Financial Reform Legislation Would Close Regulatory Gaps in Municipal Securities Market

Both the Senate and House reform bills would require municipal financial advisers to register with the SEC in recognition of the dramatic developments in the municipal securities market and a resultant regulatory gap. The municipal securities market has grown into a large and complex market providing capital for governmental projects and operations and funding a variety of other public purposes, including transportation and environmental infrastructure.

At the same time, the municipal securities market has evolved from a market in which investors were primarily commercial banks and insurers into a market with one of the highest levels of participation by individual investors, either through direct investments or through mutual funds.

The municipal securities marketplace has also evolved from one in which states and municipalities offered traditional, fixed rate bonds to finance specific projects into a market that involves the use of complex derivative products and intricate investment strategies. The current financial crisis has exposed gaps in the regulatory structure that governs intermediaries in the municipal securities markets, such as municipal financial advisers.

The legislation closes this gap by establishing federal regulations for professionals providing financial advice in municipal markets and bringing professional standards to an area of public finance that is not currently subject to formal rules. Municipal financial advisers will now be subject to SEC registration and the Commission is authorized to write rules governing the conduct of municipal financial advisers, conduct regular exams and impose sanctions.

The municipal adviser provisions of the legislation are designed to ensure that local governments receive sound financial advice and are protected from excessively risky or fraudulent transactions that could threaten their financial security. The provisions close a regulatory gap in an area where there are currently no rules governing municipal financial advisers, and no oversight of financial transactions that could put municipalities at risk.

The House legislation would define a municipal financial adviser as a professional who provides advice to municipalities on bond issuance, the investment of bond proceeds and financial contracts, such as interest rate swaps; brokers investment products for municipalities; and serves as a placement agent for municipal securities. Legal advisors and certain other professionals who interact with municipalities are exempted from the new registration requirement. The provisions also prohibit certain transactions for municipal financial advisers, and mandate fiduciary responsibility for municipal financial advisers toward their clients.

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