference 
17   data service.  And the committee really felt that the 
18   committee's intent in some comment letters was 
19   misrepresented, and the need for the corporate bond 
20   reference data service was underestimated. 
21             And we felt that it was important to be on record 
22   responding to some of those comments and worked very hard to 
23   craft a letter that we appealed to the full committee on the 
24   June conference call to support in order to be a part of the 
25   process in revalidating our view that the market does in 
0106
 1   fact need a centralized new issue corporate bond reference 
 2   data service. 
 3             So those two items consumed most of our 
 4   committee's time during the second quarter.  We're at very 
 5   early stages of really brainstorming on other areas of the 
 6   fixed income market structure where we could recommend 
 7   improvements.  None of the topics are very far along 
 8   currently so we're not anywhere close to a new 
 9   recommendation. 
10             But some of the things that we've been talking 
11   about are trading in the corporate bond gray market, 
12   potential improvements to trade settlement to expand market 
13   participation in all-to-all trading, and then finally 
14   potential ideas around modernization of investment manager 
15   best execution guidelines. 
16             So those are the -- some of the things that are 
17   bubbling up at the subcommittee now, and with that I'll 
18   conclude my report. 
19             MR. HEANEY:  Thank you, Rick. 
20             The subcommittee continues to tackle interesting 
21   topics, and we look forward to hearing the work done by the 
22   subcommittee at our next meeting in November. 
23             We'll next hear from the ETF and Bond Funds 
24   Subcommittee.  In Anan's absence, Rachel Wilson, I turn to 
25   you. 
0107
 1             MS. WILSON:  Thanks everybody. 
 2             At the April, 2019 meeting you may recall that the 
 3   subcommittee submitted a report on ETF and bond funds under 
 4   stress markets.  The issues highlighted in the 
 5   subcommittee's report are quite timely. 
 6             European Systematic Risk Board, the ESRB, has 
 7   recently released a report on can ETFs contribute to 
 8   systemic risk.  Broadly, the ESRB reports covers several 
 9   issues that were highlighted in our stress market report, 
10   including the effect of stress markets on ETF liquidity, 
11   pricing, investor flows, and liquidity in pricing of the 
12   underlying bonds.  And similar to the roadmap for future 
13   research that we sketched in the FIMSAC report, the ESRM 
14   (sic) report identifies important understudy topics that 
15   future research should focus on.  These issues continue to 
16   receive considerable attention from industry participants 
17   and financial press.  And I'd encourage the audience to read 
18   the FIMSAC report if they have not done so. 
19             The subcommittee has identified two potential 
20   panel topics for a future meeting of the FIMSAC.  The first 
21   topic, which was highlighted in our stress market report, 
22   focuses on the important role of authorized participants in 
23   the arbitrage process, and the possibility that they cease 
24   their arbitrage activities in times of stress, possibly at 
25   the same time, causing a price dislocation and significant 
0108
 1   withdrawal of liquidity, termed as step away risk in our 
 2   report. 
 3             Step away risk becomes particularly relevant under 
 4   stress markets because only a handful of APs create and 
 5   redeem shares actively on a typical day.  The subcommittee 
 6   feels that it is important to understand the extent of step 
 7   away risk and identify possible market structure 
 8   improvements.  For example, imposing affirmative obligations 
 9   on AP participation to mitigate the risk. 
10             The second panel topic is the impact of bond index 
11   construction on managed bond portfolios.  Bond index 
12   benchmark includes many more assets than equity index 
13   benchmarks.  Bond indexes are also associated with larger 
14   and more frequent turnover than equity benchmarks.  As 
15   funds, ETFs, mutual funds, other tracking the index respond 
16   to mechanical weight changes in the benchmark index.  
17   Academic research suggests that these rebalancing trades 
18   have a larger impact on the underlying bond prices that are 
19   non-fundamental in nature. 
20             Further, benchmarking to index causes the 
21   rebalancing funds to trade frequently in a predictable 
22   manner, thus imposing trading costs that hurt fund 
23   performance.  The subcommittee feels that it is important to 
24   highlight the implications of index construction 
25   methodologies for bond prices and managed fund performance, 
0109
 1   and identify possible methodological improvements to 
 2   mitigate these mechanical, non-fundamental effects. 
 3             MR. HEANEY:  Thank you, Rachel. 
 4             Any questions or comments for Rachel? 
 5             (No response.) 
 6             MR. HEANEY:  We look forward to hearing more at 
 7   our next meeting from the subcommittee.  Thank you. 
 8                     CONTENT AND TIMELINESS OF  
 9                    MUNICIPAL ISSUER DISCLOSURES 
10             MR. HEANEY:  Our first panel this afternoon will 
11   address a matter related to disclosure by municipal issuers.  
12   This has been a topic that has been covered by two of our 
13   subcommittees, both the Credit Rating Subcommittee and the 
14   Municipal Securities Transparency Subcommittee, which both 
15   have had calls on the topic. 
16             First we'll hear from Rebecca Olsen, Director of 
17   the SEC's Office of Municipal Securities, who will provide a 
18   brief overview of the regulatory regime governing municipal 
19   issuer disclosure. 
20             MS. OLSEN:  Great, thank you. 
21             So the municipal securities market has not been 
22   subject to the same level as (sic) regulation as other 
23   sectors of the U.S. capital markets.  The Securities Act of 
24   1933 and the Securities Exchange Act of 1934, both were 
25   enacted with broad exemptions for municipal securities from 
0110
 1   all of their provisions except for the anti-fraud 
 2   provisions. 
 3             So as a general matter, if a corporation wants to 
 4   access the public debt market, the Securities Act requires 
 5   the corporation to register their debt securities with the 
 6   Commission on an SEC form that requires specific line item 
 7   disclosure, and that form is subject to review by the SEC 
 8   staff for completeness. 
 9             In addition, the Exchange Act requires 
10   corporations to provide ongoing information to the 
11   Commission on SEC forms.  Annual reports on Form 10-K, 
12   quarterly reports on Form 10-Q, and current events on 8-K 
13   that also require specific line item disclosure, so long as 
14   their debt securities are outstanding.  None of these 
15   requirements apply to issuers of municipal securities.   
16             So in the absence of statutory scheme for 
17   municipal securities registration and reporting, the 
18   Commission's investor protection efforts in the municipal 
19   securities market have been accomplished primarily through 
20   the following mechanisms. 
21             So first, enforcement of the anti-fraud provisions 
22   of the Federal securities laws against municipal issuers and 
23   other municipal market participants.  Broadly speaking, the 
24   anti-fraud provisions prohibit deceit, misrepresentation, 
25   and fraud in the offer, purchase, and sale of securities to 
0111
 1   the public.  They apply to all information released by a 
 2   municipal issuer to the public that is reasonably expected 
 3   to reach investors in trading markets.  This would include 
 4   primary offering documents and continuing disclosure filed 
 5   with EMMA, and includes other disclosures made publicly 
 6   available as well. 
 7             As the Commission has previously observed, as a 
 8   practical matter, municipal issuers do not have the option 
 9   of remaining silent, and routinely in the course of their 
10   operations release information to the public.  When the 
11   market does not have access to current and reliable 
12   information about an issuer on EMMA, or perhaps on an 
13   investor relations platform, it's reasonable to expect the 
14   information made generally available to the public by the 
15   issuer will reach the securities markets. 
16             And for sake of clarity, I will also just mention 
17   that Regulation FD, fair disclosure, does not apply to 
18   issuers of municipal securities.  It only applies to issuers 
19   with securities registered pursuant to the Exchange Act and 
20   required to participate in continuing reporting under the 
21   Exchange Act. 
22             So second, moving on from anti-fraud, registration 
23   and regulation of broker-dealers and municipal securities 
24   dealers.  So in 1975 Congress created a limited regulatory 
25   scheme for the municipal securities market at the Federal 
0112
 1   level in response to growth of the market, market abuses, 
 2   and increasing participation of retail investors.  
 3   Amendments required firms transacting business in municipal 
 4   securities to register with the Commission as broker-dealers 
 5   and banks dealing in municipal securities to register as 
 6   municipal securities dealers, and gave the Commission 
 7   rulemaking enforcement authority over these dealers. 
 8             The amendments also created the Municipal 
 9   Securities Rulemaking Board and granted it authority to 
10   promulgate rules governing the sale of municipal securities 
11   by broker-dealers and municipal securities dealers. 
12             Notably the amendments did not create a regulatory 
13   regime for or impose requirements on municipal issuers.  And 
14   the amendments also included what we refer to as the Tower 
15   Amendment, which limits the SEC and MSRB's authority to 
16   require municipal issuers to make any type of pre-sale 
17   filing with the Commission or with the MSRB. 
18             Third, Rule 15C212.  So the Commission has 
19   exercised its authority over the municipal securities 
20   brokers and dealers by adopting and subsequently on numerous 
21   occasions amending Rule 15C212, which established a basic 
22   disclosure framework for the municipal securities market. 
23             So with respect to primary market disclosure, Rule 
24   15C212 requires broker-dealers acting as underwrites in most 
25   primary offerings of municipal securities to obtain, review, 
0113
 1   and distribute to investors copies of the issuer's 
 2   disclosure documents.  With respect to continuing 
 3   disclosure, Rule 15C212 imposes contractual disclosure 
 4   requirements on municipal issuers, namely before purchasing 
 5   or selling municipal securities in connection with an 
 6   offering subject to that rule, the underwriter has to 
 7   reasonably determine that an issuer of municipal securities 
 8   or an obligated person has undertaken in a written agreement 
 9   or contract for the benefit of the holders to provide 
10   certain information on a continuing basis to the MSRB.  This 
11   includes certain annual financial information and notices of 
12   occurrence of any of the specific events listed in the rule 
13   as well as notice of the failure of an issuer or an 
14   obligated person to make a timely filing of their annual 
15   information. 
16             Finally, Rule 15C212 also provides for a single 
17   centralized disclosure repository for the electronic 
18   collection and availability of information about the 
19   municipal securities market.  The MSRB established and 
20   maintains this repository known as the Electronic Municipal 
21   Market Access system, or EMMA.  It makes it freely 
22   accessible to all investors to the MSRB's website. 
23             Finally, I'll just mention a couple additional 
24   ways the Commission regulates the municipal securities 
25   market, and that is through the registration and regulation 
0114
 1   of municipal advisors.  This was new, it was added as part 
 2   of the Dodd-Frank Act.   And finally, through interpretive 
 3   guidance.  Commission releases and reports have served as 
 4   the principle source of general guidance on the Commission's 
 5   views with respect to the disclosure obligations of 
 6   participants in the municipal securities market under the 
 7   anti-fraud laws.  Thank you. 
 8             MR. HEANEY:  Thank you, Rebecca. 
 9             I'd like to now turn it over to Amy McGarrity and 
10   Lynn Martin.  Amy chairs the Credit Rating Subcommittee, and 
11   Lynn chairs, as you know, the Municipal Securities 
12   Transparency Subcommittee.  They'll be co-moderating the 
13   panel.  And we'll introduce our panelists and moderate the 
14   discussion. 
15             Amy. 
16             MS. MCGARRITY:  Thanks, Michael.  I'll take it. 
17             I think it's time for a quick quiz on what Rebecca 
18   just went over as far as the regulatory regime surrounding 
19   municipal issuers. 
20             (Laughter.) 
21             MS. MCGARRITY:  So I hope we were all paying close 
22   attention. 
23             No, first of all, thank you so much for our panel 
24   participants.  Today we have a really large panel that will 
25   hopefully dive into this subject a little bit deeper. 
0115
 1             We're going to be discussing, as you may have 
 2   guessed, municipal issuer provision of information to credit 
 3   ratings agencies and the potential lack of similar 
 4   disclosure to the users of credit ratings.  Municipal issuer 
 5   disclosure has also been a focus of the Municipal Securities 
 6   Transparency Subcommittee, and we have coordinated with Lynn 
 7   Martin regarding our efforts on this topic and the content 
 8   of today's panel. 
 9             So Lynn, thank you very much for your support, and 
10   also a big thanks to John Bagley for all of his help and 
11   assistance in not only gathering this panel together but 
12   just throughout the conversation on the subcommittee level. 
13             So today's panel includes a variety of types of 
14   issuers and panelists.  So we have from the municipal issuer 
15   side, Tim Schaefer with the Office of the California State 
16   Treasurer, and we have Kendel Taylor with the City of 
17   Alexandria.  From the investor side, we have James Wallin 
18   with Alliance Bernstein, as well as Sheila May with GW&K.  
19   We have a retail intermediary, Tom McLoughlin, with UBS.  
20   And then lastly we have Tom Doe with Municipal Market 
21   Analytics.  So we have a wide variety of insights hopefully 
22   to share with us today. 
23             Now turning to our discussion, we thought it would 
24   be helpful to focus on the different types of information 
25   generated by municipal issuers under various scenarios.  So 
0116
 1   our questions will dive into each. 
 2             We will start with a discussion of primary market 
 3   disclosure, and this will be followed by a discussion of 
 4   secondary market disclosure, including annual reporting and 
 5   interim reporting.  We will then touch on other types of 
 6   disclosures, and finally we will discuss views on the impact 
 7   of disclosure practices on market efficiency. 
 8             So first diving a bit more into primary market 
 9   disclosure, I will start with some issuer questions.  So 
10   these are directed at Tim and Kendel.  When you are 
11   preparing to go to the market with a primary offering, do 
12   you provide information to the ratings agencies that is not 
13   included in or covered by the disclosure document prepared 
14   for investors? 
15             MR. SCHAEFER:  Thank you, Amy. 
16             First, let me just take a couple of seconds and 
17   thanks to you, the subcommittee, and to the committee, and 
18   to the Commission for inviting us to participate in this. 
19             So while I'm pleased to participate, the first 
20   thing I've got to say to you is that California is by no 
21   means your typical issuer, and so I wouldn't presume to 
22   speak for other state governments. 
23             Because our municipal disclosure regime reflects 
24   this peculiarity, California is virtually a nation state.  
25   It's the largest municipal issuer in the United States and 
0117
 1   indeed has its home to the fifth largest economy in the 
 2   world.  We have a budget, excluding Federal funds, that 
 3   approximates 200 billion dollars a year.  So disclosure in 
 4   this context represents some very peculiar and challenging 
 5   circumstances for us. 
 6             California goes to the market quite often 
 7   throughout the year in two basic cycles, spring and fall.  
 8   We will often issue four to six billion dollars worth of 
 9   municipal securities in each of those cycles, or in years 
10   where we're not doing a lot of refinancing, the cycles 
11   combine. 
12             We do take our disclosure obligation seriously, 
13   and in addition to the numerous state officials and staff 
14   across all agencies and departments who touch things that 
15   would be important to investors, we also have the assistance 
16   of three prominent law firms to guide us through the ins and 
17   outs of the regulatory process. 
18             We construct our offering documents with a part 
19   that in town is known as Appendix A.  And Appendix A is the 
20   financial, economic, and demographic portions of the state 
21   operations that are brought together in a way that are 
22   intended to provide the disclosure materials that we need to 
23   provide to investors. 
24             So in short answer to your question, which I'd 
25   like to expand on once I give you the one-word answer, is 
0118
 1   no.  Our practice is to send the rating agencies a draft of 
 2   our Appendix A before and in connection with the obtaining 
 3   of that rating.  There will be opportunity for the rating 
 4   agencies to ask clarifying questions on its content, and to 
 5   us to give what we hope are responsive answers to that. 
 6             In addition to that draft Appendix A, there are 
 7   all manner of other financial and operating data points in 
 8   the state that exists through this huge organization that 
 9   may add some color or context to that, but if they aren't in 
10   Appendix A, we don't take responsibility for those in 
11   connection with securities offerings. 
12             So if the rating analyst asks a specific question, 
13   it is our practice to respond to that question, re-examine 
14   the disclosures made in Appendix A, re-examine it both 
15   within the state's team and with our team of disclosure 
16   attorneys.  And if there's something in there that's coming 
17   up that we believe is material, we won't be shy about going 
18   back and amending Appendix A.  So it's not to say that 
19   Appendix A when it's circulated as a draft is intended to be 
20   the final dispositive note on that. 
21             I would also note, and I can assure the panel of 
22   this personally, that in the due diligence process that our 
23   underwriters engage with in preparation for underwriting the 
24   state's securities, a standard question from them -- there 
25   are two standard questions I always pay more attention to 
0119
 1   than all the others.  The first standard question is have 
 2   the rating agencies raised any concerns or questions which 
 3   you believe are not adequately addressed in Appendix A?  We 
 4   could have predicted that one. 
 5             The second one brings it down to a more personal 
 6   level, and I think this is really at the heart of the -- one 
 7   of the heart issues of the integrity of the market.  Has the 
 8   deputy treasurer responsible for public finance reviewed 
 9   Appendix A?  That would be me, okay.  And in order to answer 
10   that question truthfully the -- think about then the 
11   disclosure process in the primary market as being very much 
12   a pyramid because I'm the one responsible to go into the 
13   treasurer, ask her to review the material and to sign off on 
14   it. 
15             So short answer is no, but we're not the typical 
16   issuer, Amy. 
17             MS. MCGARRITY:  Thank you for that thoughtful 
18   response, Tim. 
19             Kendel, would you like to comment as well? 
20             MS. TAYLOR:  I just -- as a much, much smaller 
21   issuer who goes about once a year.  This year we're actually 
22   not going.  And our issuances are between 23 million and a 
23   hundred million dollars.  Our goal is to actually make sure 
24   they're aware of what's changed from the prior year.  We're 
25   not sharing anything that hasn't gone to council, that's not 
0120
 1   public, that's not in the offering document, but we want to 
 2   use that hour, hour and change to say hey, here's some great 
 3   things we want to make sure you see about Alexandria, and 
 4   how we compare, and what you learned and heard about us last 
 5   year.  So it's really our chance to just draw attention to 
 6   what's in those documents. 
 7             MS. MCGARRITY:  Great, thank you. 
 8             So from the investor perspective, this is James, 
 9   Sheila, and Tom.  Does the buy side generally receive all of 
10   the disclosures that they need during a primary offering, or 
11   is your sense that ratings agencies receive additional 
12   information that might be helpful to investors? 
13             MR. WALLIN:  (Away from mic.)  I got to put it on.  
14   I thought you put it on.  Sorry about that. 
15             I guess it depends how you define additional.  We 
16   believe that, you know, in a primary offering the agencies 
17   get more color and more granularity.  They'll meet with the 
18   issuers ahead of the new deal, where we usually can't.  And 
19   some of this is for the agencies to get local color and 
20   background, and also to assess management.  And again, we 
21   don't generally have that type of access.  And at the 
22   meetings, they also get additional information such as 
23   monthly cash flows, and where the offering documents only 
24   give annual flows. 
25             So those are just some of the examples and, you 
0121
 1   know, our experience or our, you know, understanding is that 
 2   the agencies continue to get this information on an ongoing 
 3   basis and, you know, we've had analysts that have worked at 
 4   both Moody's and Fitch, and their experience reflects that.  
 5   And generally the only time we have the leverage to get that 
 6   kind of information or extra color is when the deal is in 
 7   trouble and they need us. 
 8             So, you know, again it depends how you define 
 9   additional.  But we think that the agencies have an 
10   advantage. 
11             MR. MCLOUGHLIN:  In the primary market, we 
12   generally get most of what we need.  The only thing that we 
13   may not get that we think the rating agencies may get is 
14   interim financials.  That's really -- the unaudited interim 
15   financial reports are probably the one thing that would be 
16   most relevant.  But by and large the primary market 
17   disclosure is usually sufficient in what we're getting. 
18             MS. MAY:  Yeah, I mean, I would agree with both.  
19   I don't think that there is additional information that the 
20   rating agencies get.  I wouldn't consider it material, but 
21   certainly adds a layer of detail that we don't necessarily 
22   get. 
23             Having said that, though, during the primary 
24   offering, this is when the issuers are the most accessible 
25   because they have a deal that they want to sell so, you 
0122
 1   know, you usually do get to have some sort of one-on-one or, 
 2   you know, you sign up for a call ahead of time to speak with 
 3   the issuers directly and, you know, so you can get 
 4   additional information and additional color that way. 
 5             MS. MCGARRITY:  The other Tom, Tom Doe.  I didn't 
 6   mean to leave you out.  I recognize we have multiple Toms 
 7   with different perspectives.  So Tom, do you have anything 
 8   that you would like to add? 
 9             MR. DOE:  I would just echo that with the term 
10   about can't get access, I think it's about not wanting to 
11   get access and/or not choosing to.  And I think to Sheila's 
12   point is that issuers do make themselves available to 
13   investors.  I think there are costs associated with getting 
14   that information, and that can be inhibitive. 
15             The other aspect that I think that hasn't been 
16   mentioned is that when we go through cycles, especially on 
17   the investment side, where costs get constrained because 
18   we're in fee wars in the municipal industry, everyone's 
19   lowering costs, that there's greater reliance on the credit 
20   -- on the investor's side on the rating agencies.  This 
21   isn't true across all boards, but that's where we start 
22   seeing efficiencies.  We saw this prior to 2008, and I think 
23   we're going into a cycle like that right now.  And I'll 
24   leave it to the -- what's already been said about whether 
25   the rating agencies are getting more or not. 
0123
 1             MS. MCGARRITY:  I just want -- have one quick 
 2   follow-up, and we -- this we didn't talk about in advance, 
 3   so I apologize, but it's not a zinger or anything.  But, you 
 4   know, we have some large money managers responding to these 
 5   questions. 
 6             Tom McLoughlin, what's your view -- I know you 
 7   said that the primary market disclosure was sufficient 
 8   generally speaking.  Do you think it differs to the average 
 9   retail or smaller investor wherein Sheila and her firm are 
10   able to gain access to issuers, but Amy McGarrity couldn't 
11   necessarily call up the State of California and get similar 
12   disclosure information? 
13             MR. MCLOUGHLIN:  Well, I've known Tim for 20 
14   years, so he probably would pick up the phone and answer the 
15   question. 
16             But there -- individual clients, by and large, 
17   will rely on the written document.  They will, in the case 
18   of the State of California -- Appendix A is fairly famous 
19   actually in the municipal market because it is voluminous.  
20   The likelihood of them basically picking up the phone and 
21   asking further questions, it happens, but it is fairly 
22   remote when that's going to happen. 
23             MS. MARTIN:  So as Amy mentioned, this has been a 
24   topic that's been considered by the Muni Transparency 
25   Subcommittee, particularly the timeliness of audited 
0124
 1   financials. 
 2             This question is more for Tim and Kendel.  Could 
 3   you give FIMSAC a flavor for how long following your fiscal 
 4   year you publish those audited financial statements, and 
 5   whether or not the rating agencies receive a copy of those 
 6   on an unaudited basis before they're published to the 
 7   market? 
 8             MS. TAYLOR:  So yes, I'm happy to answer that. 
 9             Our fiscal year ends June 30th, but we have 
10   trustee taxes that don't actually come in to us until -- so 
11   June is July 30th, and our sales tax isn't until August 
12   15th.  So we don't actually have all of our data, all of our 
13   numbers until the middle of August, and we are publishing 
14   for our City Council and for the public by the middle of 
15   November to meet a state requirement to produce our audited 
16   public financial reports and our CAFR, so by the end of 
17   November we're done.  And that's a compressed period from my 
18   perspective. 
19             We think of, you know, June 30th, but there's 
20   really a lot going on.  We're not producing a trial balance 
21   til early September because we simply don't have the 
22   receipts yet. 
23             In terms of whether there's a -- and interim 
24   stuff, we don't -- we just produce one.  We are -- we've 
25   timed when we go.  We have a completed public financial 
0125
 1   document.  There are no interim CAFRs that are going to the 
 2   rating agencies ahead of time.  We do publish a monthly 
 3   financial report each month, that goes to council.  We're 
 4   pretty -- we share with our council before we share with 
 5   other people.  That is the way council operates.  It keeps 
 6   us all employed if council's not reading something from 
 7   outside that they haven't heard from us first. 
 8             And in terms of the -- whether it impacts us, 
 9   whether I issue debt or not, I have to meet my state 
10   requirements.  So the two from my perspective are a little 
11   disconnected.  Whether I'm issuing debt, I have to get my 
12   audited financial reports to the state within that deadline. 
13             MS. MARTIN:  Thanks. 
14             Tim. 
15             MR. SCHAEFER:  Well, as I mentioned earlier, 
16   California is by no means typical here.  We do have some 
17   challenges in preparing, compiling financial statements.  
18   Our continuing disclosure undertaking, that you heard Ms. 
19   Olsen talk about earlier, commits us to filing audited 
20   financial statements within 270 days. 
21             That in our ecosystem shouldn't be surprising when 
22   you consider the size of some of our component units that 
23   accounting rules require be incorporated into the 
24   disclosure.  So therein is the problem.  The component units 
25   need to be finished before they can be aggregated into the 
0126
 1   CAFR. 
 2             Now having said that however, even though the 
 3   state controller, whose primary responsibility it is to 
 4   prepare those CAFRs can't do that, we do make a contractual 
 5   obligation in our continuing disclosure agreements to file 
 6   statements within 270 days, even if they're unaudited so at 
 7   least we have something to offer the market.  In fact, that 
 8   occurred this year.  We did not file auditeds on a timely 
 9   basis, although we did file our unauditeds appropriately by 
10   EMMA, and then they were followed by the audited financials. 
11             We do not give our financial statements to the 
12   rating agencies before they're filed.  What we do do is, and 
13   I'm -- a little prop here.  If you go to our investor 
14   relations website, the state controller files the statement 
15   of general fund cash receipts and disbursements and, of 
16   course, the general fund is the 800 pound gorilla in credit 
17   analysis for the state, and the Department of Finance files 
18   monthly a finance department bulletin which describes the 
19   economic circumstances. 
20             Those are available to anybody.  Those are 
21   available to somebody who owns 10 bonds, or they're 
22   available to the five large institutional investors that 
23   combined hold 11 percent of our outstanding debt.  And 
24   that's very intentional on our part to make them accessible. 
25             And then I'd conclude by saying that in the 
0127
 1   treasurer's office we also maintain an 800 number for 
 2   investors, which frequently is used by smaller investors who 
 3   are seeking information so that we can do things like direct 
 4   them to EMMA, direct them to Appendix A, answer specific 
 5   questions about things that don't involve market 
 6   functioning, but which do involve the securities that they'd 
 7   agreed to lend us money for. 
 8             MS. MARTIN:  Thanks. 
 9             From the investor perspectives, questions for 
10   James, Tom, Sheila, and Tom.  You've heard about the 
11   practices of producing financial statements from our 
12   panelists.  Do you feel that they're representative of what 
13   exists today in the market on the small scale, large scale, 
14   taking into account different size of issuers, and also 
15   taking into account other sectors of the muni market, 
16   healthcare, whatever the -- transportation, whatever the 
17   case may be?  Start with James. 
18             MR. WALLIN:  Yeah, our experiences, you know, 
19   reflects what the other panelists have sort of said in that 
20   the most troublesome sector on timeliness and detail are the 
21   large general governments like states and cities. 
22             And as issuers run into fiscal troubles, it gets 
23   worse.  Detroit and Puerto Rico had terrible disclosure 
24   prior to going bankruptcy (sic) and clammed up to any 
25   questions.  But another trouble spot are smaller issuers 
0128
 1   because a small school district, for example, may have 20 
 2   million in debt outstanding, and doesn't have the staff, and 
 3   doesn't know the market.  So they can't get what they need 
 4   to get done. 
 5             So I think it -- what we see reflects what we've 
 6   heard from the issuers here.  You know, I guess, you know, 
 7   to California's credit, while it took them 333 days to get 
 8   their audit done for '18 -- did I get that right? 
 9             MR. SCHAEFER:  Close. 
10             (Laughter.) 
11             MR. WALLIN:  You know, we do find that their 
12   website is very informative and very helpful in making -- in 
13   allowing us to, you know, carry out our fiduciary duty and 
14   keep an eye on investments.  That's not always the case.  
15   There's -- you know, while there's a pattern with timeliness 
16   and completeness, there's not a pattern with, you know, 
17   online or interim information either on EMMA or directly in 
18   the websites so -- 
19             MR. MCLOUGHLIN:  I don't think California and 
20   Alexandria are probably representative, only because they 
21   both do a good job.  The -- Tim mentioned the controller's 
22   report, the monthly report.  That actually is something that 
23   we refer to on a regular basis.  So even though they're 
24   producing with a component unit delay, financial report 
25   beyond 270 days, we're in a position where we can use that 
0129
 1   as information that's very relevant. 
 2             The average for -- cities, counties, and states 
 3   are the slowest reporters, right.  And the average there, or 
 4   the median I should say, is probably about 175, 180 days.  
 5   Not for profit hospitals, public power, toll road agencies 
 6   tend to take a hundred days, give or take.  So you've got 
 7   really wide variance in terms of how fast individual 
 8   participants in the municipal market can produce these 
 9   reports.  The State of Alabama took over 400 days.  Puerto 
10   Rico's taking three years.  So it varies, right. 
11             And we may get to this later in the conversation, 
12   but whether or not it matters in terms of pricing is just 
13   another issue we should talk about.  But from the 
14   perspective of variation, it's just all over the map. 
15             MS. MAY:  Yeah, I mean, I don't really have much 
16   to add.  I mean, I concur what we have found is that the 
17   colleges and universities are usually -- actually the 
18   privates, are usually the first to get their audits out.  
19   We'll start seeing those for most of them, you know, 
20   finishing on a June 30th fiscal year, we'll start to see 
21   their CAFRs in October, November. 
22             You know, and then as Tom, you know, mentioned, 
23   you know, it's a wide variety, but the -- my shop isn't a 
24   big small issuer investor, so I can't speak to the cities, 
25   and school districts, and such, but certainly the states, 
0130
 1   you know, are the laggards, and for obvious reasons. 
 2             And then, you know, you have your chronic late 
 3   filers.  You know, State of Illinois comes to mind.  And so, 
 4   you know, it sort of is what it is. 
 5             MR. DOE:  In the municipal industry or the market 
 6   we have 55,000 different types of issuers who we allow 
 7   access to capital at a subsidized rate under the idea that 
 8   this is important building essential infrastructure 
 9   projects.  And it's been a long history of a market, and a 
10   lot of the distinctiveness of it, you know, comes with the 
11   exemption itself. 
12             But I think to -- so you're going to have just by 
13   the definition of what we allow and think is important in 
14   terms of local oversight of an entity's debt in their fiscal 
15   health is you're going -- that variety is just going to 
16   exist.  Some will be better than others and, you know, how 
17   we benchmark what's good and right is a little bit unclear 
18   because as Tom alluded to. 
19             And we talked on our call, and we'll get to, is 
20   that the reality is is that there is no consequence for an 
21   issuer not in -- not disclosing within any kind of timeframe 
22   that's deemed to be responsible or adequate.  The business 
23   model of the industry on the investment side simply won't -- 
24   doesn't -- it makes it insignificant. 
25             So I think that's a real issue, as we're bantering 
0131
 1   around, we can talk for hours and hours on end, is what 
 2   disclosure looks like in the municipal market.  But as long 
 3   as there's not a consequence, either good or bad, then 
 4   there's no -- you know, it really gets a little bit academic 
 5   and esoteric.  
 6             MS. MARTIN:  Before turning it back to Amy I have 
 7   a bit of lightning round question for you guys.  Is there a 
 8   point in time when you believe that financial reports lose 
 9   their relevance from an issuer perspective, or does that 
10   really depend on the type of issuer or the preliminary 
11   information that's been disclosed?  This is more for the 
12   investors on our panel. 
13             MR. WALLIN:  I mean, I think it's, you know, sort 
14   of a black and white thing that the report is -- you know, 
15   has less veracity and less weight on what we do the slower 
16   it comes and the more we have to rely on independent 
17   sources, interim information put on EMMA, and our own 
18   research.  So yeah, I mean, it's -- to us it's black and 
19   white that the older a report the less probative it is, and 
20   we look to other sources for information. 
21             MR. MCLOUGHLIN:  I guess I kind of use the 180 
22   days.  The -- if you've got other source of information, if 
23   the individual issuer is posting monthly cash flows or if 
24   they're posting unaudited, then you can go longer.  But if 
25   it's beyond 180 days it becomes, from my perspective, a bit 
0132
 1   dated. 
 2             MS. MAY:  Yeah, I would agree.  It -- and again, I 
 3   -- our shop is mostly larger issuers who are in the market 
 4   frequently so we generally tend to have some sort of 
 5   interim, you know, financials that have posted on the 
 6   website or through EMMA, you know.  But I agree with Tom, 
 7   when you're getting a CAFR at the close of the fall and 
 8   fiscal year, it's really -- you know, it's -- it really 
 9   doesn't have very much use at that point. 
10             And that's certainly the case, you know, by the 
11   time, you know, it gets filed and you start to put things 
12   together that you could -- you know, you could easily be in 
13   June looking at something from the prior -- you know, the 
14   prior fiscal year that closed the prior June.  So it really 
15   depends on how much other information, you know, interim 
16   information you can get your hands on. 
17             MS. MCGARRITY:  Okay, great. 
18             So we're going to continue on the lines of the 
19   interim financial reporting going back to Tim and Kendel.  
20   You've talked a little bit about some interim financial 
21   reporting that you do currently and how you post some of it 
22   on your website and some of it to EMMA.  Is the information 
23   posted to each the same?  How has your use of EMMA evolved 
24   and changed over time?  Is there a different I guess 
25   regulatory scheme associated with posting public information 
0133
 1   on your site versus EMMA?  If you could just dive into that 
 2   a little bit more regarding interim financial reporting. 
 3             MR. SCHAEFER:  Well I gave you some examples.  The 
 4   Department of Finance monthly finance bulletin, the state 
 5   controller's report of general fund receipts, disbursements, 
 6   and position.  In addition to that, in California the 
 7   state's annual budget is released in electronic form, and it 
 8   is -- I'm probably at my age not the most tech savvy person, 
 9   but even I can find my way around the budget, and find the 
10   things in that are relevant to the financial operations of 
11   the state. 
12             It is twice a year the Department of Finance 
13   releases an update to those budget numbers.  And of 
14   particular interest I would hope to investors is the 
15   excellent work done by the state's legislative analyst's 
16   office who is in service of the state legislature.  These 
17   are the policy makers who are making the financial policy 
18   decisions that affect investors.  And this happens to be one 
19   of the resources that when we take incoming calls to that 
20   800 number we will often refer people to the legislative 
21   analyst because it is -- we believe the information is quite 
22   valuable. 
23             Having said that, however, I would say that now I 
24   wish to speak for just a few seconds, not as Tim Schaefer, 
25   Deputy Treasurer in California, but as a 25 year municipal 
0134
 1   advisor before I became a state employee.  The vexing part 
 2   of this to smaller issuers, and I dealt with issuers in my 
 3   MA practice that were considerably smaller than Kendel, is 
 4   that one could never answer the question.  If I would sit in 
 5   front of a city manager and say, you need to do this because 
 6   this is good for you, and I'm saying it's good for you, not 
 7   -- I'm not making that up. 
 8             I spent the first half of my career -- now 
 9   everybody's going to know how old I am.  I spent the first 
10   half of my career actually trading for the House on Wall 
11   Street.  And so if you want to get a bid for the bonds which 
12   improves your market reception as a trader, as a secondary 
13   market trader, I'd pay very close attention to whether or 
14   not I can get a good bead on how you are doing on that 
15   interim basis.  Therefore this is good for you.  Now I'm 
16   going to go back to my MA hat and say this is good for you. 
17             Now invariably -- and I don't mean to be flippant 
18   or irreverent in this room at all, but invariably I can 
19   promise you that the response from most small town city 
20   managers was, can you prove that.  And the answer was always 
21   no because there were very, very rare instances where you 
22   could point to a cause and effect price relationship. 
23             Now as a trader I could say well, I think there is 
24   a relationship there, but it was more intuitive or a matter 
25   of co-relation than it was direct cause and effect.  And I 
0135
 1   think that's the vexing part of what you're trying to get at 
 2   with your question, Amy. 
 3             MS. TAYLOR:  I will answer the question, but I 
 4   also want to piggyback on what he just said because I -- 
 5   we're a relatively small municipality, 16 square miles, 
 6   2,500 employees.  My finance department is a hundred 
 7   employees, and we are responsible for procurement, payroll, 
 8   cash investing, all the tax assessing, all the tax 
 9   collection, the cash flow.  And for me to compete for more 
10   resources to do more of this, I'm competing with classroom 
11   teachers and police officers, and to go to council and then 
12   the public to say I need another accountant, they just say 
13   run along, little girl, it's not going to happen. 
14             And so we -- there's a resource to the taxpayer 
15   that is involved in all of this, and to do more more 
16   quickly.  And to some extent on the interim, we can't, the 
17   data isn't available, but also just the -- having the 
18   resources to even put -- I mean, right now for our monthly 
19   financial report, it goes to council, it's on the council 
20   webpages.  We also post it on the financial pages so 
21   somebody knows that's going on. 
22             The budget is very prominently located.  You can't 
23   open the website during budget season and not know that we 
24   are in the process of producing a budget.  The revenue 
25   projections, the expenditure projections are all there very 
0136
 1   prominently located on our website. 
 2             But the resources we have are actually what we can 
 3   do.  So it's touching on what you were talking about, that 
 4   there is only so much a small locality can honestly look at 
 5   their taxpayer and say you should fund more. 
 6             MS. MCGARRITY:  I neglected to highlight this 
 7   portion of the question, and so I apologize, I'm going to go 
 8   back to you one more time.  This information, it sounds like 
 9   you all are doing a great job of providing disclosure so, 
10   you know, we obviously appreciate that.  But just curious, 
11   do you provide different information on an interim reporting 
12   basis to the credit ratings agencies than you provide 
13   publicly on your website or EMMA? 
14             MS. TAYLOR:  So other -- what's on my public 
15   webpages is what I provide.  We have never had something so 
16   sort of catastrophic that we had to do interim reporting to 
17   the rating agencies.  We haven't had disasters of any kind.  
18   And your comment on Friday was different from mine.  But for 
19   me, we've been very, very fortunate that what we plan has 
20   typically been what's happened. 
21             MR. SCHAEFER:  In an economy as large as ours in a 
22   state as inclined to the famine, pestilence, locusts, and 
23   all the other things that happen in California, you can 
24   imagine that from time to time we have these kinds of 
25   questions. 
0137
 1             To answer your question somewhat abruptly, we 
 2   don't give it to the rating agencies unless we're giving it 
 3   to everybody. 
 4             MS. MCGARRITY:  Great, thank you. 
 5             So now going to the investor perspective, James, 
 6   Sheila, Tom, Tom.  Is interim unaudited information useful 
 7   in assessing the current financial position of a municipal 
 8   issuer?  Is the generally public information helpful?  Is 
 9   EMMA better, maybe it's more comparable?  Could you just 
10   discuss how you access this information and its value 
11   broadly? 
12             MR. WALLIN:  Well, you know, our first stop is 
13   EMMA, but EMMA is something we can use as professional 
14   investors, it's not particularly user friendly in our view.  
15   And again, it's up to the issuer what they put in EMMA, so 
16   there's no standard, there's no reasonable expectation that, 
17   you know, a random issuer is going to have sufficient 
18   interim information. 
19             Issuer websites, you know, are useful, too.  
20   They're probably not that helpful to the individual investor 
21   either because of the esoteric nature and the different 
22   formats they follow.  But then again, that varies widely.  
23   And, you know, the information is important. 
24             You know, Kendel pointed out the difficulty, and 
25   Tim pointed out the difficulty in quantifying, you know, in 
0138
 1   terms of dollar metrics what the impact of lack of 
 2   information is on the price and the cost to the issuer of 
 3   issuing debt in this market, but when we see munis getting 
 4   cheap relative to other sectors and have new clients 
 5   interested in this area, they're immediately taken aback 
 6   when they're -- you know, we deal with professional 
 7   investors, pension funds.  They see the level of disclosure 
 8   and the quality of the disclosure and they're pretty much 
 9   appalled by it. 
10             So, you know, there's plenty of anecdotal evidence 
11   that the lack of mandates, and formats, and quality 
12   standards for disclosure impacts the cost of borrowing, it's 
13   just not quantifiable in day to day dollar terms, in our 
14   view. 
15             MS. MCGARRITY:  Thanks. 
16             MR. MCLOUGHLIN:  I think EMMA is getting better, 
17   and it is our first stop as well.  So I guess I'm more 
18   optimistic that that source is improving over time.  The 
19   issue with some issuer websites is that they vary, as 
20   probably everybody in the room realizes, in clarity.  
21   Sometimes you can find the information pretty quickly and 
22   sometimes it's -- you know, it's like an investigative tool, 
23   take you a couple of hours to actually wade through all the 
24   stuff sitting in there. 
25             In terms of the cost, the impact, we're at 29 
0139
 1   consecutive weeks of mutual fund inflows today.  There's no 
 2   penalty for not disclosing right now because there's a 
 3   complete imbalance between supply and demand. 
 4             The question then becomes, and I think I said this 
 5   when we spoke, the municipal market is characterized by 
 6   three years of tranquility followed by three months of 
 7   chaos, right?  And we saw this in 2010, we saw it in 2013, 
 8   we came close in 2016, and it didn't actually happen.  And 
 9   what happens is that when basically you get a reversal in 
10   fund flows, disclosure matters.  That's when it matters. 
11             So it's one of those things where the disclosure -
12   - the quality of the disclosure and its impact on pricing, I 
13   think it does happen.  It happens periodically, it doesn't 
14   happen consistently. 
15             MS. MAY:  For us, EMMA is not our first stop.  
16   Issuer websites and issuer investor sites are usually our 
17   first stop.  What we use EMMA more for is to alert us.  We 
18   get all the EMMA alerts to alert us if a document has been 
19   filed, but more importantly if an event notice has been 
20   filed. 
21             You know, in terms of whether the rating agencies 
22   get different information, I think it varies widely, but I 
23   have actually a very timely example.  There was a recent 
24   rating agency report for a California public utility talking 
25   about this particular utilities exposure to wildfire risks 
0140
 1   within its service area.  And so, you know, obviously 
 2   something that's come up very recently.  And so, you know, 
 3   it just may be an issue where, you know, the issuers haven't 
 4   had a chance to sort of figure out how they're going to 
 5   disclose this information. 
 6             But having said that, the rating agency report 
 7   included, you know, some very detailed information regarding 
 8   the service area's exposure to wildfire risk.  And so our 
 9   analysts spoke to Moody's and said, you know, where did you 
10   get this, you know, data?  I'm trying to find it.  You know, 
11   California provides a fire threat map but, you know, I can't 
12   -- I don't see the level of detail that you have.  And they 
13   said well, no, we got it directly from the issuer.  We got 
14   this information directly from the issuer. 
15             So it's things like that.  Again, you know, our 
16   experience has been that it's granularity, it's additional 
17   information, it's details that -- you know, I'm sure that if 
18   we took the fire threat map and, you know, tried to draw the 
19   -- we could get there, you know. 
20             So -- and I think that's the -- you know, that's 
21   sort of where the differences are with the rating agencies 
22   is they get the information packaged for them in a much more 
23   easy, you know, usable manner in certain situations. 
24             Again, I don't think, you know, it's material, but 
25   it does exist.  And we've definitely seen, you know, things 
0141
 1   relating to derivatives, swaps, counterparties, information 
 2   that the rating agencies are getting that, you know, we're 
 3   just not getting.  Triggers for termination events, you 
 4   know, things like that. 
 5             And, you know, we all know how long it took to do 
 6   amendments to 15C212 just for getting direct loans included, 
 7   you know, in terms of information material, information, and 
 8   even that -- you know, that was six years it took basically 
 9   from the time it was introduced and bandied about before 
10   those amendments were finally made. 
11             So again, you know, I don't think it's material, 
12   but there are definitely instances where, you know, the 
13   rating agencies at least are getting things packaged for 
14   them maybe a little bit better, getting a little bit more 
15   color, particularly on an interim basis. 
16             As far as, you know, what we use interim 
17   information for is largely just to -- you know, the monthly 
18   cash flows are very important.  We want to see sort of how 
19   the issuer is running versus its budget.  Are they going to 
20   have to make corrections?  Are revenues coming in less than 
21   they anticipated?  You know, are expenses, you know, way 
22   over what they had planned for?  And, you know, again most 
23   of the issuers that we deal with are larger and have the 
24   capacity and the sophistication to provide that information. 
25             MR. DOE:  Just three quick points.  First, when 
0142
 1   we're talking about small investors and the individual 
 2   investor who is buying bonds on their own behalf or with a 
 3   financial advisor is that they're relying on the rating 
 4   agencies for that information.  They're looking at a letter.  
 5   What's the letter?  They're not going onto EMMA in any kind 
 6   of great troves, and they're not going onto -- they'll go 
 7   onto websites a little bit.  But it's really they're doing 
 8   one-stop shopping.  How can I look at the rating agency and 
 9   get that information?  Is it good or bad? 
10             The second thing is that what's evolved is we had 
11   a period of time, you know, more than a decade ago where we 
12   had a number of NERMSERs and a lot of information was in 
13   decentralized places.  And so EMMA emerged to try to 
14   centralize that, and it's come up several times, and we have 
15   people from the MSRB here.  But what's now evolved with how, 
16   you know, we use the word Fintech has become intrigued by 
17   this four trillion dollar market in 55,000 different issuers 
18   is that there must be some money here. 
19             And so now what's happened is we have new entities 
20   that have evolved in trying to gather issuer information and 
21   make it available, whether it's bond link, or it's municipal 
22   advisories with PFM or Hilltop Securities who are trying to 
23   build additional platforms or even the electronic trading 
24   platforms themselves to try to make information available to 
25   make a transaction occur. 
0143
 1             And then I think -- then finally my last point.  
 2   So we've got this now dispersion going on, and I think what 
 3   we're seeing is competition has evolved for EMMA. 
 4             The last point is just, as Tom was mentioning, is 
 5   that we have to recognize the context of the municipal 
 6   industry.  And when municipal mutual bond funds began in the 
 7   late 1970s, we had a period of time from 1982 to 1997 where 
 8   the cumulative price appreciation of municipal bond was in 
 9   excess of 50 percent.  In the last 15 years that price 
10   appreciation has been four percent, okay. 
11             So what we've gone is from a total rate of return 
12   type of product in the 80s and 90s to now one that is 
13   essentially flat.  It's not providing returns that can 
14   compete with the equity market.  So now we're in an assets 
15   under management business.  And so the accumulation of 
16   assets and the fees that are paid on that, that's what 
17   drives the business model and why fund flows are so 
18   important.  It's why access to product is so critically 
19   important. 
20             And right now in 2019, where we have an imbalance 
21   that Tom alluded to where we have more demand than there is 
22   supply, there is essentially given the model that is 
23   assessed under management and performance doesn't matter 
24   truly to the individual investor is that we just were trying 
25   to get -- it's access to products is critical, and there's a 
0144
 1   lot of band width and allowance given to that availability 
 2   of that product. 
 3             MR. WALLIN:  I'd just like to pick up on something 
 4   Tom said and that is that, you know, taking our experience 
 5   in the corporate bond market and applying electronic 
 6   trading, electronic data gathering, and electronic analysis 
 7   to the problems of fragmentation, you know, we've had great 
 8   success.  You know, we have a product that -- I won't 
 9   mention its name because that's too commercial, but that's 
10   had some success. 
11             And, you know, I can see with, you know, the 
12   fragmentation both of knowledge and price information that 
13   exists in the muni market that, you know, a tool like that 
14   could drive a lot of what we're looking to accomplish here 
15   in terms of establishing a standard and a mechanism for 
16   promoting transparency. 
17             And, you know, again I don't know if there's been 
18   enough focus on that, you know, based on some of the work 
19   we're doing with our muni group or, you know, focusing on 
20   more electronification, but that's an important tool that I 
21   think is even more powerful the more fragmented a market 
22   gets. 
23             MS. MCGARRITY:  Tim, did you have something you 
24   wanted to add? 
25             MR. SCHAEFER:  Can I riff on that for just a 
0145
 1   moment? 
 2             MS. MCGARRITY:  Sure. 
 3             MR. SCHAEFER:  I can't resist.  I'm a long-time 
 4   member of the National Federation of Municipal Analysts.  
 5   That's one of the reasons that Tom and I know one another so 
 6   long.  He was just a child. 
 7             (Laughter.) 
 8             MR. SCHAEFER:  One of things that I discovered was 
 9   particularly vexing.  When I joined state service I joined 
10   state service working for the state controller's office.  
11   The state controller then became the treasurer, and that's 
12   how I ended up in the treasurer's office.  That's just one 
13   administration ago. 
14             One of our projects there was to take a mechanical 
15   process where localities in California, and we've got about 
16   4,400 of them, report their financial data to the state 
17   controller.  And you had the -- it was a land -- it wasn't 
18   even a land of PDFs, it was a land of bound books.  So if 
19   you wanted to do comparative analysis between Agency A and 
20   Agency B, the data was there, but it reminded me of the 
21   Raiders of the Lost Ark, it was buried in there somewhere, 
22   okay. 
23             (Laughter.) 
24             MR. SCHAEFER:  And then State Controller John 
25   Chiang stood up a platform which attempted to digitize this 
0146
 1   information.  And I applaud that, think it was a wonderful 
 2   idea.  But to me as a governmental employee in the finance 
 3   world, I don't think we're done. 
 4             The State of Florida has introduced, and I believe 
 5   it's enacted into law, and the State of California is 
 6   considering enacting into law a requirement to have local 
 7   governments report using XBRL or machine readable language 
 8   like EDGAR requires. 
 9             Now this is being live streamed so I've got 4,400 
10   controllers and finance directors out there whose heads are 
11   exploding when they hear me say this because nobody's 
12   figured out how to pay for this yet.  But that to this 
13   treasurer is part of the answer.  Let's at least learn about 
14   it. 
15             And so the bill that's in the California 
16   legislature at this point would require a study, and we 
17   suspect that if you -- if the study is thoughtful and well-
18   executed, you would at least begin the problem of breaking 
19   the back of comparability.  And if you break the back of 
20   comparability you at least wouldn't add an accelerant to the 
21   fragmentization of the market.  Is that a word, James?  The 
22   fragmenting of the market that's going on that I think we 
23   all find a little troubling. 
24             MR. WALLIN:  I find it very interesting what you 
25   just said, and it ties a lot together in terms of what could 
0147
 1   erupt if you had both the digitally available information 
 2   and well-constructed commercial tools to aggregate it. 
 3             MS. MCGARRITY:  Thank you for those additional 
 4   comments. 
 5             This is the last portion of my prepared questions, 
 6   and then we'll open it up to the broader FIMSAC.  But we've 
 7   touched on market efficiency throughout this conversation, 
 8   but just to put a fine point on it, let's talk to the 
 9   issuers just briefly.  How do you think your disclosure 
10   practices impact your cost of borrowing, and have your 
11   disclosure practices changed over time to influence your 
12   cost of borrowing? 
13             MS. TAYLOR:  You know, I looked back a few years 
14   at what our -- sort of the appetite for our issuances are 
15   and it's, you know, eight to 12 banks are competing for my 
16   debt.  I have -- I follow the rules.  I do what I am 
17   supposed to do when I am supposed to do it.  So it's hard 
18   for me to judge what would have happened had I not done 
19   that.  So for me it's a tough question. 
20             I just -- my gut is it's about my credit rating.  
21   I have a Triple A rating, and then when you look at 
22   Alexandria, we are a -- we have a strong tax base, we have 
23   financial policies, we follow the best practices of GFOA 
24   related to fund balance, and all of those things.  So all of 
25   that goes together, but I -- so I can't answer in terms of 
0148
 1   my disclosure practices because I'm doing what I'm supposed 
 2   to do. 
 3             MR. SCHAEFER:  I don't know how to answer the 
 4   question, honestly.  We believe, but it is an impression, it 
 5   is not -- I don't think it's particularly evidence-based, 
 6   that our disclosure practices are helping.  But that is an 
 7   impression, it is not an evidenced-based conclusion because 
 8   of the topics we talked about a few moments ago. 
 9             I will tell you that our disclosure practices have 
10   evolved and continue to evolve today.  They've evolved in 
11   the five short years that I've been in the state treasurer's 
12   office.  They have significantly evolved since the report to 
13   the Commission in 1975 on New York City, okay.  
14             In 1975 State of California's general obligation 
15   bond offering documents consisted of the front and back of 
16   one 8 1/2 by 11 sheet of paper.  So I can assure you that if 
17   bulk is the measurement tool being applied, we're doing 
18   better. 
19             (Laughter.) 
20             MR. MCLOUGHLIN:  So maybe one other point on that.  
21   I took -- one of the fastest reporting cities in America is 
22   Columbus, Ohio, perennially.  I have no idea why, but they 
23   come out really fast with their report.  They trade through 
24   the State of Ohio, so you would expect that they're very 
25   popular among investors.  But is that because they're the 
0149
 1   home of Ohio State University and probably have a stronger 
 2   economy, limited geographically though it is, than maybe the 
 3   entire state?  I don't know. 
 4             It's going to be -- it's one of those things.  Go 
 5   back to what Tim said.  It's going to be really difficult to 
 6   basically extract out how much timely disclosure is 
 7   affecting the individual trading relationships. 
 8             Given the fact -- one other point on Columbus, the 
 9   last institutional size lot for the City of Columbus Ohio 
10   geo bonds was done in May.  The last trade for Columbus, 
11   Ohio was done 32 days ago. 
12             So the pricing that we're seeing is matrix 
13   pricing, you know, and it's based on where they think the 
14   bond's going to trade.  So again, this is actually a fairly 
15   vexing problem. 
16             MR. HEANEY:  So if I can just jump in.  And this 
17   has been an incredibly interesting conversation, and there's 
18   a bit of a tug of war, right, going on with I totally 
19   understand the resource allocation argument, especially with 
20   municipalities, and cities, and the small issuers.  And on 
21   the other side, of course, there's the protection to small 
22   and retail investors. 
23             But there's -- following on the kind of analogy of 
24   the corporate market, there are -- this precedence where you 
25   would say, you know what, if you can't provide the 
0150
 1   documentation or the disclosure, issue as a private, issue 
 2   as a 144A, and you will only sell to QIBs. 
 3             So that is not any answer that the issuers will 
 4   want to hear, but I'm curious from Rebecca's point of view 
 5   or the investors, should -- is there something ever been 
 6   considered, do you think about what if there were some of 
 7   kind of guardrails in terms of if you exceed, I'm not even 
 8   going to start throwing out how many days, for financial 
 9   disclosure, perhaps you start limiting the base that you 
10   sell it to.  Just throwing it out there. 
11             MS. OLSEN:  So I'll just make a couple remarks.  
12   And that is, you know, I think this panel has been very 
13   focused on the timeliness of the disclosure and perhaps what 
14   that means in terms of their cost of capital for borrowing.  
15   And -- but, you know, one thing we haven't really talked 
16   about, and it's something I think our Chairman touched on 
17   this morning, is that we also have an investor protection 
18   concern, and when people are buying and selling municipal 
19   securities in the market, and they just haven't gotten any 
20   information in a year.  There may be absolutely nothing 
21   wrong, but you do have people making decisions that aren't 
22   informed.  And I think of the example that was thrown out by 
23   someone that it's sometimes issuers who tend to get 
24   themselves in financial difficulties that then clam up and 
25   go the longest without disclosing. 
0151
 1             So I just think another perspective of this really 
 2   is just -- people being able to make informed investment 
 3   decisions that reflect appropriate valuations of securities. 
 4             MS. MAY:  So my shop takes disclosure very 
 5   seriously, and we track it.  We know exactly when each of 
 6   our issuers is supposed to file and, you know, we have sort 
 7   of a surveillance pop up that says, you know, State of 
 8   California's audit's due, it's not in, or what have you. 
 9             And so we -- if we don't have disclosure, we will 
10   call the issuer, and if we don't like the answer, then we'll 
11   sell the bonds.  And we tell them that, and they could care 
12   less because we are in the minority by far in terms of the 
13   buy side.  There will be somebody else who would be more 
14   than happy to buy their paper. 
15             And this is not, you know, Triple B rated, you 
16   know, these are A rated.  There's a Triple A rated bond that 
17   we sold out of just because they didn't do their filings.  
18   They probably didn't feel like they had to.  Or they weren't 
19   timely, and they were not cooperative with us in terms of, 
20   you know, when the documents were going to come. 
21             And then sort of on a separate note, there's, in 
22   my opinion, a very large Mid-Atlantic state that is 
23   incredibly unsophisticated in terms of its disclosure.  
24   There's one person who's been in the office for decades who 
25   is the only person that could answer any questions.  And 
0152
 1   I've talked to bankers endlessly about, you know, this 
 2   particular state really should step up its game in terms of 
 3   disclosure, in terms of investor relations.  There is no 
 4   investor relation website, per se.  So on and so forth. 
 5             And, you know, the answer is well, if I bring that 
 6   to them then I'm not going to get the business.  So, you 
 7   know, either -- there's, you know, the pragmatics of it and 
 8   the rationale part of it, and then there's the market 
 9   reality. 
10             MR. DOE:  I think you just have to just keep in 
11   mind, keep coming back to what we've talked about, is just 
12   how large and eclectic this marketplace is.  And I -- we 
13   tried to draw analogies on a regulatory front to the 
14   corporate market, and I don't mean to be funny about this, 
15   but I -- when we talk about it we always think, in our firm, 
16   about the municipal industry. 
17             It's really like residential real estate, right.  
18   We have -- it's a long only market, there's not an ability 
19   to control, and when a price gets too high, there's no 
20   ability to short it and to correct a price that's too price.  
21   So the bias of the market is always to trend up and price 
22   higher.  And information also becomes very eclectic and 
23   difficult.  What's disclosed?  How do you buy the property?  
24   What's it worth?  And there are a lot of different opinions, 
25   and it's hard to get that information if you're making a 
0153
 1   very personal investment. 
 2             And it all comes back down to the allure of the 
 3   exemption is powerful to investors, and again it allows for 
 4   a lot of -- they're the individual buying, doesn't 
 5   necessarily make a rational decision.  And there is 
 6   increasingly deference to the professionals that are here 
 7   who are managing money, that they're doing it right, and for 
 8   the most part that's true. 
 9             But I think that, you know, the information 
10   continues to be very difficult as long as we're going to 
11   continue to allow -- and I subscribe to it's the right thing 
12   to do is allowing a lot of issuers access to capital in this 
13   way. 
14             MR. MCLOUGHLIN:  Yeah, I agree with Tom.  I think 
15   this is a market that -- the liquidity in this market is not 
16   a problem today, right, just because of that imbalance 
17   between supply and demand, and it's been going on for some 
18   time. 
19             The issue in terms of the impact of absence of 
20   disclosure or poor disclosure is going to hit when we 
21   actually have the correction.  And that correction is 
22   basically going to be driven primarily by a change in fund 
23   flows.  What precipitates the fund flow change you -- is 
24   anybody's guess.  But it will happen.  Again we -- was it 
25   Herbert Stein who basically said, what can't go on forever 
0154
 1   stops?  29 consecutive weeks of inflows.  This will not go 
 2   on forever.  So when it changes, and you basically see the 
 3   flows going out, that's when you're going to see some 
 4   discrimination in pricing on disclosure. 
 5             But the other thing to remember is that it is 
 6   still a retail market even though right now the price is 
 7   probably set by the mutual fund who is buying the bonds.  
 8   There's less liquidity in this market than there was five 
 9   years ago, 10 years ago, 15 years ago.  You've get entire 
10   classes of investors, institutional investors, that are not 
11   as committed to this market as they once were. 
12             So effectively what I sometimes tell individual 
13   private clients is you are the liquidity to this market, and 
14   that actually kind of gets their attention.  It's not 
15   necessarily the broker-dealer who's gone a step up, it's not 
16   the property and casualty insurance company, it's not the 
17   bank trust department.  It's other retail investors. 
18             So when the sentiment changes, and we actually 
19   have more and more flows going the other way, who steps up?  
20   And at that point that probably is when the disclosure kicks 
21   in as an important trading impetus. 
22             MS. MCGARRITY:  Thank you.  I think we need to -- 
23   we're sort of out of time.  But Larry, your card's been up.  
24   Do you have a question you'd like to ask? 
25             MR. HARRIS:  I have an observation and then also a 
0155
 1   question. 
 2             So the observation is that financial disclosure 
 3   serves three main purposes in our markets whether they're 
 4   equity, taxable, or tax exempt fixed income.  The first 
 5   purpose is in the primary market, and there the purpose is 
 6   to ensure that the best projects get capital.  And here I 
 7   have some particular concerns because the financial markets 
 8   can provide discipline to municipalities that otherwise may 
 9   not have good disciplinary mechanisms because it -- the 
10   shareholders don't exist really, they just have taxpayers, 
11   and it's difficult. 
12             I'm particularly concerned where muni issuers 
13   provide services that compete with public issuers.  So for 
14   instance, hospitals and stuff like that.  We want to make 
15   sure that capital is allocated in a sensible way, and so the 
16   information's very important. 
17             The second area is -- and this is especially 
18   important in equities, but we can imagine such importance in 
19   the not for profit or the muni area as well, is that 
20   accurate pricing of instruments gives us some sense of how 
21   well the capital is being managed.  So in the equity space, 
22   we like to have good disclosure so we can figure out whether 
23   the managers are actually using the capital well. 
24             Here in the munis, getting those types of signal 
25   is kind of muted again because of the difficulties of 
0156
 1   control, but one could imagine the difference. 
 2             And the last is in the questions of fairness.  We 
 3   want to make sure that some people don't have inside 
 4   information or some asymmetric advantage that hurts other 
 5   people.  And so as we think about how to advise the 
 6   Commissioner, perhaps potentially even Congress because of 
 7   the lack of authority in this area, I think we should be 
 8   thinking about these issues. 
 9             I'm particularly concerned, though, about the 
10   capital allocation issues between muni -- or issuers that 
11   are providing services in the muni sector that are also 
12   being provided in the public sector.  By public I mean the 
13   public capital sector.  Because that's a mismatch -- or a 
14   misbalance issue that potentially is quite costly. 
15             The question is fully unrelated, and it's based on 
16   the following observation.  We have a huge number of issuers 
17   in the muni space, and many of them issue quite small.  And 
18   it's easier to imagine that we could get substantial 
19   benefits by consolidating the issues. 
20             And a way to do that is to create state bond banks 
21   where instead of the City of Riverside, California perhaps 
22   or some other Riverside, mosquito abatement district, going 
23   to the market for three quarter of a million dollars where 
24   they don't know anything about the market, instead they go 
25   to their state bond bank and the bond bank then issues a 
0157
 1   general bond that -- over all of this, and the bond bank is 
 2   then responsible for the credit quality of the localities. 
 3             And so I wanted to ask our panelists, to the 
 4   extent that they're familiar with bond banks, how they've 
 5   worked in the past.  I know there are a few states that use 
 6   them.  And then what are some of the practical issues that 
 7   we should be aware of as we think about how to advise the 
 8   Commission and potentially even Congress on how to deal with 
 9   these issues? 
10             Recognizing that if we could reduce the huge 
11   number of issues to a much smaller and manageable number, 
12   that we could substantially increase the liquidity and 
13   thereby lower the funding costs and provide a tremendous 
14   benefit to the taxpayers. 
15             MS. MCGARRITY:  If I could just interrupt briefly 
16   here.  We have to cut it at 2:10, so we have about four 
17   minutes, and we have two more questions.  So talk about your 
18   speed round. 
19             (Laughter.) 
20             MR. SCHAEFER:  I can answer the question.  As a 
21   52-year practitioner in the municipal securities business 
22   and not as an academic.  And so my perspective is that bond 
23   banks, for my entire career, have been seductive and have 
24   always been derailed by the weak link problem. 
25             When we put -- when we attempt to aggregate 
0158
 1   smaller issuers, invariably the market does find enough 
 2   efficiency to price to the weak link.  That takes out the 
 3   stronger borrowers, and as a practitioner, seems to 
 4   exacerbate the problem of the goats being separated from the 
 5   sheep too quickly. 
 6             MS. MCGARRITY:  Thank you. 
 7             Maybe that's a topic that we can talk about on a 
 8   further subcommittee call.  Thanks for bringing it up. 
 9             Gilbert. 
10             MR. GARCIA:  Yeah, mine's quick.  In these 
11   instances where these CAFRs come out late, I mean, sort of 
12   later than normal, is the information surprising to the 
13   downside, or does it just generally come in line as you 
14   would expect?  I mean, I'm just trying to get a sense for is 
15   this really that big of a problem or not. 
16             MR. SCHAEFER:  I can only speak to our case.  In 
17   our case there was nothing surprising in it.  California is 
18   in the midst of standing up a billion dollar technology 
19   project that would incorporate financial reporting 
20   purchasing and a variety of other functions in the state. 
21             That's occupied the time and attention of the 
22   state controller to the point where developing those 
23   component units and aggregating them into the CAFR just was 
24   -- you know, it's a once a year event.  Even though it goes 
25   on all year, it's still a resource loading problem, as 
0159
 1   Kendel described. 
 2             MS. MAY:  Yeah, it hasn't been my experience that 
 3   there's been surprises.  It's usually been held up by, you 
 4   know, some minor technicality.  They couldn't get the swap, 
 5   you know, information correct, or whatever.  And oftentimes 
 6   as is -- California did this past year, there's unaudited 
 7   financials that are provided that are very close to what the 
 8   final numbers come in at. 
 9             MS. TAYLOR:  Some of the things that keep me up 
10   between the end of the fiscal year and actually producing a 
11   CAFR, we wait on the Virginia retirement system.  A new GASB 
12   comes out, everyone is learning how to actually report on 
13   that.  And so you can have all your ducks in a row, and 
14   whether it's the component unit, or your actuary, or the 
15   retirement systems, all of these pieces have to have all 
16   their ducks in a row in order to have it go smoothly. 
17             MS. MCGARRITY:  Everybody blames it on the pension 
18   system. 
19             (Laughter.) 
20             MALE PARTICIPANT NO. 1:  There you go. 
21             MR. TABB:  You know, as a group here, should we be 
22   thinking about maybe recommending like standards, like FBRL, 
23   or XML, or putting more formal guidelines down or -- you 
24   know, or would that be viewed as problematic and overly 
25   burdensome to different taxable entities? 
0160
 1             MR. WALLIN:  I think in terms of facilitating 
 2   aggregation and reporting, getting the ball rolling by at 
 3   least putting that idea out there would be an excellent 
 4   idea, and I don't think would be prejudicial to anybody.  
 5   You know, to get this data digitized, and to establish a 
 6   standard, you'd be doing most of these municipalities a 
 7   favor because you would free them from the burden of making 
 8   that decision themselves.  So, you know, anything that could 
 9   get that concept rolling would be an excellent idea in my 
10   personal opinion, which I think my colleagues share. 
11             MS. MARTIN:  Yeah, we had actually talked about 
12   doing that, the Muni Transparency Committee, as an idea.  
13   And one item we couldn't quite get our head around is the 
14   cost for the smaller issuers that implementing something 
15   that was more technologically advanced, how they would get 
16   their head around.  So any perspective.  I don't know.  
17   Kendel, if you have a perspective on that? 
18             MS. TAYLOR:  I can share -- GFOA has 20,000 
19   members and they do range from a small school system in 
20   North Dakota all the way to Patrick McCoy at the MTA in New 
21   York, and we are happy -- the debt committee can work with 
22   you to help issue best practices that can help issuers know 
23   what it is that could help everyone involved in municipal 
24   issuance. 
25             MS. MARTIN:  That's great.  Thank you. 
0161
 1             MR. WALLIN:  I mean, a good example, sorry to 
 2   chime in again, is the SEC's EDGAR, which is now in its 35th 
 3   year.  And from a pilot in '84 to something that any issuer 
 4   can buy a program to EDGARize a document that's done blindly 
 5   essentially, and it provides an, you know, excellent 
 6   consistent database. 
 7             MR. DOE:  I'd be remiss, if I could just throw in 
 8   one last comment here, is that while we've been talking a 
 9   lot about the financial disclosure is that -- and what Tom 
10   was talking about, what creates, you know, the next period 
11   of adversity where there's demand for liquidity in issues.  
12   And oftentimes it's more of a emotional response that can 
13   drive investor's behavior and focus on disclosure. 
14             And well the thing that keeps me up at night is -- 
15   are the issues such as we had with pensions that was not 
16   really aware in the municipal market for a long period of 
17   time, and now we're on the front now of looking at, you 
18   know, climate change, and what's the impact, what are the 
19   choices that are being made financially on that side. 
20             Those are the kind of issues that create emotional 
21   reactions and makes capital available or not.  So I think 
22   there's going to be -- around disclosure, yes, there's the 
23   financial side of it, timeliness and all, but it's also the 
24   additional elements that are going to impact an operation.  
25   And we've seen it in the long ramp-up on pensions, and we're 
0162
 1   going to see another ramp-up associated with climate and the 
 2   choices that impacts on budgets.  So it's a little bit 
 3   broader.  So things to think about. 
 4             MR. REDFERN:  Yeah, and just -- I think just to -- 
 5   first of all I want to thank this panel.  This is a 
 6   fascinating discussion, and I think on a very important 
 7   topic. 
 8             For the Commission, the issues of disclosure and 
 9   transparency have been big areas of focus for us in many 
10   areas of the market because it often has a very important, 
11   powerful effect on competitive markets that sometimes solves 
12   problems that would otherwise have more draconian regulatory 
13   responses. 
14             Secondly, a big priority of this Chairman is 
15   retail investor fraud.  We are very concerned about retail 
16   investors, and so certainly from the conversation today 
17   there are areas in which there would be some concerns about 
18   delayed disclosures and the potential retail risk, although 
19   it's unclear to me exactly what it is when you hear that a 
20   lot of times they're just late but they're not horrific. 
21             So I would simply ask, please keep in mind any 
22   areas where you see potential harm to retail investors.  And 
23   if you see that, please let us know.  That is certainly a 
24   driver of how we think about things.  We're looking at 
25   disclosure issues, for example, in over-the-counter stocks 
0163
 1   that are late reporting and what might be able to be done 
 2   there and in other areas of the market as well. 
 3             So just keep in mind that if there are issues that 
 4   are a risk to retail, we would want to take these concerns 
 5   very seriously here at the Commission. 
 6             But I just really wanted to thank you.  A 
 7   fascinating discussion, and it looks like there's more 
 8   discussion to be had on this topic. 
 9             MR. HEANEY:  Great.  Thank you very much.  We 
10   appreciate all your time to come down to DC, thoughts on 
11   this.  This is great food for thought for the subcommittee 
12   and for FIMSAC as a whole, so I'm sure there will be much 
13   more to discuss, as Brett said. 
14             We have slightly run over.  Let's do a quick six, 
15   seven minute break and be back at 2:20 for the last panel, 
16   please.         
17             (Whereupon, at 2:14 p.m., a brief recess was 
18   taken.) 
19                          CREDIT RATINGS: 
20                 FUTURE MODIFICATIONS OR STATUS QUO 
21             MR. HEANEY:  Okay.  Our final panel of the day 
22   will discuss the matters concerning the structure of the 
23   market for credit ratings in corporate bonds.  I'll turn it 
24   back over to Amy, who is doing a doubleheader today and 
25   moderating this panel as well, to introduce our panelists 
0164
 1   and moderate the discussion. 
 2             MS. MCGARRITY:  Great.  Thanks, Michael. 
 3             You may recall that during our October, 2018 
 4   FIMSAC meeting Michael hosted an excellent panel discussion 
 5   on the topic of the role of credit ratings in a higher 
 6   leverage world with outside experts including buy side 
 7   portfolio managers, a sell side credit strategist, and 
 8   credit rating services. 
 9             Following that October meeting we formed a new 
10   subcommittee to do a deep dive on various aspects of the 
11   credit ratings process with an eye toward identifying 
12   potential areas for improvement. 
13             Since its formation in January of this year, the 
14   Credit Rating Subcommittee has held several meetings to 
15   discuss a range of topics, some of which we just covered in 
16   the last panel, but including the use of credit ratings by 
17   various market participants and the implications of ratings 
18   changes for these market participants.  Costs and benefits 
19   of the current model for credit rating issuance.  The U.S. 
20   Regulatory Regime for Credit Rating Agencies registered as 
21   NRSROs.  And lastly, issuances of unsolicited credit ratings 
22   and the publication of commentaries and municipal issuer 
23   disclosure to ratings agencies. 
24             As the subcommittee explored topics like the 
25   issuer pay model for ratings and the competitive landscape 
0165
 1   for ratings agencies, it became apparent that we needed to 
 2   hear more on these topics from corporate bond issuers. 
 3             And so today, we are very fortunate to be joined 
 4   by issuers as well as representatives from the credit rating 
 5   agencies to discuss the topics of competition and payment 
 6   models in the credit ratings industry, and most importantly, 
 7   ideas for improving on the status quo. 
 8             I should also note that two of our FIMSAC members, 
 9   Rachel and Scott, are also experienced bond issuers, and 
10   while Rachel is participating on the panel, Scott, please 
11   feel free to contribute as you feel you'd like to. 
12             So first let me just briefly introduce our outside 
13   panelists.  We have Otis Otih from Mars, Inc.  We have Susan 
14   Sheffield from GM Financial who joined us this morning as 
15   well.  Thank you.  And Rachel Wilson from Iron Mountain, a 
16   member of the FIMSAC.  On the NRSRO side we have Daniel 
17   Gates with Moody's Investors Services and Yann Le Pallec 
18   from S&P Global. 
19             Before we start the discussion, I would just like 
20   each of our panelists to briefly introduce themselves by 
21   giving a short bio and description of your experience with 
22   bond issuance and the credit ratings process.  I know that 
23   while I introduced you and your current employer, you may 
24   have some historical experience that may contribute to the 
25   discussion. 
0166
 1             Rachel, will you kick it off? 
 2             MS. WILSON:  Happy to.  Thanks, Amy. 
 3             So I'll -- you know I am at Iron Mountain.  I have 
 4   been leading treasury and financial planning and analysis 
 5   there.  But prior to that I was at Jarden where I was 
 6   leading corp dev, and I was also with IR, and I was at Avon, 
 7   and spent a large part of my career, though, in investment 
 8   banking, where I was corporate finance.  I was at Morgan 
 9   Stanley for most of my career, and then at Citi, and I 
10   focused on consumer products companies within that. 
11             So my exposure to the credit ratings process is 
12   both yes as a bond issuer, and I had the pleasure of coming 
13   to Iron Mountain and had a lot of fun refinancing about 70 
14   percent of our debt portfolio, so had a lot of fun working 
15   with that.  And also Iron Mountain, we'll probably get into 
16   this, it's a little unclear what industry classification 
17   Iron Mountain fits into, which is also a very interesting 
18   one when you talk to both investors but also with the credit 
19   rating agencies, so it was interesting. 
20             And then also I've done a lot of event type of use 
21   with the credit ratings agencies where you are doing an M&A 
22   or a transaction, and so you're also looking at what kind of 
23   rating might you get, or what might happen, and is there 
24   different ways you might tweak the cap structure to achieve 
25   certain ratings outcomes, and so you would also use an 
0167
 1   advisory service for that.  So several different ways that 
 2   I've worked with the agencies, so hopefully we'll be drawing 
 3   in a lot of that today.  Thanks. 
 4             MS. SHEFFIELD:  I'm Susan Sheffield, and I'm the 
 5   CFO of General Motors Financial.  I've been with company 18 
 6   years and was with the predecessor company.  And so in that 
 7   role I'm responsible for basically investor relations, 
 8   funding for the company as well as FPNA and financial 
 9   reporting now as the CFO. 
10             So we are a regular issuer in the capital markets 
11   both on the ABS and the unsecured side, and we issue about 
12   20 to 24 billion a year.  So all of this debt is rated, and 
13   so we have a longstanding relationship with the rating 
14   agencies and a pretty good perspective across the two 
15   different asset types around the process. 
16             MR. OTIH:  Hi, name is Otis Otih.  Thank you, Amy.  
17   I appreciate the opportunity join this important panel 
18   discussion. 
19             I'm the corporate global treasury director for 
20   Mars, Inc.  If I can just take a few second, for those of 
21   you who don't know, Mars is a privately owned family 
22   business, a global business with brands such as Mars, 
23   Skittles, Uncle Ben's.  I don't have samples for you. 
24             (Laughter.) 
25             MR. OTIH:  But I'm really very happy to be here. 
0168
 1             As the global director, I am responsible for 
 2   strategic finance, acquisition financing, and the 
 3   relationship with rating agencies and, of course, strategy 
 4   relationship management with our banks.  I have spent many 
 5   years in this area, and for me, the most interesting part of 
 6   this panel is that as a private company we do tap into debt, 
 7   but for the first time we issued debt.  And I'm hoping that 
 8   through the panel discussion we'll be able to share some of 
 9   our experiences. 
10             I am also an active member and a board member of 
11   National Association of Corporate Treasurers and, in fact, 
12   my chairman there, Tom Diaz, do participate in your panel.  
13   In addition to that, I am the treasurer of Mars Family 
14   Foundation.  So here, I am representing a practitioner, an 
15   investor to Mars Foundation, and also a representative of 
16   corporate treasurers.  And I'm really looking forward to our 
17   conversation this afternoon. 
18             MR. LE PALLEC:  So good afternoon, I'm Yann Le 
19   Pallec.  I'm representing S&P Global Ratings.  I actually 
20   head up global rating services, and I've been with S&P as a 
21   credit rating agency for 20 years.  10 years on one side of 
22   the firewall as an analyst and a manager of analysts 
23   covering sectors ranging from insurance to international 
24   public finance, governments to corporates and financial 
25   services.  And the other half of my career, another 10 
0169
 1   years, was as a general manager, so on the other side of the 
 2   firewall, in charge of heading up our business for Europe, 
 3   Middle East, and Africa.  And in my current role I'm also 
 4   general manager. 
 5             So that's the reason why to be talking about 
 6   competition, business model, I will be having those 
 7   discussions with you as opposed to Craig Parmelee, my 
 8   colleague, who spoke at the October panel that was about 
 9   credit rating agencies and corporate ratings, which was much 
10   more focused on our analytical approach, how we cover 
11   surveillance, which is clearly on the analytical side. 
12             When it comes to talking about competition, 
13   business models, given our own internal rules and policies 
14   that make a clear difference between analytical and 
15   commercial, it has to be a general manager to be delivering 
16   these type of remarks.  So I'm really looking forward to it. 
17             MR. GATES:  I'm Dan Gates.  I manage the ratings 
18   and process oversight group at Moody's.  My group has global 
19   responsibilities for maintaining the quality and consistency 
20   of credit ratings and rating practices through activities 
21   that include portfolio monitoring and formulating policies 
22   and procedures for analytical practices. 
23             I've been with Moody's for 22 years.  I've been 
24   that entire side -- time on the analytical side, so I'm 
25   actually the opposite of Yann.  Be happy to talk about 
0170
 1   anything on the analytical side.  I'm limited in what I can 
 2   say on anything that's a commercial question such as market 
 3   concentration. 
 4             I've been in a variety of roles including being a 
 5   lead analyst, managing rating groups, and for the last 12 
 6   years my role is focused on credit policy and ratings 
 7   oversight. 
 8             MS. MCGARRITY:  Great.  Thank you for those 
 9   introductions. 
10             So I think we'll start with Otis, despite not 
11   bringing samples from Mars.  You know, you discussed earlier 
12   that you issued your first debt offering.  Can you just 
13   start by sharing with us your perspectives as a first-time 
14   issuer on the process for assigning credit ratings?  Was 
15   there anything about the process of obtaining ratings you 
16   wish you had understood at the outset? 
17             MR. OTIH:  Thank you, Amy. 
18             Let me start by clearly articulating why it went 
19   well.  I can summarize it by saying it was smooth and very 
20   successful despite the fact that we are privately owned.  
21   And I believe that it is because of the preparation we took. 
22             Few items that really help us.  We investment 
23   grade company, so I don't pretend to understand what happens 
24   to non-investment grade issuers.  And for us, it was very 
25   good that we had a well-articulated and transparent company 
0171
 1   financing policies. 
 2             It did help that we have a very strong balance 
 3   sheet.  It also helped that we are well-diversified.  We 
 4   have a well-diversified portfolio.  And more importantly, we 
 5   had capable advisors, and that's the investment bank, 
 6   accounting firm, law firm that understand, you know, BUN 
 7   offering, and finally strong and capable internal resources. 
 8             So as I think through what made it successful, we 
 9   invested a lot of time upfront with the rating agencies 
10   trying to gauge what do they need.  This is before even we 
11   made a decision -- we made the go or no go decision, to 
12   understand what do they need to do their work, what are the 
13   parameters?  And they were very clear, you know, the 
14   leverage ratio portfolio wise.  And availability of the 
15   analyst.  And so we shared timing, where we are planning to 
16   go to the market, and what we were trying to do. 
17             So I believe that the system was smooth.  It was 
18   very clear to me what we were trying to achieve.  The 
19   analyst was very supportive.  But I guess we'll get into it 
20   later on sometime within the panel discussion.  It was clear 
21   to me that I have no choice but to get to the three 
22   agencies.  It wasn't -- we weren't thinking about the market 
23   is -- you have a lot of agencies you have to pick from, it 
24   was very clear to me that I have three agencies that I need 
25   to pick from, and we finally settled with Moody's and S&P. 
0172
 1             Throughout the discussion, there were no surprises 
 2   to me.  I knew exactly what leverage ratio that I need to 
 3   hit to make my point.  I knew exactly what we need to 
 4   disclose to the investors, what was involved.  And finally, 
 5   they were timely to give me the rating indication and the 
 6   final product. 
 7             So overall, a very good experience because I had 
 8   spent a number of years in the system and have maintained 
 9   ongoing dialogue with the rating agency, recognizing the 
10   fact that they are there to protect the investors at the 
11   same time to make sure that they give me the rating that I 
12   need. 
13             MS. MCGARRITY:  You talked about settling with two 
14   NRSROs for your credit ratings assignment.  Do you have any 
15   thoughts on the state of competition in the NRSRO market? 
16             MR. OTIH:  Here is what I would say, today 90 
17   percent of the market, and I hope my colleagues here will 
18   agree with me, is basically controlled by the three 
19   agencies.  And it's again, Moody's, S&P, and Fitch. 
20             Competition is always good.  I don't know what the 
21   barrier of entry is like in this space, but I am pretty sure 
22   -- my instinct is that competition should be welcomed and 
23   encouraged. 
24             Other than that, the three agencies do a pretty 
25   good job, particularly in the space where I am, and also in 
0173
 1   terms in investment grades -- an investment grade issuer.  I 
 2   didn't have any issue at all. 
 3             MS. MCGARRITY:  Great, thank you. 
 4             Susan, let's move to you next.  You have 
 5   experience with issuing a range of debt instruments.  We'd 
 6   be interested in hearing your thoughts on these same topics.  
 7   In particular, do you see any differences in the market for 
 8   ratings for corporate debt as compared to other types of 
 9   debt securities that GM Financial may issue? 
10             MS. SHEFFIELD:  Okay.  So for GM Financial we have 
11   really two platforms, as I mentioned.  We have a -- we issue 
12   unsecured or senior notes, and we have a suite of ABS 
13   platforms, so all auto finance related.  And we have good 
14   relationships with the rating agencies.  There are two 
15   separate teams that do unsecured and secured analysis and 
16   provide the ratings. 
17             I would say that on the structured finance or ABS 
18   side it's very formulaic, you know, you're looked -- the 
19   agent -- the analyst is looking at a pool of collateral, and 
20   we provide a lot of information on the performance of that 
21   collateral.  Historically what the current pool looks like.  
22   And it's pretty formula driven, especially since the new 
23   rules came into place with the Dodd-Frank Act.  They're 
24   really -- you send over your pool of collateral and a 
25   structure for the transaction, and then request ratings, and 
0174
 1   then they either -- you either got them or didn't.  And if 
 2   you didn't get what you wanted then you can either add more 
 3   collateral or -- but it's pretty formulaic.  It's very 
 4   structured.  It's got a process that is very smooth. 
 5             And what we try to do from choosing rating 
 6   agencies that rate those transactions, we typically rotate 
 7   among four, and we put two on each transaction.  Because 
 8   what we learned over the years, investors didn't need three 
 9   ratings, they really only needed two.  And DBRS was the one 
10   that was added later into the rotation coming out of the 
11   crisis as they began to develop their footprint in the U.S.  
12   So that's how we manage that program. 
13             I will say that, you know, adding a new agency, 
14   really it's going to be driven by investor demand.  So it's 
15   really -- if an investor has that rating agency approved in 
16   their investment criteria then, you know, we would add it. 
17             We also rotate just to prove that we are not 
18   rating shopping, because that was very important to make 
19   sure investors know we're not rating shopping.  We try to be 
20   very consistent with the credit enhancement.  And even 
21   though the ratings we get might end up being a little higher 
22   than we originally asked for, a lot of times we will leave 
23   the credit enhancement as is for consistency for investors. 
24             On the senior note side, we typically use three in 
25   the U.S.: Fitch, Moody's, and S&P.  When we raise unsecured 
0175
 1   debt in Canada we use DBRS also because they are the rating 
 2   agency firm most accepted by investors in Canada.  So you 
 3   really cannot issue a bond there successfully and get good 
 4   execution, meaning subscription levels and competitive 
 5   pricing, if you were to leave them off.  And they do a good 
 6   job of analysis. 
 7             So I would say that relationship really again is 
 8   investor driven as far as who we put on transactions.  And 
 9   we typically again in the U.S. use all three.  Part of that 
10   also is going to be a reflection of indices in the U.S. and 
11   needing two of the three larger NRSRO's ratings to qualify 
12   for the index because that's important for creating 
13   liquidity in your bonds, to be part of the index. 
14             So I would say that's really our philosophy on how 
15   we manage the two programs that we have. 
16             MS. MCGARRITY:  Thanks, Susan. 
17             Rachel, given your experience at Iron Mountain and 
18   your previous experience, how do you feel the credit ratings 
19   assignment process is working, and what are your thoughts on 
20   market concentration? 
21             MS. WILSON:  I'm going to take the last part of 
22   the question first because it will just keep the theme, 
23   which is how do you feel about the market concentration. 
24             And I think what you're hearing us all say is as 
25   issuers, we're going to respond to what our debt investors 
0176
 1   need and want, and what we need to do for index.  So if it's 
 2   two out of the three major, you know, agencies and that's 
 3   what they have to get approval, guess what, they're going to 
 4   go to two out of the three major agencies. 
 5             And, you know, for us there is not only a 
 6   quantitative cost, there's the cost of keeping them updated, 
 7   right, and meeting with them and -- every time you're doing 
 8   an issuance.  So, you know, there's a cost to how many of 
 9   those you can keep up and keep up at the right level and 
10   depth of dialogue that you would want. 
11             So, you know, as I said I think from our 
12   perspective, I think you're kind of hearing us universally 
13   say, as issuers we're going to be responsive to what debt 
14   investors want and index requirements, right, so there's a 
15   reason that that follows. 
16             In terms of the rating agency and kind of being 
17   assigned, you know, to different analysts, what -- sometimes 
18   it's very clear.  I mean, if you're -- you know, if you're 
19   Mars, you know where you're going.  It's not exactly, you 
20   know, a tough one to figure out which area you might be 
21   headed to. 
22             However, Iron Mountain is a REIT.  We started -- 
23   we became a REIT -- we started really in a business services 
24   coverage.  We now have data centers, you know, we kind of 
25   are spanning a lot of different industries.  And so where's 
0177
 1   your natural place to fall?  And you'd say well, does it 
 2   really matter, can co-coverage work?  Sure, there's all 
 3   these different approaches.  However, you know, as Otis 
 4   said, it was very clear to him.  You knew which metrics you 
 5   were supposed to hit and what certain ranges meant for your 
 6   rating. 
 7             What's interesting is, you know, being a REIT, 
 8   leverage means one thing, it has certain ratings 
 9   implications versus that same leverage being interpreted as 
10   a business services company.  So, you know, sometimes it's a 
11   very clear process and you know where you're going to line 
12   up. 
13             Other times if you started -- and we did start as 
14   business services.  Migration and how you respond or might 
15   change as your business changes can be a bit sticky.  And, 
16   you know, the agencies certainly -- that's where that close 
17   dialogue with the agencies really does matter and, you know, 
18   moving to creative solutions like co-coverage or other 
19   answers to try to get there.  But it's a little harder for 
20   us to necessarily pick out exactly what formula they might 
21   be applying to us. 
22             MS. MCGARRITY:  Interesting. 
23             Dan and Yann, do you have any comments about any 
24   of the points raised by the issuers? 
25             MR. GATES:  Sure.  So -- do you want to go first?  
0178
 1   I'll go first. 
 2             So I noticed that both Susan and Rachel mentioned 
 3   investor demand being important.  Certainly I want to point 
 4   out that it's in a rating agency's own self-interest to 
 5   publish credible high-quality ratings that build our 
 6   reputation with investors.  So that's an inherent self-
 7   interest. 
 8             We compete -- or we try to compete based on the 
 9   quality of our credit opinions, and we've long-supported 
10   competition on the basis of credit ratings quality.  We 
11   regularly analyze the performance of our ratings, and 
12   there's various quantitative metrics that can help you look 
13   at different aspects of ratings, including how they 
14   relatively rank the risk of default and loss.  And those 
15   quantitative metrics are published.  We make them available 
16   on our website.  They do demonstrate that overall credit 
17   ratings are effective in distinguishing defaulters from non-
18   defaulters, going to my main point, which is we try to 
19   compete based on rating quality. 
20             MR. LE PALLEC:  So first of all on competition, we 
21   welcome competition.  There is competition.  If you look at 
22   market sub-segments like structured was mentioned as having 
23   four players in the U.S.  If you look at insurance ratings, 
24   you've got AM Best.  That is a very large player in the 
25   insurance financial strength ratings space. 
0179
 1             So there is competition in asset classes and 
 2   obviously internationally in different countries.  Canada 
 3   was referenced before again.  So I would really insist on 
 4   the fact that worldwide we compete with more than 60 credit 
 5   rating agencies, and therefore the analysis of the state of 
 6   competition has really to be carried by asset class and by 
 7   country. 
 8             Second point is that we compete on ratings -- on 
 9   the quality of our ratings.  That is reflected by ratings 
10   performance, as Daniel said.  Because we are in this very 
11   unique position that we are paid by issuers, but the end 
12   user is the investor.  And it is the investors that make 
13   their own judgment on which credit ratings are the most 
14   relevant to them. 
15             How do we do that?  At any point in time we make 
16   sure that our rating -- what we call rating track record and 
17   transitions are up to our standards by sub-asset class, by 
18   country over time, over one year, two years, three years.  
19   This is obviously exposed. 
20             But whenever we review our methodologies, we also 
21   make sure that our methodologies really try to do two 
22   things: to make sure that our credit ratings give the right 
23   rank ordering of credit risks, and that there is some 
24   requirements in terms of ratings stability that are met.  In 
25   other words, the higher rating you have, the more time it 
0180
 1   takes for you to go to default.  That's what we call the 
 2   past default. 
 3             So if you're a non-investment grade company, 
 4   you're path to default would be shorter than for an 
 5   investment grade company. 
 6             So at any point in time, both through annual 
 7   surveillance but also through the annual review of our own 
 8   methodologies, we do make sure that we -- our ratings can 
 9   really continue to demonstrate this excellent ratings 
10   performance. 
11             Transparency and predictability are key.  Otis 
12   mentioned it before.  It is true in our -- starting with our 
13   intellectual property which are methodologies, they are 
14   public.  Whenever we change them, and whenever there is a 
15   significant change, we make it public, there's a request for 
16   comment, and investors and issuers can respond and provide 
17   their comments.  And we always adjust based on market 
18   feedback whenever we believe that market feedback has 
19   brought in some relevant comments on new methodologies. 
20             The second point is that we have to be absolutely 
21   transparent whenever we issue a rating, a rating decision.  
22   And this element of predictability is there for the 
23   investors to understand upon which changes in the operating 
24   conditions we could change our rating.  That's what we call 
25   the outlook.  And over time we've made sure that our outlook 
0181
 1   sections of our ratings would give the investors and the 
 2   issuers a clear understanding of upon which circumstances 
 3   would we change our view on the rating, and in which 
 4   direction. 
 5             The third point is the transparency in the 
 6   process.  That's the predictability element that works for 
 7   the investors, but for the issuers as well.  Whenever we 
 8   engage with an issuer, the issuer needs to understand how 
 9   the company's -- how the process takes place, what are the 
10   timelines.  In the non-investment grade market there are 
11   windows, and we need to adapt to those windows and produce 
12   the ratings according to the timelines of the issuer. 
13             And we also need to make sure that throughout the 
14   ratings process, again, the issuer can understand what he's 
15   going to make us change our views, or how frequently we are 
16   going to contact the issuer to make sure that surveillance 
17   is carried out, which for investment grade companies, 
18   typically every quarter. 
19             So really two key ideas there that I want to leave 
20   with you, which is this notion of competing on the 
21   excellence of the ratings performance; and second, 
22   transparency, where obviously regulation and regulatory 
23   disclosure helps. 
24             MS. MCGARRITY:  Great, thank you. 
25             Let's talk a little bit about business models.  
0182
 1   Susan, I have just a couple of questions for you along these 
 2   lines.  What are your thoughts on the current issuer-pay 
 3   model for ratings?  Do you know -- have you thought at all 
 4   about an alternative payment model for ratings that you 
 5   think could be an improvement?  And if so, what do you think 
 6   might be some hurdles associated with an alternative payment 
 7   model? 
 8             MS. SHEFFIELD:  Well, I know while it might seem -
 9   - because it is a unique relationship, as Yann was saying, 
10   that the issuer is paying for a rating that's really for the 
11   investor's benefit.  However, I would say that it actually 
12   works pretty well, and I -- since I've been doing this for 
13   18 years, and having this dialogue with the rating agencies 
14   on multiple fronts, it's important I think to -- so that 
15   they have the most transparent information from the 
16   companies, to have that direct dialogue so that their 
17   analysis can be fulsome, and we can have a rating that 
18   represents, you know, how the company is meeting the 
19   criteria. 
20             So I think that that actually works pretty well.  
21   If we were going to turn it around and have investors pay, 
22   I'm not sure how that would work with timing, and 
23   flexibility, and process.  So, you know, when you decide to 
24   go to market, or you're a frequent issuer, you know, we're 
25   always looking to try to be flexible, and there's a process 
0183
 1   and a timing that takes place, and if -- I don't know how 
 2   that would work on the investor's side.  Because typically 
 3   we call and say okay, we're looking -- getting ready to do a 
 4   deal, and we have a shelf in place, we want to do a 
 5   takedown, it needs a rating.  So the timing of that and 
 6   having to move smoothly through that process is really 
 7   important. 
 8             So the issuer needs to, out of necessity I think, 
 9   continue to play a very important role there.  And so that's 
10   one process.  And timing.  And then I would say, you know, 
11   if -- you know, the -- it's, you know, fairly expensive to 
12   get ratings fees.  I mean, we pay quite a bit to support our 
13   ratings program, but it's a very important part of our 
14   funding platform obviously and necessary.  If we were to 
15   turn that around, I think we would potentially just those 
16   fees would get passed back to us maybe through higher credit 
17   spreads or something like that. 
18             And I would also be concerned with depending on 
19   how that would work, would the smaller investor, who maybe 
20   doesn't have as many resources financially to make those 
21   kind of payments, could they afford to do that, to get the 
22   ratings? 
23             So those would be kind of the two things.  I do 
24   think it works pretty well.  It can be, you know, if you're 
25   on the issuer's side and as -- you know, we went from being 
0184
 1   a non-investment grade rated company to an investment grade 
 2   rated company, and that took, you know, several years to get 
 3   there.  So the dialogue is really important, the sharing of 
 4   information.  And so I think again that it is really an 
 5   important part of the process. 
 6             And the other thing I would say is that under the 
 7   current model, and I think this was mentioned already, it's 
 8   very separate, the analyst versus the marketing fee 
 9   structure relationship.  So they're not the same people.  
10   They're not even -- there's a firewall between the two.  So 
11   we can't buy a rating, so to speak.  That's really based on 
12   the criteria and our ability to communicate our plan, and 
13   how we're doing, and vision. 
14             MS. MCGARRITY:  Great, thanks. 
15             Otis, same question for you.  What are your 
16   thoughts on the current issuer pay model, and can you 
17   conceive of an alternative payment model for ratings that 
18   you think could be an improvement to the current? 
19             MR. OTIH:  This is -- it's a very interesting 
20   question because as an issuer, I think the risk is more of a 
21   concept, I -- we cannot prove it, that there will be a 
22   conflict of interest because if the issuer is paying, how do 
23   you -- how does the investor know that the rating agency is 
24   not favoring the issuer so that the rating agency would give 
25   the issuer business? 
0185
 1             I did -- I knew historically the other model was 
 2   in existence way long time ago when the rating agency -- the 
 3   investors were paying for their services, and somehow it 
 4   changed.  And it's not something to brush aside very easily.  
 5   I think it's something to look into it.  Maybe a hybrid 
 6   approach where the investor can pay some of the fees because 
 7   we are -- we both have a skin in the game. 
 8             And I agree with Susan.  As it currently stands, 
 9   it works, it allows me, the issuer, to tell my story and to 
10   be responsive to the rating agency who then have more 
11   information to do the -- to give the opinion.  But I -- it's 
12   a struggle because I -- as I look at the rating agencies, I 
13   know that their reputation is such that they do not want to 
14   give any impression that they are favoring the issuer.  
15   Otherwise they would not be in business.  And having gone 
16   through the process, and I find myself actually questioning 
17   then why am I paying you when you're grilling me so much to 
18   be independent. 
19             (Laughter.) 
20             MR. OTIH:  So, you know, because they give a clear 
21   -- again for investment grade, they give a clear guidance, 
22   this is where you need to be to make it, you need to provide 
23   us audited financial statement, you need to give us 
24   quarterly information, you need to make sure that if there 
25   is any material change in the company that you promptly 
0186
 1   disclose it to your analyst. 
 2             So I'm confident that they are taking appropriate 
 3   step to make sure that the investment community continue to 
 4   get a quality service that they deserve.  I just don't know 
 5   this thing about conflict.  It will be interesting to hear 
 6   what the two rating agencies would say in terms of removing 
 7   the perceived, or what could be a perceived, conflict of 
 8   interest. 
 9             But from the issuer perspective, again as Susan 
10   say, it works.  We pay them on time, get good service, and 
11   retain our investors. 
12             MS. MCGARRITY:  Thanks, Otis. 
13             Rachel, as a subcommittee, you know, we have been 
14   -- we have spoken a lot about how issuers use NRSROs for 
15   services other than credit ratings assignment.  How does 
16   Iron Mountain use credit ratings agencies outside of the 
17   traditional credit ratings process? 
18             MS. WILSON:  Iron Mountain has not.  So I'm going 
19   to just speak on past lives because we have only used kind 
20   of the traditional service and things for, you know, using 
21   our bonds and issuances the way normally we would do as 
22   issuers. 
23             In an M&A situation is a good example where you 
24   really are going to fundamentally change your capital 
25   structure, and you could do -- maybe there's three or four 
0187
 1   different ways you're contemplating how much equity mix you 
 2   want to put into the transaction, or do you want to put in a 
 3   tranche, a preferred, or how might you structure this, and 
 4   how sensitive to the ratings might you be?  And what you can 
 5   do there is you can use something called an advisory 
 6   service, a ratings agency advisory service. 
 7             And by the way, most of the investment banks give 
 8   you a pretty good read on this as well so you don't 
 9   necessarily have to do that.  Generally your investment 
10   bankers will also give you similar reads as to where they 
11   think ratings might fall out. 
12             But you could choose to do something like that, 
13   and they will give you an indicative rating, it is not your 
14   final rating.  You would still have to go and -- go forward, 
15   and it could change from your indicative rating, but it is a 
16   way to help fine tune a capital structure decision if you 
17   are thinking about that. 
18             MR. LE PALLEC:  I've got to jump in at this stage.  
19   We do not provide any advisory service whatsoever.  The 
20   ratings evaluation service, as we call it, at S&P Global 
21   Ratings is based on scenarios that are designed by either 
22   the issuer or the investment bank that advises the company, 
23   or both. 
24             And what the company presents us with is one, or 
25   two, or three scenarios that have been designed by the 
0188
 1   company that are very detailed and that we do not opine on.  
 2   What we do is that we take the one, the two, the three 
 3   scenarios, we look at each of them.  We apply the 
 4   methodology, and we give the company a clear answer about 
 5   what the rating would be if scenario one gets implemented, 
 6   two, three, et cetera. 
 7             There is no advisory.  There is a policy that 
 8   covers all our products outside of traditional credit 
 9   ratings that is called ancillary services policy that covers 
10   not just this one but other products because we do not only 
11   provide credit ratings, we provide green evaluations that 
12   speak to the greenness of a particular bond issuance.  More 
13   recently since April we provide a product called ESG 
14   evaluation that speaks to the ESG compliance of an entity, 
15   not an issue to a certain set of ESG risks. 
16             But let me be very clear, we do not advise.  We 
17   are independent.  We do not provide any advisory or 
18   consulting services as such.  So it is an important 
19   precision to make. 
20             MS. WILSON:  That's fine, although I think what 
21   we're saying is what, beyond rating, have you gone to the 
22   rating agencies for?  Thus, an ancillary service.  And I 
23   agree, we would be providing, along perhaps with your 
24   investment bank, these scenarios, okay, which I was 
25   discussing, if there's different capital structures.  We 
0189
 1   provide that scenario.  And yes, we would bring it forth to 
 2   the agencies. 
 3             MR. LE PALLEC:  Thank you. 
 4             MS. WILSON:  So I don't think we are at all 
 5   speaking -- 
 6             MR. LE PALLEC:  But as you can imagine, this is a 
 7   sensitive matter, so it's important to make sure that we're 
 8   all -- 
 9             MS. WILSON:  You have made the record clear. 
10             MR. LE PALLEC:  Thank you. 
11             MS. MCGARRITY:  Yes.  Thank you for that, and for 
12   the clarification. 
13             Susan, you may not want to answer the question, 
14   but do you have anything to add on the ancillary services 
15   used by issuers, and do you see any potential conflicts of 
16   interest arising in using NRSROs for these ancillary 
17   services? 
18             MS. SHEFFIELD:  Yeah, we haven't used them at GM 
19   Financial, really just because we could -- we just didn't 
20   think we needed that, and we didn't -- the situation didn't 
21   arise.  So unfortunately I can't really speak to that. 
22             MS. MCGARRITY:  That's okay. 
23             MS. SHEFFIELD:  What I would add is on the 
24   conflicts of interest.  You know, if we turn the model 
25   around and had investor pay, I don't know that you eliminate 
0190
 1   the conflicts of interest, just because if the investors had 
 2   a certain investment criteria they were trying to meet, or 
 3   let's say just to -- you know, someone had a certain view on 
 4   a certain company, and they wanted to try to change the 
 5   rating or influence the rating to achieve whatever 
 6   objective, I don't -- you know, so I'm not sure that 
 7   eliminates the conflict of interest -- the perceived 
 8   conflict of interest. 
 9             MS. WILSON:  Yeah.  And to be clear, when we had a 
10   -- you know, our prep call with some of the committee 
11   members, I think all of us were quite clear, none of us -- 
12   we felt the quality that we get from the agencies -- or 
13   quote/unquote an ability to influence us.  We have no 
14   ability.  We don't feel we have any ability to influence, 
15   other than to share the information, but we have not 
16   experienced a feeling that we could influence. 
17             So from that sense, that is not our personal 
18   experience with working with the agencies.  And I think we 
19   were a little hard-pressed to say what could an alternative 
20   be because we value that close dialogue, we think that is 
21   important in sharing that information.  So I think we were a 
22   bit stymied with what really ultimately could be better in 
23   maintaining some of the benefits of that close and frequent 
24   dialogue that we need to have. 
25             MR. OTIH:  Yeah, I just want to add to it.  Sorry.  
0191
 1   I actually think the model is favorable to investors, to be 
 2   honest with you, because as you can imagine, if you have 300 
 3   investors, an issuer is not going to call each individual 
 4   investor when there is something going on with the company.  
 5   So the idea that you have a relationship with the rating 
 6   agency, that you inform on a regular basis, you tell your 
 7   story, I actually think is good for the investor. 
 8             Again, but I don't want to completely just ignore 
 9   the perceived conflict of interest.  I don't know whether it 
10   would be a subcommittee or a small group of individuals who 
11   should look at it and then conclude finally, because it is 
12   there.  And I've heard investors basically saying you paying 
13   for this, how do we know that we are getting the services we 
14   need? 
15             MR. GATES:  Just if I can jump in there.  You 
16   know, this debate about what's the best business model, 
17   investor pay, issuer pay?  It's a longstanding debate.  
18   There's been academic studies, there's been studies by the 
19   SEC and GAO.  All of them seem to suggest that no matter 
20   what the business model is, there's only pros and cons to 
21   each, but all business models have inherent conflicts.  If 
22   investors pay for ratings, they will still have an interest 
23   in the outcome of the rating. 
24             So our view is that we focus on managing the 
25   conflicts, and that we identify them.  We manage them, we 
0192
 1   maintain objectivity and integrity of the rating process. 
 2             Just a few points there.  Analysts are not 
 3   involved in fee discussions.  Analysts are not aware of the 
 4   fees for a particular rating.  There's no incentive for the 
 5   analysts.  There's no involvement by analysts in fees or 
 6   sales and marketing.  But also their compensation and their 
 7   performance evaluation, they're not based on the revenues 
 8   that Moody's generates from issuers for which an analysts 
 9   participates. 
10             And the rating -- and I think it's been mentioned 
11   a couple times, it's in our self-interest to maintain high-
12   quality credible ratings, provide a clear rationale to 
13   investors as well as issuers, so that we maintain a 
14   reputation with investors where they value our ratings. 
15             I'd also want to highlight I think what's a 
16   positive characteristic of the issuer pays model, namely 
17   this model gives free access to credit ratings for anyone in 
18   the market.  So our ratings are publicly available to anyone 
19   who has internet access and goes into our website.  You can 
20   Google a company name or a city name and Moody's rating, and 
21   you can get it from other sources than just from us.  And so 
22   this has been noted in those studies that I mentioned about 
23   business models. 
24             And so in our view, free access to ratings and to 
25   the rationale that explains the rating in our press 
0193
 1   releases, it helps reduce what's information asymmetry 
 2   between issuers and investors. 
 3             MS. MCGARRITY:  Yann, I wanted to give you another 
 4   opportunity to react to the entire discussion surrounding 
 5   the business model.  I know you reacted to the ancillary 
 6   services aspect of it, but do you have any comments related 
 7   to the issuer pay side of it? 
 8             MR. LE PALLEC:  No, I would say exactly the same 
 9   thing as Daniel.  You've got -- this is quite -- the 
10   business model question is existential for us.  As you can 
11   imagine, we spend quite a bit of time thinking about it.  
12   And back in 2010 we published a white paper that is still 
13   extremely valid that looked at all the possible models. 
14             You've got issuer pay, investor pay, and public 
15   agency.  Public agency hasn't managed -- hasn't been 
16   mentioned so far in this debate.  It is a possible operating 
17   model whereby it's paid by the companies, by the taxpayer, 
18   and it's managed as a government agency.  It does create 
19   potential conflict when it comes to the fairness of ratings 
20   on government-owned entities, and even bigger problems if 
21   you want to be a global credit rating agency that rates 
22   securities across all asset classes and in all countries in 
23   the world. 
24             Investor pay is the one that reduces the most 
25   information asymmetry between the investor, who buy the 
0194
 1   securities, and the issuer.  So therefore we believe that it 
 2   is certainly a business model that has lots of advantages.  
 3   It puts -- it makes our ratings, their rationale, all our 
 4   disclosure publicly available, and it's there for scrutiny. 
 5             And the way -- when I talk to junior analysts with 
 6   two presence of compliance in the room, I always tell them 
 7   that for me -- for an analyst to be talking to an investor 
 8   and engaging in a constant dialogue with an investor also 
 9   means that investors for me are completely part of quality 
10   assurance. 
11             Internally we've got a three line of defense risk 
12   management framework that is inspired from the banking 
13   industry where we've got risk and compliance, internal 
14   controls, and then we've got internal audit and the 
15   equivalent of an inspection group that looks at rating 
16   committees after the fact for the quality of the actual 
17   credit rating decisions. 
18             But I view the engagement, and the very open 
19   engagement, with the investors as closing the loop in terms 
20   of quality assurance to make sure that our ratings are 
21   really out there for scrutiny, and that anyone who disagrees 
22   who's got a different point of view can make it known, and 
23   helps us to look at those complex issues more thoroughly 
24   from lots of different angles and possibly come up with 
25   better ratings. 
0195
 1             So the issuer pay with the investor as the end 
 2   user is really the one that allows most transparency, most 
 3   disclosure so that investors can have a critical view, which 
 4   for us is very important. 
 5             On the -- one of my comments on what we -- what 
 6   our true north is, if you will, is really what we call it at 
 7   S&P, analytical excellence.  And when we talk to analysts 
 8   about analytical excellence, it has really three dimensions 
 9   that have already been mentioned, but I'd like to repeat. 
10             It's to produce excellent ratings as measured by 
11   ratings performance.  Second, it is the time to market being 
12   efficient, quick, and informing investors as quickly as they 
13   should.  And third leads to clarity.  It's going to the 
14   essence.  When you talk to investors, tell them very clearly 
15   why you came at that particular conclusion. 
16             And again, the current issuer pay business model 
17   is probably the one that gives us most opportunity to 
18   deliver that analytical excellence, but there is a potential 
19   for conflict.  So that -- those -- that potential for 
20   conflict needs to be managed, remedied, and disclosed.  And 
21   this where certainly regulation plays a big part, because as 
22   you know, we have to disclose any error or any change in 
23   methodologies very, very quickly.  So in that way regulation 
24   has strength and this transparency to the investors in 
25   particular. 
0196
 1             MS. MCGARRITY:  Thank you. 
 2             So you can imagine the subcommittee -- the Credit 
 3   Rating Subcommittee has explored these business model, 
 4   competition, et cetera, within our conversations over the 
 5   past several months and will likely continue to do so. 
 6             But with that I'd like to open it up to questions 
 7   from the broader FIMSAC for our panelists.  Larry -- 
 8             MR. HEANEY:  Can we just got to Chairman Clayton 
 9   first, please? 
10             MS. MCGARRITY:  I'm sorry.  Yes.  Of course. 
11             MR. HARRIS:  Oh, of course.  Go ahead. 
12             CHAIRMAN CLAYTON:  And actually -- so I apologize.  
13   This is a question that wasn't directly on your agenda, but 
14   I'm going to take advantage of the fact that you're here.  
15   And anybody can chime in, or you can simply say I'm not 
16   prepared, and that's a fine answer. 
17             I get a lot of questions about so-called covenant 
18   light loans or a -- I'll put it more generally, a reduction 
19   in the rigor of covenants in certain instruments, and 
20   whether this creates additional risk, which if it does on an 
21   issuer level, I would think would be reflected in ratings 
22   assessments, or not, I don't know. 
23             But any perspective -- I will tell you there was a 
24   couple of things that -- it can cut a lot of ways.  One nice 
25   thing about rigorous covenants is people get notice of 
0197
 1   potential issues earlier rather than later, and that may 
 2   give you more time to work things out.  There's a flip side 
 3   of it.  Sometimes instruments that are, I would say, you 
 4   know, further down the spectrum in the capital structure may 
 5   have control as a result of covenants earlier than you would 
 6   want them to.  But any quick advice for me on how to look at 
 7   this issue? 
 8             MR. GATES:  Sure.  I'm on the analytical side, so 
 9   that's a good question for me.  We have more, as a percent 
10   of loans in the market, a higher percent that's covenant 
11   light than has ever been the case.  That does give issuers -
12   - and many of these issuers are controlled by PE firms, so 
13   they're pretty tightly controlled.  It gives them more 
14   financial flexibility than they've had in previous economic 
15   cycles. 
16             Now we take that into account, so if an entity has 
17   an ability to pull out equity and return it to the owner, 
18   you know, there's a -- we're going to differentiate between 
19   that issuer and one that doesn't have that ability because 
20   they agreed to a covenant when they negotiated with their 
21   lenders. 
22             The question -- you made a good point about 
23   covenants can be good as well as bad.  Moody's has 
24   published, by the way, a lot on covenant light, non-
25   recovery, and the impacts, and we're happy to provide those 
0198
 1   publications to anyone who wants them.  But in the 2009 
 2   recession, it was a very short liquidity squeeze for non-
 3   financial corporates.  When the Fed flooded the markets, 
 4   liquidity came back to low spec grade non-financial 
 5   corporates.  Maybe not so much for financials because 
 6   they're not as transparent so there's more fear in the 
 7   market typically for financials than non-financials. 
 8        And it was interesting, covenant light wasn't actually 
 9   helpful because those issuers that violated their covenants 
10   at the peak of the trough, recoveries were going to be 
11   lower, asset prices were lower. 
12             The biggest thing we actually see with recovery, 
13   aside from leverage, and that's where covenant light comes 
14   into play, and it allows the issuer to get more leverage if 
15   they want it, but the biggest component of recovery that we 
16   see is actually the capital stack.  And we're seeing today a 
17   lot more of that higher percentage of that capital stack is 
18   senior secured, meaning there's less debt cushion under it, 
19   meaning there will be lower recoveries in the next 
20   recession. 
21             CHAIRMAN CLAYTON:  Sorry to highjack, but it was 
22   an opportunity. 
23             MR. REDFERN:  Just quickly while the mic's over on 
24   this side of the table.  So I'm interested in also just 
25   exploring a little bit more on the various pay models.  And 
0199
 1   I think in my mind I am contrasting this to how I look at 
 2   sell side research, right. 
 3             So in sell side research you have a relationship 
 4   between, you know, companies, and analysts, and there's a 
 5   whole set of ways in which that communication occurs.  And 
 6   in light of this conversation where there is some discussion 
 7   around like how fulsome is the discussion, we like the 
 8   direct relationship, and all that, it seems I would like to 
 9   hope that it works reasonably well with respect to the 
10   analyst providing coverage as well as the -- you know, with 
11   their relationship with the company. 
12             So in contrast to that, can you tell me if you 
13   think that that would be a -- you know, how you would look 
14   at those things relative to one another?  Or do you think 
15   the communication is less fulsome?  You know, just I'm 
16   looking at those models sort of side by side to understand 
17   the pros and cons. 
18             MS. SHEFFIELD:  I mean, one distinction I would 
19   make is on sell side research, they elect to start doing the 
20   research, right.  It's up to the institution if they want to 
21   provide coverage on a company.  Whereas for GM Financial or 
22   anyone needing to raise debt, I mean, we have -- I would say 
23   we have to have ratings by the rating agencies if we're 
24   going to sell that debt broadly to the investor base because 
25   investors having ratings criteria to make their investment 
0200
 1   decisions. 
 2             So we have to engage in a rating process, right.  
 3   I mean, would -- companies like to have sell side research, 
 4   and they like to have that coverage, but they don't 
 5   necessarily make the decision.  Whereas we have to take 
 6   action to get a rating to sell the bonds.  So I don't know 
 7   how that would -- 
 8             MR. REDFERN:  Yeah, that definitely would be one 
 9   difference.  Do you think in terms of just the 
10   communication, though, and the -- you know, we were talking 
11   about the nature of that communication.  Do you think that 
12   because of the payment model, that it's an impediment in 
13   some way to the fulsome understanding of the company from -- 
14             MS. SHEFFIELD:  One the -- no, I mean, I think -- 
15   well I'm not sure if I got the direction right on this.  But 
16   I think -- there's probably more -- just because of the 
17   nature of the rating agency company rating, they're 
18   privileged to sometimes more non-public information so that 
19   we can tell the story more broadly and provide that 
20   information.  Then they can -- they can't disclose that in 
21   their published material, but they can use it to inform 
22   their rating decision. 
23             And I think to the point maybe, Chairman Clayton, 
24   you were making about visibility into not necessarily 
25   covenant light or covenant heavy, but if they have that lens 
0201
 1   into a company, then the rating, and I don't want to speak 
 2   for them, should reflect the company's performance across 
 3   the cycle.  And if they're changing the rating, that would 
 4   be an indication to investors that something beyond what 
 5   we're telling -- we try to be very transparent to all of our 
 6   constituencies.  But I guess that's what I would say there. 
 7             MR. HEANEY:  Can I just ask one very quick follow-
 8   up to the matrix question? 
 9             So the subcommittee, this is not answer topic when 
10   you think about matrix or a multi-pay model, and the 
11   subcommittee has talked about it, and it's -- there's no 
12   easy answer, bottom line.  But if there were some 
13   combination of buy side plus the issuing entities or 
14   corporations, I mean, I guess the question becomes -- I 
15   assume you have no issue if a multi-pay model were to be 
16   created, that the rating agencies would say business as 
17   usual, just the fact that perhaps it's 75/25?  Or we can get 
18   into all the iterations of how you can do that. 
19             But I'm curious your reaction to if there were a 
20   multi-pay model on a blank sheet of paper that FIMSAC 
21   created, your reaction to that as a process. 
22             MR. LE PALLEC:  On this issue, we actually have a 
23   small portion of investor pay ratings, it's a minority.  But 
24   to your point, we've already got a dual model.  It's just 
25   that the issuer pay is the one that got the most traction, 
0202
 1   and again, overall provides, you know, ensures, you know, 
 2   that more information is made available to the market. 
 3             MR. HEANEY:  But I'm just saying envision a world 
 4   where it's not done that way, it's 75 cents on every dollar 
 5   is paid by the issuer and 25 percent is paid by a consortium 
 6   of investors.  Please don't hold me to that -- any of that.  
 7   Any -- your reaction?  Business as usual. 
 8             MR. LE PALLEC:  No, not necessarily.  But I think 
 9   this is something we'd have to take into account -- as I 
10   said, we've got a preference for issuer pay for the reasons 
11   I gave in terms of dissemination of information.  But when 
12   it comes to what you describe, we'd have to adapt.  But as I 
13   said, all models have got, you know, potential for conflict.  
14   It's just that we've got to manage them, and get the market 
15   to understand that we -- and show that we demonstrate that 
16   we manage them effectively. 
17             MS. MCGARRITY:  Michael, do we have time to take -
18   - 
19             MR. GATES:  I'll just also chime in if I can.  
20   Just from our standpoint, I would say it would depend on the 
21   impacts on the usefulness and quality of ratings, and 
22   whether there's any unforeseen side effects such as the 
23   reduced availability of ratings and opinions around ratings. 
24             MS. MCGARRITY:  Larry, thanks for your patience. 
25             MR. HARRIS:  Sure. 
0203
 1             Yann and Daniel, both of you spoke about the 
 2   importance of ratings importance to developing investor 
 3   confidence and acceptance, and that this is the ultimate 
 4   determine of the value of your services.  Yet I note that in 
 5   any given year very few firms default, and so we don't 
 6   really learn that much about the quality of ratings except 
 7   for over very, very long periods of time. 
 8             So I was wondering, what do you -- over what sort 
 9   of period of time do we -- do you imagine that we -- or 
10   investors learn about quality ratings?  And if you would, 
11   perhaps each of you could share one or two events where you 
12   felt that the company got it wrong, and that you actually 
13   were hurt in front of your -- the people to whom you're 
14   providing service ultimately. 
15             MR. GATES:  I guess I'll start on this.  We 
16   publish tables showing cumulative default rates by year.  
17   For example, in the back of our annual default study 
18   published every February, which is available on our website, 
19   we have at least 20 cumulative default rates.  And you'll 
20   see with large numbers of issuers, you know, tens of 
21   thousands of issuers, in long periods of time you actually 
22   get what you should see, which is a monotonic increase in 
23   default rates as you go down the rating scale.  You will not 
24   find over any short period of time that ratings are perfect. 
25             I think someone mentioned before investment grade 
0204
 1   defaults.  We do occasionally have investment grade 
 2   defaults.  It's inherent in -- and actually I'd say it's 
 3   very humbling as someone who has done this for 22 years, to 
 4   try to provide a forward looking opinion.  So you're going 
 5   to be wrong some of the time. 
 6             And I was in a corporate rating space at the time 
 7   of ENRON and some other investment grade defaults in 
 8   2001/2002.  You know, there were situations where there was 
 9   blatant fraud, there were attempts to mislead the rating 
10   agencies.  It was so harmful to our reputation, and there 
11   also -- we -- always when we have a highly-rated default, we 
12   look at it to try to figure out what is we can learn from 
13   this?  What is it we can look at next time differently?  
14   What is it we can generalize for other issuers? 
15             So, you know, please be assured that we're 
16   constantly trying to improve and learn from experience, even 
17   though we've been doing this for a hundred years.  But we 
18   also are very transparent in terms of publishing data that 
19   can be used, and is used, by academics and others to 
20   demonstrate that ratings really are predictive, again, not 
21   in every single case. 
22             But if you take large numbers of ratings, which we 
23   have, and you look at any time period more than a couple of 
24   years, you will find that rating performance is very good in 
25   terms of differentiating between defaulters and non-
0205
 1   defaulters with lower versus higher ratings. 
 2             MR. LE PALLEC:  If I may add, it's not just about 
 3   learning from defaults, but also rating transitions.  A 
 4   Triple A according to what we call one of our definitional 
 5   pieces that is called ratings stability, a Triple A within a 
 6   year is not expected to go down by more than one notch, i.e. 
 7   to Double A.  So Triple A that retrospectively would go 
 8   straight to Triple B for instance would raise internally 
 9   lots of questions and trigger lots of reviews to see whether 
10   this is an isolated case or then if there is an issue in the 
11   methodology. 
12             So we learn every day, and like in the case of 
13   Moody's, we make all the default and transition tables 
14   public.  They are extremely detailed.  They look at default 
15   and transitions of a one year, two years, three years, five 
16   years, 10 years.  And again, it's not just from defaults 
17   that you learn, it's from retrospectively making sure that 
18   the rating transition has been what would be expected.  In 
19   other words, that the higher ratings have slower 
20   transitions.  Transition more slowly to lower ratings than, 
21   you know, non-investment grade credits would. 
22             And then for, you know, disappointment from the 
23   market.  You know, U.S. subprime didn't live up to our 
24   historical ratings performance.  That's probably the most 
25   obvious example. 
0206
 1             MR. HARRIS:  Very quick follow-on.  So among the 
 2   analysts it surely must be well-known that transitioning a 
 3   Triple A to a Triple B is unattractive.  So what mechanisms 
 4   exist to provide the discipline to ensure that that happens 
 5   if it's supposed to happen? 
 6             MR. GATES:  We -- this is an issue of not wanting 
 7   analysts to hide a problem or feel that they have to manage 
 8   ratings to some performance metrics.  You know, we always 
 9   tell analysts it's a new day, we've got a new information, 
10   new outlook.  If a rating needs to move, it should move to 
11   the right rating level.  You still have an issue that 
12   analysts may, like anyone else, feel that well they'd like 
13   to hide this a little bit, they'd like to limit the rating 
14   movement. 
15             There's some tools to make sure that that doesn't 
16   happen.  One is our rating methodologies which we use for 
17   our ratings, which are developed and approved by a group 
18   that's separate from the analysts. 
19             You know, there's the rating committee itself, 
20   which is a group of individuals, one person, one vote, free 
21   debate by all parties.  And then we have others, including 
22   my group, that have the ability to mandate that a rating 
23   committee be held, can be a independent outside broad 
24   perspective force for saying that this doesn't look to us 
25   like a Triple A, or a Double A, or whatever it is, in fact.  
0207
 1   So those are the ways we combat the natural human tendency 
 2   to want -- not want to admit to what may to the analyst feel 
 3   like a mistake. 
 4             MR. LE PALLEC:  Yeah, our internal process is 
 5   very, very similar.  But, you know, our committee is chaired 
 6   by a very senior credit analyst.  A recommendation from a 
 7   Triple A to be downgraded by more than one notch is going to 
 8   be under a lot of scrutiny, and at the end of the day, as 
 9   Daniel said, we need to put the rating where it should be. 
10             But the mere fact that there would be such a rapid 
11   transition is going to trigger lots of discussions, 
12   potentially the committee could be postponed for further 
13   work to be carried out.  And after the event, certainly 
14   internally, like in Daniel's group, we've got a group that's 
15   leads in the first line, so within the analytical teams, 
16   that looks at the surveillance of the portfolio that may ask 
17   for a review of that decision.  And then ultimately in the 
18   third line of defense, reporting straight into the audit 
19   committee. 
20             We've got the equivalent of an inspection group in 
21   a bank that is likely to trigger their own review that could 
22   in turn trigger a review either of all similar ratings or a 
23   review of the methodology if they believe that there's an 
24   issue with the methodology. 
25             MS. MCGARRITY:  Thank you. 
0208
 1             Gilbert. 
 2             MR. GARCIA:  Yeah, very quickly. 
 3             Yann, you talked about competition.  What 
 4   collectively do the two of you have in market share on debt 
 5   issuance here in the U.S., and then how much outside the 
 6   U.S.? 
 7             MR. LE PALLEC:  This is public information that we 
 8   disclose. 
 9             MR. GARCIA:  Yeah, I just don't -- yeah, if you 
10   could just share it. 
11             MR. LE PALLEC:  In the U.S. we're probably close 
12   to 80, 85 percent, something like that.  And outside would 
13   be fairly similar.  Well, in the developed markets.  We are 
14   at least -- S&P, we're very little present in what we call 
15   domestic markets, so domestic ratings, not global scale 
16   ratings.  Something like that. 
17             MR. GARCIA:  Thank you. 
18             Dan, do you -- do you know, Daniel, offhand? 
19             MR. GATES:  I don't.  As I said, I'm on the 
20   analytical side, but it I think is similar. 
21             MR. GARCIA:  Similar? 
22             MR. GATES:  I mean, these numbers are published 
23   and they're readily available even to people like me who 
24   don't want to focus on them. 
25             MR. GARCIA:  Understood. 
0209
 1             MR. LE PALLEC:  In certain jurisdictions it's 
 2   actually an annual -- it's information that we need to 
 3   disclose annually. 
 4             MR. GARCIA:  Thank you. 
 5             MS. MCGARRITY:  Well with that I think we'll close 
 6   down our panel.  Thank you very much to our panelists.  Your 
 7   insights were very helpful for us.  Thank you. 
 8             MR. HEANEY:  I just want to echo that.  This is -- 
 9   I'm sure there's plenty of discussion to follow at the 
10   subcommittee level, and we appreciate you coming down to DC 
11   and taking the time to share your thoughts. 
12             Again, to the FIMSAC members, thank you for your 
13   participation today.  It's been another full day and another 
14   successful day.  We continue to put forth actionable ideas 
15   to the Commission, and that are insightful for not only 
16   investors, but issuers alike, here's a good example of that. 
17             It's due to this committee's hard work and 
18   enthusiasm, and most importantly willingness to serve, which 
19   has gotten us where we are today, which is 10 
20   recommendations to the SEC.  I thank you for that. 
21             I look forward to the follow-up on the 
22   subcommittee calls as they take place over the next week or 
23   two, and here we go again.  And I look forward to seeing you 
24   on November 4th. 
25             At this point I'll entertain a motion to adjourn. 
0210
 1             MALE PARTICIPANT NO. 2:  So moved. 
 2             MR. HEANEY:  All in favor? 
 3             (A chorus of ayes.) 
 4             MS. SHANK:  Aye. 
 5             (Whereupon, at 3:33 p.m., the meeting was 
 6   adjourned.) 
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0211
 1                     PROOFREADER'S CERTIFICATE 
 2    
 3   In the Matter of:  FIXED INCOME MARKET STRUCTURE ADVISORY  
 4                      COMMITTEE MEETING 
 5   File Number:       OS-0729 
 6   Date:              Monday, July 29, 2019 
 7   Location:          Washington, D.C. 
 8    
 9             This is to certify that I, Christine Boyce 
10   (the undersigned), do hereby certify that the foregoing 
11   transcript is a complete, true and accurate transcription of 
12   all matters contained on the recorded proceedings of the 
13   meeting. 
14    
15   _______________________       _______________________ 
16     Proofreader's Name)           (Date) 
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0212
 1                       REPORTER'S CERTIFICATE 
 2    
 3   I, Kevin Carr,  reporter, hereby certify that the foregoing 
 4   transcript is a complete, true and accurate transcript of 
 5   the matter indicated, held on __7/29/2019___________, at 
 6   Washington, D.C.,  in the matter of: 
 7   FIXED INCOME MARKET STRUCTURE ADVISORY COMMITTEE. 
 8   I further certify that this proceeding was recorded by me, 
 9   and that the foregoing transcript has been prepared under my 
10   direction. 
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13                       Date:  7/29/2019 
14          Official Reporter:  Kevin Carr 
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