MuniLand

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.

Cheers to the MSRB

The Municipal Securities Rulemaking Board made a wonderful regulatory push when it issued its proposed rule for the conduct of municipal advisers. Municipal advisers are professionals who are supposed to help state and local governments structure their borrowing and investment activities in the most economically efficient way.

In the past, advisers did not always place the interest of their government clients ahead of all other interests and they had undisclosed conflicts of interest. Basically, local governments could be treated as “muppets” by advisers without any restraint from the law.

In the Dodd-Frank Reform Act, Congress created a new law to protect municipalities and gave new authority to the MSRB to create rules to regulate the activities of municipal advisers. To put the law into effect, the MSRB issued Proposed Rule G-42, and said:

Diluting the MSRB

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.

Muniland, meet your issuers

 

Bloomberg’s Joe Mysak, whom I consider the king of muniland, had a delightful stream of consciousness via Twitter today about how little information he had to report from when he was a muni reporter in the 1990s. In one tweet he laments the lack of access to preliminary official statements for bond offerings. To get one, “you basically had to rely on spies,” he says.

Thankfully, those days are over. Official statements are in the public domain via a giant file cabinet called EMMA, which is maintained by the Municipal Securities Rulemaking Board. It’s muniland’s equivalent to the SEC’s Edgar system for corporate securities (actually it’s even more advanced).

Muniland’s regulator hard at work

I heard an economics editor give an amusing response the other day when asked if the U.S. has “free” markets. She responded that, since all markets are regulated, that, pretty much, yes. I had to chuckle because municipal bond markets, although regulated reasonably-well on the primary side when bonds are issued, have minimal supervision or regulation on the secondary or trading side after bonds have been issued. It’s difficult to have confidence that investors are always protected when you read stories about abuses like excessive mark-ups, for example.

Listening to a press call with the MSRB (the municipal market’s overseer), after its quarterly meeting on Friday, I felt a jolt of enthusiasm. The board has been spending a lot of effort untangling the thorny issues that must be addressed to bring more transparency into primary and secondary municipal bond markets. Here is the MSRB’s priority list (my comments in parentheses):

Trade Reporting Concept Release: To support the MSRB’s ongoing commitment to increasing transparency in the municipal market related to pricing of municipal securities, the Board agreed to publish the second concept release in a series of releases on the MSRB’s existing transaction reporting system. The new concept release will seek public comment on improving the quality and usefulness of available post-trade information and the appropriate standards for the collection and dissemination of pre-trade information on the MSRB’s Electronic Municipal Market Access (EMMA®) website. (I can’t wait to see the details)

Building a new municipal bond market

When FIX – the industry electronic trading standard – was fleshed out for fixed income in 2003, municipal bonds were incorporated. I got a fresh look at FIX at the FIX Protocol Americas Trading Conference this week. All the major muniland alternative trading systems (ATS)  including Bonddesk, MuniCenter and Tradeweb, as well as the major dealers are already FIX compliant for the latest 4.4 version.

The SEC has tasked the Municipal Securities Rulemaking Board (MSRB) with several new pre-trade transparency initiatives. They are considering two projects:

1) Determining the “prevailing market price” for a municipal security.

Make way for new muniland disclosure and market structure

The SEC released its long-awaited report on muniland disclosure and price transparency yesterday. Ten years from now, every retail investor will want to say a word of thanks to Commissioner Elisse Walter, even if only half her recommendations on transparency and investor protection are implemented. Unfortunately, her term as SEC commissioner expires June 5, 2013, which leaves her less than a year to get the ball rolling on her proposals.

The report is composed of two primary areas: The first part concerns better disclosures by municipal bond issuers about their finances, and the second addresses the market structure for trading municipal bonds. It’s the second part that contains the really game-changing parts of the report.

On disclosure, the report recommends institutional changes, such as the requirement that muniland participants adopt the standards of the Government Accounting Standards Board and make timely and audited financial disclosures. The report recommends that conduit borrowers (think non-public entities like non-profit hospitals and private colleges) be subject to the same registration and disclosure standards as corporate securities and barred from using exemptions that municipal issuers rely on. Conduit issuers happen to have the highest incidence of defaults, and investors need the greatest level of disclosure for these securities.

Examining muniland’s indices after the Libor scandal

The muni market’s overseer, the Municipal Securities Rulemaking Board (MSRB), is taking aggressive action to survey muniland indices following the Libor scandal. The board is asking index providers to disclose more about how certain indices are developed. The MSRB has no direct authority to regulate indices because, as with Libor, they are maintained by private companies and are outside of the board’s legislative mandate to regulate dealers. Alan Polsky, the current chairman of the MSRB, said in a press call that the board did not believe that there was any wrongdoing in this corner of the market, but that increasing transparency would enhance investor confidence. Here’s what he stated in a press release:

“Like other regulators, the MSRB is concerned about the transparency surrounding the development of market indices,” said MSRB Chair Alan Polsky. “We plan to review indices used by the municipal market – and develop educational materials about their use – to ensure that the market operates fairly and transparently.”

This is exceptionally good news because the municipal markets generally lag behind the equity markets in the transparency of their indices. You could easily calculate the value of the Dow Jones industrial average yourself, because information on all of the Dow’s components are publicly available. The same can’t be said for the Bond Buyer 20 index.

JPMorgan fails to disclose

Charlie Gasparino of Fox Business News seems to have scooped a muniland story yesterday when he reported that JPMorgan had failed to include material facts in a municipal bond offering on which it was the lead underwriter.

Lead underwriters have a special role in muniland. The Tower Amendment, passed in 1975, prohibited the federal government from requiring issuers of municipal debt to make specific disclosures to investors prior to offering securities for sale. Underwriters, however, do not enjoy the same protection, so the law has evolved to make them liable for the contents of the offering document for municipal debt. This requirement is administrated by the Municipal Rulemaking Board through Rule G-17, or the fair-dealing rule.

MSRB’s Rule G-17 is the Ten Commandments of muniland (emphasis mine):

Rule G-17 precludes a dealer, in the conduct of its municipal securities activities, from engaging in any deceptive, dishonest, or unfair practice with any person, including an issuer of municipal securities. The rule contains an anti-fraud prohibition. Thus, an underwriter must not misrepresent or omit the facts, risks, potential benefits, or other material information about municipal securities activities undertaken with a municipal issuer.

Muniland retail bond buying is getting more attention

A little-known provision in the Dodd-Frank financial reform law expanded the board of directors of the Municipal Securities Rulemaking Board (MSRB), the self-regulatory organization that oversees muniland. The board used to be composed of employees of municipal bond dealers and big banks, and many would say privately that MSRB rulemaking favored industry players rather the public. Dodd-Frank radically altered the board’s composition to balance representation from the municipal industry and the public. The law firm Duane Morris explained the change (emphasis mine):

The [Dodd Frank] Act alters the composition of the MSRB so that a majority of the minimum 15-member Board are independent of municipal securities brokers, dealers or advisors. The new composition of the Board meets the stated goal of the Act, to ensure that the public interest is better protected on the Board. The Board has a new charge to protect the public interest in addition to municipal entities and investors. 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.

The remaining seven “regulated representatives” will consist of individuals associated with a broker, dealer, municipal securities dealer or municipal advisor. At least one of the regulated representatives will be a “broker-dealer,” representative of nonbank brokers, dealers or municipal securities dealers. At least one individual must be a representative of banks, and at least one individual must be associated with a municipal advisor. The number of public representatives on the Board must always exceed the number of regulated representatives.

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