Diluting the MSRB

August 20, 2013

Muniland’s overseer, the Municipal Securities Rulemaking Board, has a big job keeping the $3.7 trillion municipal bond market in order. The MSRB was first authorized by Congress in 1975 and mandated to have 5 securities firms, 5 bank dealers and 5 public members. It was nonetheless dominated by the views of bank and dealer members, rarely undertaking investor protection initiatives. There was minimal oversight of municipal bond trading and underwriting practices as dealer banks were steering the ship.

After some gruesome muniland disasters like this one detailed by Bloomberg, Congress added law within the Dodd-Frank bill for the MSRB:

Joseph Ambrosini says the deal looked so easy. JPMorgan Chase & Co. bankers told him there was really no risk. All he had to do was sign a public financing contract, and the bank would give $280,000 to his school district in New Castle, Pennsylvania.

“They basically said, unless the world goes under the sea, we’d be in good shape,” says Ambrosini, the district’s business manager.

In September, Ambrosini says, his 3,400-student district went underwater. On Sept. 25, the week after Lehman Brothers Holdings Inc. collapsed, the New Castle Area School District’s interest rate on $9.7 million of financing arranged by JPMorgan hit 10.6 percent, more than doubling since the month began, as investors demanded skyrocketing returns for municipal debt.

The financial crisis opened our eyes to the fact that Wall Street was pillaging America’s school districts and hometowns with inappropriate financial products. The MSRB had been exercising almost no oversight.

Dodd-Frank gives authority to the MSRB to register and oversee municipal advisors to help protect small issuers from these sorts of deals. The MSRB was also given authority to protect issuers (cities, states and other municipal borrowers), a class that was previously not protected in regulation. An Office of Municipal Securities was set up at the SEC.

Congress’ financial regulation reform did not address the municipal market as heavily as it did derivatives, another under-regulated area, but it did mandate the expansion and change in composition of the MSRB. Congress mandated that the MSRB board composition be flipped to have a majority of “public members”:

The Board will consist of eight individuals known as ‘public representatives,’ independent of any municipal securities broker, municipal securities dealer or municipal securities advisor. At least one of the public representatives must be a representative of institutional or retail investors in municipal securities. At least one of the public representatives must also represent municipal entities, and another of the public representatives must have knowledge or experience in the municipal securities industries.

In 2010, the MSRB, following Dodd-Frank’s mandate, enacted a rule that expanded the board to 21 members, keeping a majority of “public members.” But recently the MSRB appealed to the SEC, which oversees its activities, to water down the definition of “public member” to include people who work for companies that have broker-dealer subsidiaries, even though they may work in another area of the firm. Americans for Financial Reform, an umbrella group for 250 progressive and labor groups, describes it like this:

For example, a current employee of JP Morgan Chase Bank NA could qualify as a Public Member of the MSRB, simply because they were not currently employed by JP Morgan’s municipal securities broker affiliate.

AFR goes on to argue that there is a large pool of truly independent public members to draw from:

  • Current or former elected officials, officers, employees and appointed board members of over 50,000 municipal issuers;
  • Current or former elected and appointed officials who play a role in overseeing municipal finance at the state level, or employees of state entities who play a role in such oversight;
  • Current or former employees of the members of the National Association of Bond Lawyers;
  • Certified Public Accountants familiar with municipal finance and securities;
  • Professors in universities, law schools, and business schools familiar with municipal finance; and
  • The countless number of retail investors in municipal securities nationwide as well as the employees of non-associated institutional investors

I agree with AFR the other groups that filed comment letters with the SEC about the MSRB proposal. I personally encouraged several people who know muniland well to apply for board seats as public members. They were not chosen. Maybe the MSRB needs to enlist an outside recruitment and screening firm. Muniland issuers and investors need protection.

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