Municipal Securities, Government Securities, and CMOs

Each product family (munis, CMOs, government securities) has its own advertising rule on top of the general content standards, so treat this as three short checklists rather than one blended rule.

What Rules Apply to Municipal Securities?

The MSRB regulates advertising for municipal securities through the municipal-advertising rule:

What Advertising Standards Apply?

• No dealer may publish any advertisement concerning municipal securities that the dealer knows or has reason to know is materially false or misleading
• This is a "knew or should have known" standard. Ignorance is not a defense if the dealer should have caught the error.

Who Must Approve Municipal Advertisements?

• Advertisements must be approved in writing by a municipal securities principal or general securities principal prior to first use
• Records of all advertisements must be maintained in a separate file

Exam Tip: Gotchas

• The municipal-advertising rule requires written principal approval for muni ads before first use. This is similar to retail communication rules under FINRA, but the approval comes from a municipal securities or general securities principal specifically.

What Is an Official Statement?

• The municipal-disclosure rule requires underwriters of municipal securities to obtain and distribute official statements (the municipal equivalent of a prospectus) to investors
• The official statement contains financial and operating data about the issuer and the terms of the bonds

What Rules Apply to Government Securities and CMOs?

Collateralized mortgage obligations are complex products that require special communication rules to protect retail investors.

What Must a CMO's Product Name Include?

• All retail communications and correspondence concerning CMOs must include the term "Collateralized Mortgage Obligation" in the product name
• The full name cannot be abbreviated to just "CMO" in advertisements

Exam Tip: Gotchas

• "Collateralized Mortgage Obligation" must appear in full in CMO retail communications and correspondence. Simply writing "CMO" is not sufficient.

What Can a CMO Communication Not Do?

• A CMO communication may not compare a CMO with any other investment, including a bank CD
• Where applicable, it must disclose that an agency guarantee covers only face value, not any premium paid, and that yield and average life change with prepayments and interest rates

What Must a Communication Promoting a Specific CMO Disclose?

A retail communication or correspondence that promotes a specific CMO or gives yield information must present two disclosure blocks with equal prominence:

• An identification block: the CMO, coupon rate, anticipated yield and average life, specific tranche number and class, final maturity date, and underlying collateral, all in equal type size
• A prepayment-disclaimer block: the prescribed prepayment-assumption disclosure, unaltered

Two more blocks may be added but are not required: an optional product-features block (minimum denomination, rating, agency backing, income structure, tranche type) and a company-information block that the firm can tailor to its own format.

The prepayment assumption behind these figures must come from a nationally recognized service, or be supportable by the firm's own records, and that support must be kept with the communication.

If the communication includes an anticipated yield, it must include any intended sales charge in that figure. It must also state that the security is offered subject to prior sale and price change, and identify an accrual bond that is not currently paying principal and interest.

Exam Tip: Gotchas

• CMOs cannot be compared to a bank CD or any other investment, even though both are sometimes pitched as safe, income-producing products.
• The identification block and the prepayment disclaimer must carry equal prominence. A firm cannot bury the required disclaimer in fine print while highlighting the yield figures.

What Educational Material Must Be Offered to Retail Investors?

Before selling a CMO to a non-institutional investor, a member must offer (not necessarily deliver) educational material covering:

• Characteristics and risks: credit quality, prepayment rates, average lives, interest rates
• Structure of a CMO: types of tranches and the rights and risks associated with each
• The relationship between mortgage loans and mortgage securities
• Tax considerations, minimum investments, transaction costs, and liquidity
• Questions an investor should ask before investing, and a glossary of CMO terms

Exam Tip: Gotchas

• The customer can decline the offer, and this requirement applies only to non-institutional (retail) investors; institutional investors do not need to be offered the educational material.

What Must Radio and Television CMO Advertisements Disclose?

Radio or television advertisements for CMOs must open with this required disclaimer, in place of the written identification block used in print communications:

"The following is an advertisement for Collateralized Mortgage Obligations. Contact your representative for information on CMOs and how they react to different market conditions."

They must also include this required oral disclosure, in place of the written prepayment disclaimer:

"The yield and average life reflect prepayment assumptions that may or may not be met. Changes in payments may significantly affect yield and average life."

Think of it this way: The key risk unique to CMOs is prepayment risk, which causes the actual yield and average life of a CMO tranche to differ from initial projections. The required broadcast disclosure addresses exactly this risk.

Exam Tip: Gotchas

• The required radio/TV CMO disclosure specifically addresses prepayment assumptions and their impact on yield and average life. If the exam asks what the broadcast disclaimer must cover, the answer is prepayment risk.

What General Rules Still Apply?

• Government securities and certificates of deposit (CDs) communications must also comply with the general content standards in the communications-with-the-public rule
• The fair-and-balanced requirement applies on top of any product-specific rules

What Should You Check on Exam Day?

• Route municipal advertising approval to a municipal securities or general securities principal, in writing, before first use.
• Spell out "Collateralized Mortgage Obligation" in full in every CMO retail communication; "CMO" alone is not sufficient.
• Confirm CMO educational material was offered (not necessarily delivered) to a non-institutional buyer before the sale.
• Check that a broadcast CMO ad includes the required prepayment-assumptions disclosure.
• Flag any comparison of a CMO to another investment, including a bank CD, as prohibited.
• For a communication promoting a specific CMO, confirm the yield/tranche details and the prepayment disclaimer get equal prominence.
• Check that CMO educational material includes investor questions and a term glossary, not just risk and structure topics.
• Confirm an anticipated-yield figure includes any sales charge, and that prior-sale/price-change and accrual-bond disclosures are present where applicable.
• Confirm a broadcast CMO ad identifies itself as an advertisement and directs the audience to a representative, in addition to the prepayment disclosure.