Rule G-17 of the Municipal Securities Rulemaking Board

Underwriters Are Not Financial Advisors

An underwriter is not a financial advisor.  Unlike financial advisors that have a fiduciary duty to issuers, underwriters must now disclose that they have no responsibility to serve in the best interest of municipal entities and must now make this perfectly clear under new securities laws. Effective August 2, 2012, underwriters must make the following disclosures to issuers, in writing:

bulletpoint  the underwriter must deal fairly at all times with both municipal issuers and investors,

bulletpoint  the underwriter’s primary role is to purchase securities with a view to distribution in an arm’s-length commercial transaction with the issuer and it has financial and other interests that differ from those of the issuer;

bulletpoint  unlike a municipal advisor, the underwriter does not have a fiduciary duty to the issuer under the federal securities laws and is not required by federal law to act in the best interest of the issuer without regard to the  underwriter’s own financial or other interests; and,

bulletpoint  the underwriter has a duty to purchase securities from the issuer at a fair and reasonable price, but must balance that duty with its duty to sell municipal securities to investors at prices that are fair and reasonable.

In addition, the underwriter also must not recommend that the issuer not retain a municipal advisor. The MSRB has stated that "an underwriter may not discourage an issuer from using a municipal advisor or otherwise imply that the hiring of a municipal advisor would be redundant because the underwriter can provide the same services that a municipal advisor would."

Rule G-17

 

The Municipal Securities Rulemaking Board (MSRB) is the regulatory agency that oversees firms involved in underwriting municipal bonds and providing financial advice.  The MSRB's Rule G-17 is sometimes referred to as the "fair dealing rule" and the content of the rule is as follows:
 

"In the conduct of its municipal securities or municipal advisory activities, each broker, dealer, municipal securities dealer, and municipal advisor shall deal fairly with all persons
and shall not engage in any deceptive, dishonest, or unfair practice."
 

The four disclosures noted above are part of the requirements imposed on broker-dealers (underwriters) under an interpretive notice concerning the application of Rule G-17 approved by the Securities and Exchange Commission on May 4, 2012.  The disclosures above are "baseline" disclosures required for every transaction except for issues sold by competitive bidding.  As part of the baseline disclosures, an underwriter must also (i) indicate that it has read the official statement, (ii) must disclose to the issuer whether its underwriting compensation will be contingent on the closing of a transaction and that compensation that is contingent on the closing of a transaction or the size of a transaction presents a conflict of interest, and (iii) describe any other potential or actual conflicts of interest. 

 

In addition to the baseline disclosures, when the underwriter recommends a complex financing structure the underwriter "must disclose the material financial characteristics of the complex municipal securities financing, as well as the material financial risks of the financing that are known to the underwriter and reasonably foreseeable at the time of the disclosure."

 

These disclosures are intended to enable an issuer to evaluate for itself how best to protect its own interests in the transaction.

 

The disclosures must be made in writing to an official of the issuer whom the underwriter reasonably believes has the authority to bind the issuer by contract with the underwriter (the "Official") (i) in sufficient time before the execution of a contract with the underwriter to allow the Official to evaluate the recommendation and (ii) in a manner designed to make clear to such Official the subject matter of such disclosures and their implications for the issuer. The underwriter must attempt to receive written acknowledgement by the Official of receipt of the foregoing disclosures. 

Why the Rule Was Changed

"In the underwriting process issuers often also will engage firms to serve as their financial advisors which under the Dodd-Frank Act are bound as municipal advisors by a fiduciary duty to put the issuer's best interest first and to sit on the same side of the table with the issuer as compared to the across the table, or arms-length relationship, of underwriters."

 - Statement by the MSRB, June 12, 2012
 

The Municipal Securities Rulemaking Board was established in 1975 as a self-regulatory organization governed by broker-dealers. Its mission was to develop rules regulating securities firms and banks involved in underwriting, trading, and selling municipal securities with the mission of protecting investors.  

With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act on July 21, 2010, the MSRB’s responsibilities were expanded to include the protection of state and local government issuers as well as investors.  Upon the adoption of the Rule G-17 interpretive notice the MSRB stated:

"MSRB rules previously prohibited an underwriter from engaging in any deceptive, dishonest or unfair practice with respect to an issuer of municipal securities. The new requirements significantly clarify the different roles, responsibilities and relationships of the financial professionals involved in municipal bond deals, and highlight for state and local governments the risks and characteristics involved in complex municipal financings."

Considerations for Issuers

As noted above, underwriters must attempt to receive written acknowledgement of receipt of the foregoing disclosures by the Official. Issuers should consider the following:

(i)    Acknowledge receipt of disclosures only.  Do not sign anything that suggests that the disclosures are complete or correct.

(ii)   If the disclosures contain information regarding the risks of the transaction that you don't understand, consider sending a notice or letter to the underwriter stating your lack of understanding.

(iii)   Engage an independent financial advisor to represent your interests.  As made clear by the new disclosures, the services provided by a financial advisor are not the same as those provided by an underwriter.  Furthermore, only financial advisors can provide advice designed specifically for your best interests.

For the complete text of the rule, as amended, see Rule G-17 at the Municipal Securities Rulemaking Board's web site.  

 

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