A Municipal Advisor's Road to Regulation

Trials and Tribulations

Under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) independent financial advisors (advisors that are not associated with brokers, dealers or banks) will be required to register with the Securities Exchange Commission (SEC) and will be regulated by the Municipal Securities Rulemaking Board (a Self Regulatory Organization that previously regulated only brokers, dealers and banks). The Municipal Securities Rulemaking Board ("MSRB") was created in 1975 to protect investors.  Under the Act, the MSRB is now required to protect the interests of issuers as well as investors. This page describes my personal regulatory experience which I hope will be both informative as well as a light hearted look at my road to regulation over the next ? years. 
 

July 21, 2010 – The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) becomes law.

Under the Act, all "Municipal Advisors" will be required to register with the SEC and will be regulated by the Municipal Securities Rulemaking Board.

The Act defines "Municipal Advisor" as any person that "provides advice to or on behalf of a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities, including advice with respect to the structure, timing, terms, and other similar matters concerning such financial products or issues."

The term Municipal Advisor excludes any individual who is a municipal entity or an employee of a municipal entity, a broker, dealer, or municipal securities dealer serving as an underwriter (as defined in section 2(a)(11) of the Securities Act of 1933) (15 U.S.C. 77b(a)(11)), any investment adviser registered under the Investment Advisers Act of 1940, or persons associated with such investment advisers who are providing investment advice, any commodity trading advisor registered under the Commodity Exchange Act or persons associated with a commodity trading advisor who are providing advice related to swaps, attorneys offering legal advice or providing services that are of a traditional legal nature, or engineers providing engineering advice.

Effective October 1, 2010, Municipal Advisors have a fiduciary responsibility to their municipal clients. In addition, under the Act, the MSRB is now required to:

August 17, 2010 – The MSRB Proposes Amending Rule G-23 (the Rule that prohibits brokers and dealers from simultaneously serving as Financial Advisor and Underwriter)

Currently, Rule G-23 prohibits any broker, dealer or municipal securities dealer (“dealer”) acting as financial advisor to an issuer in connection with its new issue of municipal securities from also serving as underwriter for such issue.  However, a financial advisor may discontinue its financial advisory relationship and serve as underwriter for the issue if the dealer submits a letter stating that this may create a conflict of interest. For several years the National Association of Independent Public Finance Advisors has urged the MSRB to amend Rule G-23 in order to protect issuers from the conflict of interest created by role switching.  In 2006, when Rule G-23 remained unchanged, the Government Finance Officers Association wrote "MSRB Rule G-23: Who's Protecting Whom."

August 18, 2010 – My Rule G-23 Comments

Today I began writing my comments. My thoughts: Will my comments be read?  Will my comments be worthy of consideration?  I better write my comments in King's English. If I don't, the MSRB will surely read my letter and require me to have additional continuing education.
 

September 1, 2010 – The SEC adopts the "Interim Final Temporary Rule"

The SEC adopts the "Interim Final Temporary Rule" to enable Municipal Advisors to be registered by
October 1, 2010.

"Interim Final Temporary Rule;" is it just me or is this an oxymoron?

As to my G-23 Comments - I'm still writing.  I just won't worry about it anymore.  I can file my comments as "Interim Final Temporary Comments".  If  I make grammatical error or typos I'm covered.

The SEC established a comment period on the Interim Final Temporary Rule that expires on October 8, 2010. I'm not writing because I'm certain that no one submits comments on an Interim Final Temporary Rule.
 

September 1, 2010 – The MSRB Files Proposed Changes to Rule A-3 with the SEC Relating to the Composition of its Board

On September 1, the MSRB filed a request with the SEC to change its Board composition and, as part of the filing, the SEC requests comments within 45 days following publication in the Federal Registrar.

Under the Act, the MSRB must have a new Board by October 1, 2010 with at least 15 members. The majority must be public members who are independent of any municipal securities broker, municipal securities dealer, or municipal advisor, at least 1 of whom must be representative of institutional or retail investors in municipal securities, at least 1 of whom must be representative of municipal entities, and at least 1 of whom must be a member of the public with knowledge of or experience in the municipal industry. The remaining 7 individuals are to be associated with a broker, dealer, municipal securities dealer, or municipal advisor, including at least 1 who is associated with and representative of brokers, dealers, or municipal securities dealers that are not banks or subsidiaries or departments or divisions of banks, at least 1 who is associated with and representative of municipal securities dealers which are banks or subsidiaries or departments or divisions of banks, and at least 1 individual who is associated with a municipal advisor and, together with the broker-dealer representatives and the bank representatives, are referred to as ‘regulated representatives’.

Try to stay with me on this.

In its filing with the SEC, the MSRB announced plans to expand the number of members to 21.  This would enable the MSRB to have 10 regulated representatives and permit retention of its members whose terms are not expired.  With respect to the public members, the MSRB defines independent to mean "no material business relationship," which in turn, would mean that, at a minimum, the individual is not and, within the last two years, was not associated with a municipal securities broker, municipal securities dealer, or municipal advisor, and that the individual does not have a relationship with any municipal securities broker, municipal securities dealer, or municipal advisor, whether compensatory or otherwise, that reasonably could affect the independent judgment or decision making of the individual.  30% of the regulated members are to be Municipal Advisors.

Although the MSRB apparently selected its new Board in late July, no announcement was made regarding its members.

Now this is something I can sink my teeth into.  I don't have a clue who comprises the Board but I'm a financial advisor - I can do the math even if its a guesstimate. I know there are 10 regulated representatives 3 of which are Municipal Advisors but the Municipal Advisors might also be associated with a broker, dealer or bank.  That leaves 11 that are public members who could be former employees of a broker, dealer or bank. So if I do my math correctly 11+10 = 21 or 100% of the Board could be associated with brokers, dealers or banks.

So why do I care?  Underwriters and independent financial advisors have always sat on opposite sides of the table in representing investors and issuers, respectively.  If the majority of the MSRB's Board is comprised of brokers, dealers and banks is it possible that the MSRB could impose punitive regulations for independent financial advisors rather than constructive efforts to improve transparency and fair dealing in the market place?  And the answer is ...  I guess I better write a comment letter.
 

September 22, 2010 – Comments Relating to the Composition of the MSRB Board (Rule A-3) are Due Today

I finished my Rule A-3 letter with time to spare. Other Independent Financial Advisors also submitted letters. We all supported more representation by Independent Financial Advisors. Some of us believed that the MSRB's definition of  "independent" with respect to public representatives was not sufficient to insure independence.

Given the MSRB's new expanded role to protect issuers, the Government Finance Officers Association ("GFOA") properly requested that more than one issuer be added to the Board as public members. 

As to my G-23 Comments - I'm still writing.
 

September 23, 2010 – MSRB Comments on Comments to Rule A-3

I'm impressed, the MSRB has a speed reader. Twenty-four hours after the comments were due, the MSRB commented on the comments.  It took me more than a month following passage of the Act to begin writing this saga.
 

September 30, 2010 – The SEC Approves the New MSRB Board

The SEC adopts MSRB's proposed Rule A-3 without any changes. I think they read my letter but didn't like it.
 

September 30, 2010 – Comments are due on Rule G-23 (The Rule that Prohibits an Underwriter from Simultaneously Serving as a Financial Advisor)

I finished my letter on time. My partner also submitted a letter and so did other Independent Financial Advisors. All of the Independent Financial Advisors supported a stronger Rule G-23 than the MSRB is proposing.  It's not a big deal, we just happen to think it's a conflict of interest for an underwriter to serve as financial advisor on one transaction and simultaneously serve as an underwriter on a different transaction for the same issuer.

The GFOA submitted a comment letter supporting the proposed amendments to Rule G-23. Among their comments were the following: "We support and encourage the MSRB to implement the significant and long overdue changes it has proposed to Rule G-23 (Rule). For many years, the GFOA has encouraged the MSRB to adopt changes to the Rule that prohibit a financial advisor (FA) from resigning and becoming the underwriter for the transaction."

Of course brokers and dealers expressed their preference to have no changes to the current rule.  Most of the remaining 71 comments were from Kentucky issuers.  As you know, a primary role of a financial advisor in a competitive sale is to provide services that result in the largest number of bids possible. However, these Kentucky issuers have the same Broker Financial Advisor who is unable to get them more than one or two bids in a competitive sale. Consequently, these issuers share the same philosophy:  allow their Broker Financial Advisor to submit a bid and have the opportunity to serve as underwriter.

I have an idea Kentucky issuers!  I can serve as your financial advisor so that the broker with whom you presently work can submit bids without a conflict of interest. Furthermore, there is a good chance that my marketing efforts would produce more than two bids.
 

October 1, 2010 – People do submit comments on "Interim Final Temporary Rules"

I bumped into the SEC's comment page and was surprised to find comments.  One firm seemed to have the formulas on how companies could serve as "Municipal Advisors" without being classified as "Municipal Advisors".  So I'm writing again. 
 

October 8, 2010 – Comments to the "Interim Final Temporary Rule" are due

I finished my letter on October 5. Maybe I'm getting the hang of this writing thing.  I hope the SEC likes this letter more than the letter I wrote regarding Rule A-3. 

December 24, 2010 – SEC Proposes a Permanent Rule for the Registration of Municipal Advisors

Just in time for the holidays the SEC released its rule on December 20.  The release includes the rule for the permanent registration of municipal advisors, basis for the rule and questions for comments (due in 45 days after the release is published in the Federal Registrar) all in a brief 231 page document.  The rule does provide some clarification relating to individuals that will be considered to be and must register as municipal advisors.  In addition to independent financial advisors and broker dealers serving as financial advisors, the rule includes additional guidance relating to attorneys, accountants and engineers.