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Rule G-23 of the Municipal Securities Rulemaking Board |
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Underwriters Prohibited from Serving as Financial Advisors An underwriter is not a financial advisor. Underwriters have no responsibility to serve in the best interest of municipal entities and must now make this perfectly clear under new securities laws. Effective November 27, 2011, underwriters must make the following disclosure to issuers, in writing:
"The primary role of an underwriter is to purchase, or arrange for the
placement of, securities in an arm’s-length commercial transaction between
the issuer and the underwriter and that the underwriter has financial and
other interests that differ from those of the issuer."
Rule G-23
The Municipal Securities
Rulemaking Board (MSRB) is the regulatory agency that oversees firms
involved in underwriting municipal bonds and providing financial advice.
The disclosure noted above is part of the requirements imposed on
broker-dealers under the MSRB’s Rule G-23. Amendments to Rule G-23 were
approved by the Securities and Exchange Commission in May 2011 and became
effective on November 27, 2011. The primary purpose of Rule G-23 is to prevent
conflicts of interest by prohibiting an underwriter from serving as a
financial advisor and subsequently serving as the underwriter of the issue.
While firms known as “independent” financial advisors (also referred to as
independent municipal advisors) never underwrite
bonds and always serve in a fiduciary capacity to issuers, some
broker-dealers (underwriters) periodically serve as financial advisors.
In general, Rule G-23 was amended to prohibit a broker, dealer, or municipal
securities dealer (“dealer”) that serves as financial advisor to an issuer
for a particular issue sold on either a negotiated or competitive bid basis
from switching roles and underwriting the same issue.
History of Rule G-23
Rule G-23 was first adopted
on September 20, 1977. At the time of adoption, the MSRB filed a notice
regarding Rule G-23 with the Securities and Exchange Commission. The
following text, extracted from the notice, describes the different roles of
a financial advisor and an underwriter.
"Proposed rule G-23
addresses certain aspects of the conduct of a municipal securities
professional acting as a financial advisor or consultant to a state or local
governmental unit. As a financial advisor, the municipal securities
professional acts in a fiduciary capacity as agent for the governmental
unit, assisting it in determining its debt structure, determining when and
under what circumstances to market its securities, and preparing or
assisting in the preparation of documents to be used in connection with the
sale of its securities . . .
The role and
interests of a securities professional acting as financial advisor to a
governmental unit are significantly different from the role and interests of
a securities professional acting as an underwriter or as a purchaser in a
private placement. For example, as agent for the issuer, a financial advisor
would normally seek to achieve the lowest possible interest cost for the
issuer, while an underwriter, acting as principal for its own account, would
normally want to establish yields which make the securities attractive for
resale to others. Other marketing features, important from an underwriting
perspective, may conflict with an independent determination of the same
matters from the perspective of the issuer. If the underwriter has
customers for large amounts of the securities to be issued, the underwriter
may be influenced to advocate a larger issue than might otherwise be in the
best interests of the issuer; conversely, an underwriter might advocate a
smaller issue if its own customers’ interest is not strong. Maturities,
redemption provisions and remedy covenants are other facets of an issue with
respect to which a municipal securities professional may be influenced to
give different advice, depending on whether the securities professional is
acting as an underwriter or private placement purchaser of the securities,
or solely as the issuer’s agent. The size of the underwriting spread may
also be affected by the arm’s-length character of the relationship between
the issuer and its agents, on the one hand, and the underwriter, on the
other."
In spite of the conflict of
interest, Rule G-23 allowed broker-dealers to serve as a financial advisor
and then switch to an underwriter as long as the firm received written
consent to do so by the issuer.
Why the Rule Was Changed
"Financial Advisers should be prohibited from resigning as financial advisor
to an issuer, and then underwriting that issuer’s bonds, as they are
currently allowed to do under MSRB rule
- Mary Schapiro, Chairman of the Securities and Exchange Commission, May 7,
2010 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 (also known as the
Dodd-Frank 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. As a result of the passage of the Dodd-Frank Act and at the
request of the Securities and Exchange Commission, on August 17, 2010, the
MSRB proposed changes to Rule G-23. Following a public comment period, on
February 9, 2011 the MSRB submitted proposed amendments to the SEC and in
its release stated the following:
"The proposed rule
change resulted from a concern that a dealer financial advisor’s ability to
underwrite the same issue of municipal securities, on which it acted as
financial advisor, presented a conflict that is too significant for the
existing disclosure and consent provisions of Rule G-23 to cure. Even in the
case of a competitive underwriting, the perception on the part of issuers
and investors that such a conflict might exist was sufficient to cause
concern that permitting such role switching was not consistent with "a free
and open market in municipal securities," which the Board is mandated to
perfect.
The imposition by
Dodd-Frank of a fiduciary duty upon municipal advisors, which includes
financial advisors, made the existence of such a conflict a greater
concern." The MSRB also noted that the
proposed rule change would help protect municipal entities.
Restrictions of the Rule The long overdue
amendments preclude a broker-dealer that serves as financial advisor
from switching to an underwriter for that transaction regardless of
whether the issue is sold through a negotiated or competitive sale.
Along with the passage
of the amendments to Rule G-23, the MSRB released an interpretive notice
stating that an underwriter may provide advice concerning the structure,
timing, terms, and other similar matters concerning an issue of
municipal securities, provided that the underwriter: (i) clearly
identifies itself in writing as an underwriter and not as a financial
advisor from the earliest stages of its relationship with the issuer
with respect to that issue (e.g., in a response to a request for
proposals or in promotional materials provided to an issuer);
(ii) the writing makes clear that the “primary role of an underwriter
is to purchase securities in an arm’s-length commercial transaction
between the issuer and the underwriter and that the underwriter has
financial and other interests that differ from those of the issuer”; and
(iii)
the dealer does not engage in a course of conduct that is inconsistent
with an arm’s-length relationship with the issuer in connection with
such issue of municipal securities.
Conflicts of Interest Continue It is important to note
that the Rule did not eliminate conflicts of interest when a broker-dealer
offers both underwriting and financial advisory services. As noted above a
firm may serve as both underwriter and financial advisor to the same issuer
as long as the company does not switch roles for a specific issue.
Consider what an issuer should do when its broker-dealer municipal advisor
that is serving on one transaction seeks to be employed as underwriter for
the issuer's next transaction. For this reason, among others, when
engaging a municipal advisor, issuers should carefully consider the benefits
of engaging an "independent" municipal advisor rather than a broker-dealer
municipal advisor.
For the complete text of the rule, as amended, see
Rule G-23
at the Municipal
Securities Rulemaking Board's web site. |
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