Tuesday, June 02, 2015

MSRB Submits Conduct Rule for Municipal Advisors, Industry Weighs In

By Amy Leisinger, J.D.

The MSRB has filed a rule proposal with the SEC concerning rules and standards applicable to municipal advisers. The Dodd-Frank Act charged the MSRB with developing a protocol to protect the interests of state and local governments that engage the services of municipal advisors, and, in 2014, the MSRB twice sought comment on draft versions of the rule. As finally proposed, new MSRB Rule G-42 would establish core standards of conduct for non-solicitor municipal advisors and provide guidance on the obligations that accompany their duties to all clients.

Proposed MSRB Rule G-42. The key provisions of proposed MSRB Rule G-42 address the duties owed by a municipal advisor to its clients. Municipal advisors would be required to exercise due care when advising all clients, which includes a responsibility to conduct appropriate research to provide informed advice and make suitability determinations for client recommendations. Under the proposed rule, when dealing with municipal entities, municipal advisors also owe a duty of loyalty and must put their clients’ interests ahead of their own. The rule would also require municipal advisors to provide full and fair written disclosure of all material actual or potential conflicts of interest before or upon providing services for a client.

Proposed Rule G-42 also would require municipal advisors to put into writing the details of the municipal advisory relationship with a client, including information regarding compensation, scope of activities, required disclosures, and termination at least promptly after beginning a new relationship. If a municipal advisor recommends a transaction or product, the municipal advisor must use reasonable diligence to determine whether the transaction or product is suitable for a client in terms of risk tolerance, financial situation, and experience.

The proposed rule would also prohibit municipal advisors from receiving excessive compensation, misrepresenting their knowledge or qualifications, and participating in certain fee-splitting arrangements or payments to secure business. Proposed Rule G-42 also bans entering into principal transactions with a municipal entity client that are directly related to the transaction for which the municipal advisor is providing advice.

Bond Dealers of America. In comments on the proposal, the Bond Dealers of America (BDA) noted that the proposed rule provides different timing requirements for delivery of conflicts-of-interest information and evidence of municipal advisory relationships. The group agreed that the difference “makes sense in light of the activities-based definition of municipal advisor” and suggested the same distinction for conflict of interest and other disclosures to ensure that municipal advisors are not prohibited from engaging in in any municipal advisory activities without providing these disclosures. The BDA also expressed concern with the vagueness of the proposed rule’s principal-transaction prohibition, suggesting that the MSRB rephrase the language to specifically address situations in which a municipal advisor structures a transaction and then creates a potential conflict by participating in that transaction or another transaction on which it has rendered advice.

Investment Company Institute. While generally supporting the MSRB’s effort to subject municipal advisors to standards of conduct, the Investment Company Institute (ICI) reiterated its previous recommendation that the proposed rule be clarified to ensure that municipal advisors are not required to verify the truth of information provided by municipal clients. A municipal adviser relying on information should not be required to verify its veracity or completeness nor should a client be expected to affirm it, according to the group; to require otherwise “is both inconsistent with the suitability obligations imposed on other financial professionals and it is impractical,” the ICI opined. The ICI also recommended clarification that the new rule’s disclosure and documentation requirements will only apply prospectively.

National Association of Municipal Advisors. The National Association of Municipal Advisors (NAMA) expressed concern about the lack of definitive guidance as to how compliance would be determined during examinations. “[T]he Proposed Rule currently relies too heavily on subjective criteria that will be open for interpretation by examiners, and opens the door to inconsistencies,” the group explained. NAMA urged the MSRB to make several changes to proposed Rule G-42 and the supplementary information to clarify how regulators plan to interpret the requirements and to provide non-exclusive examples and general principles regarding compliance.

American Bankers Association. The American Bankers Association (ABA) offered suggestions on how to tailor the prohibition on principal transactions to minimize the impact on commercial banks and their affiliates that are also registered municipal advisors. The prohibition could limit entities from offering a full range of banking services to their municipal entity clients, and “the alignment of interests of the bank and the municipal entity differentiates the bank loan situation from that of a broker-dealer underwriting the issuance of municipal bonds,” the group explained.

Securities Industry and Financial Markets Association. The Securities Industry and Financial Markets Association (SIFMA) recommended a number of changes to provisions the proposed rule that, according to the organization, “render it unreasonably burdensome and anticompetitive in ways that do not clearly promote the fundamental policies of the municipal advisor provisions.” SIFMA suggested that the proposed principal-transaction ban be limited to apply only to transactions directly related to advice provided by the municipal advisor. SIFMA also urged the MSRB to not treat investment funds advised by a municipal advisor as affiliates subject to proposed Rule G-42, and to have a clear end date defined in relation to the end of the municipal advisory relationship. The MSRB should also modify the proposed rule to ensure that municipal entities can receive full-service brokerage and securities execution services, the group opined.