MSRB rules prohibit municipal firms from entering into which transaction with an investment company?

• A. Accepting a pre-sale order from an investment company for a new municipal issue
• B. Acting as a broker's broker for a large block of bonds that the investment company wishes to sell
• C. Accepting portfolio trades for the investment company as compensation for sales of the investment company's securities
• D. Buying the securities issued by an investment company to fill existing customer orders

Answer: (C)

The key idea is that MSRB rules forbid any arrangement where a municipal firm receives compensation that is tied to the sale of an investment company’s securities. Accepting portfolio trades from the investment company as payment for selling its securities creates exactly that kind of incentive—the dealer would earn a benefit based on the fund’s sales, which can bias trading decisions and allocations away from a focus on best execution and fair treatment of all customers. Such compensation-for-sales arrangements raise conflicts of interest and undermine investor protection, so they are not allowed.

The other activities described are generally permissible: pre-sale orders from an investment company for a new issue are part of the underwriting process; acting as a broker’s broker for a large block the investment company wishes to sell is a normal intermediary function; and buying the investment company’s securities to fill customer orders is standard inventory management, provided it’s done in accordance with fair-dealing and best-execution principles.