The SEC’s new municipal adviser rule is not confusing
Governing.com ran a story titled “Why’s the SEC’s New Municipal Advisor Rule So Confusing?” Actually the new rule, although not yet finalized, is not confusing. There are resources for muniland participants to understand how it will be implemented and what responsibilities muni advisors have towards their clients. In fact, I have never seen a better rollout for a new regulatory effort.
Here is a roadmap:
As directed by Congress in the 2010 Dodd Frank legislation, the SEC published the definition of a municipal adviser last September. Over 1,100 municipal advisers have registered with the SEC and MSRB (registrations here including a downloadable list). Reuters detailed what happened last January:
After it was signed in 2010, the Dodd-Frank law ignited a fight over exactly who counts as a municipal adviser. The dispute lasted until the SEC approved a final definition in September, which allowed the MSRB to begin drafting regulations.
The code of conduct proposed on Thursday will serve as the nucleus of an extensive regulatory regimen encompassing the duties of solicitors, political contributions and examinations for advisers.
The proposal lays out advisers’ fiduciary duties and other responsibilities in representing clients’ interests. It suggests advisers have enough expertise to give advice, disclose conflicts of interest, document compensation and tell bond buyers about their affiliations.
It would also prohibit advisers from receiving excessive compensation, billing for work they did not perform, misrepresenting themselves in proposals, splitting fees with underwriters or paying to retain business.
The MSRB is providing a 60-day comment period on the draft as well as 13 multi-part questions for commenters to address.
The MSRB is accepting comments on the Proposed Rule until March 10.
The area of the law that seems most confusing is which activities municipal advisors who are also broker/dealers can do without breaching their fiduciary responsibility.
Here are a few of these dual activity firms from the MSRB registration database:
Law firm Chapman and Cutler published a summary of the new muni adviser landscape that lays out the bright line for muni advisors who are also registered broker dealers (page 2). Basically, a municipal adviser who is also a broker dealer must hold themselves to a higher fiduciary standard toward the client and cannot do principal transactions with his municipal client (this prohibition is actually part of MSRB Rule G-23). The SEC defines a “principal transaction” as an adviser, acting for his own account, who either buys a security from or sells a security to the account of a client.
This is an important element of the law that says a muni adviser or a broker-dealer affiliate cannot sell or buy a security from a government in the course of an advisory relationship. Broker-dealer group Sifma has concerns with this portion of the rule. From The Bond Buyer:
[Sifma’s] Norwood said the draft rule’s ban on acting as a principal in transactions outside the advisory relationship essentially pushes bank-affiliated MAs out of the market, because the fact that their banking arms might manage accounts for a municipal entity locks them out of being that entity’s MA.
A dual muni adviser-broker dealer can have a distinct underwriting relationship with a municipal entity, although not at the same time as serving as adviser. The law firm Latham and Watkins details what a broker dealer can do for a municipal entity when it has its underwriter hat on (page 3):
A broker, dealer or municipal securities dealer wanting to avail itself of the underwriter exclusion would only be able to advise on the structure, timing, terms and other similar matters in the context of a specific issuance, where such underwriter has a direct relationship to a particular transaction. Other activities within the scope of this exclusion include preparation of rating strategies, the preparation of presentations related to the offering, assistance with the planning and execution of road shows, advice regarding retail order periods and institutional marketing.
Essentially, a dual muni adviser-broker dealer has to choose either to give advice to a government as an adviser and follow strict fiduciary guidelines that put the client’s interest above everything, or to act as an underwriter and have a lower threshold of responsibility to its municipal client.
Since the MSRB is accepting comments until March 10, details of the rule won’t be finalized for several months and speculation of how restricted underwriters and other market participants will be in their communications with municipal entities is not yet decided. But public officials won’t have to worry about getting down in the weeds on these separations of activity because muni advisers and underwriters should be policing themselves. If they step over the line, securities regulators will be there to examine their activities and prosecute if necessary.