Dodd-Frank appears in muniland
Already the long reach of Dodd-Frank into muniland is having an effect. Al.com tells the story (emphasis mine):
The Wall Street investment bank leading Jefferson County’s pitch to exit Chapter 9 municipal bankruptcy could be violating securities law if it serves as an underwriter in the deal, a lawsuit brought by Jefferson County sewer ratepayers says.
Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, an investment bank may not act as both a financial advisor to a municipal issuer and as an underwriter when that debt goes to market. Serving in both roles could create a conflict of interest for the bank, and the practice was outlawed in 2011.
That appears to have been what’s happening as part of Jefferson County’s plan to exit bankruptcy.
Dodd-Frank is the first substantive law for muniland since 1975. One of the law’s most important provisions is that it added “municipal adviser” as a new category subject to regulation and disciplinary authority. Dodd-Frank outlawed the practice of an underwriter serving as a municipal adviser and then switching hats to underwrite the same deal.
State and local governments that issue municipal bonds often rely on advisers to help them decide how and when to issue the securities and how to invest proceeds from the sales. These advisers receive fees for the services they provide. Prior to passage of the Dodd-Frank Act, municipal advisers were not required to register with the SEC like other market intermediaries. This left many municipalities relying on advice from unregulated advisers, and they were often unaware of any conflicts of interest a municipal adviser may have had. There were numerous instances where a municipal adviser was a person or entity that served in both advisory and underwriting roles.
Now this is strictly prohibited. Attorneys Rick Witte, Todd Brewer and Andrew L. Bethune of Andrews Kurth LLP explain how underwriters are exempted from this provision only if they are formally engaged as the underwriter:
Brokers, dealers and municipal securities dealers serving as underwriters, either as agents on a best-efforts basis or as principals on a firm commitment basis, who provide advice regarding the structure, timing and terms of a particular issue of municipal securities. The exemption applies during the period in which the underwriter is engaged for a particular offering.
Back to what is happening in Jefferson County, Alabama. From Al.com again:
In July, the Jefferson County Commission hired Citigroup Global Markets, Inc. to lead its team when the county returns to the market to sell new warrants. If the county’s plan is approved by the court, those warrants would refinance the remaining debt not conceded by the county’s creditors.
However, Citigroup has worked closely with Jefferson County since at least 2008 to find a solution to its financial problems. While the Dodd-Frank law was adopted until 2011, the Securities and Exchange Commission has not allowed banks to be grandfathered in.
The muni adviser-related bit, MSRB’s G-23 Rule, was put in place in 2011. This activity happened before and after that rule. Al.com again:
Citigroup’s managing director and co-head of public finance, David Brownstein, has advised the county for years, county officials have said.
“Even before this commission took office in November 2010, Brownstein volunteered his company’s time and resources in search of a solution to the county’s financial problems,” Commission President David Carrington told the Alabama Media Group in July.
Commissioner Jimmie Stephens also said then that Brownstein had helped run several models for the county as it negotiated with creditors and sought a way out of its financial hole.
Undoubtedly Citigroup will argue that it was giving bankruptcy advice rather than underwriting advice, but typically that is not viewed as the responsibility of banks and dealers. Dodd-Frank is unfolding in muniland. Its effects are likely to be far-reaching.
SIFMA’s Leslie Norwood explains the intricacies of the SEC’s 800-page municipal adviser rule to @ORenickBB.