Rule G-17 of the Municipal Securities Rulemaking Board - April 2021 Updated

Underwriters Are Not Municipal Advisors

An underwriter is not a municipal advisor (also known as a "financial advisor").  Unlike municipal advisors that have a fiduciary duty to issuers, underwriters must disclose that they have no responsibility to serve in the best interest of municipal entities and must now make this clear under securities laws. Beginning on August 2, 2012, underwriters were required to make certain disclosures to issuers, in writing, to make this distinction clear.  Effective March 31, 2021, the disclosures were slightly modified and one additional disclosure was added (iv below).  The written disclosures an underwriter must now make relating to the distinction of underwriters and municipal advisors are as follows:

                                             i.                     the underwriter must deal fairly at all times with both issuers and investors,

                                           ii.                     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;

                                          iii.                     unlike a municipal advisor, an 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 its own financial or other interests;

                                         iv.                      the issuer may choose to engage the services of a municipal advisor with a fiduciary obligation to represent the issuer’s interests in the transaction; and,

                                           v.                     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. Accordingly, "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 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 November 6, 2019 that became effective on March 31, 2021.  The disclosures above are "standard" disclosures required for every transaction except for issues sold by competitive bidding.  As part of the standard 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 standard 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 standard disclosures and transaction-specific disclosures must be made in writing to an official (the “Official”) of the issuer identified by the issuer as a primary contact for that issuer for the receipt of the foregoing disclosures. In the absence of such identification, an underwriter may make such disclosures in writing to an official of the issuer that the underwriter reasonably believes has the authority to bind the issuer by contract with the underwriter and that, to the knowledge of the underwriter, is not a party to a disclosed conflict. A sole underwriter or syndicate manager must make the standard disclosure concerning the arm’s-length nature of the underwriter-issuer relationship at the earliest stages of the underwriter’s relationship with the issuer with respect to an issue (e.g., in a response to a request for proposals or in promotional materials provided to an issuer). 

Why the Rule Was Implemented

"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 original Rule G-17 interpretive notice in 2012 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

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 municipal advisor to represent your interests.  As made clear by the required disclosures, the services provided by a municipal advisor are not the same as those provided by an underwriter.  Furthermore, only municipal 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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