Following the 2008 financial crisis, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) to better regulate, among others, the municipal securities industry. On September 20, 2013, the Securities and Exchange Commission (“SEC”) adopted a final rule on the registration of municipal advisors, granting the Municipal Securities Rulemaking Board (“MSRB”) regulatory authority over municipal advisors. As a result, the MSRB proposed Rule G-42 pertaining to the Duties of Non-Solicitor Municipal Advisors. On April 15, 2015, following the usual comment period, the MSRB filed proposed Rule G-42 with the SEC.
Summary of New Municipal Advisor Rule
A municipal advisor is a person who provides advice to or on behalf of a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities or solicits a municipal entity. Municipal advisors must register with the SEC and owe a fiduciary duty to municipal entities. However, the rule provides exclusions for attorneys, underwriters, and placement agents, among others.
Exclusions and Exemptions
The rule contains a number of exclusions (relating to the role of a specific party) as well as exemptions (primarily relating to the borrower’s specific situation). Exclusions relating to attorneys, underwriters, and placement agents are highlighted below.
Attorneys offering traditional legal advice or providing services that are of a traditional legal nature are excluded from the definition of “municipal advisor”. The following types of transaction-specific advice are covered by the exclusion, but only when such advice is provided within an attorney-client relationship specifically related to the issuance of municipal securities and consists of: (i) advice comparing structures, terms, or associated costs of issuance; (ii) advice on tax consequences; or (iii) advice recommending a particular financing structure based on legal considerations. However, the following types of advice would require the attorney to register as a municipal advisor: (a) advising as to the financial feasibility of a project; (b) estimating or comparing relative cost to maturity depending on interest rate assumptions; or (c) recommending a particular structure as financially advantageous. Further, if an attorney presents him/herself as a financial expert, the exclusion will not apply. Nevertheless, the exclusion is designed to preserve working group discussions in connection with a transaction since the attorney is only responsible for advising his/her client and is not responsible if another participant in the transaction receives or acts upon the legal advice of the attorney.
Brokers, dealers, and municipal securities dealers serving as underwriters are not considered municipal advisors under certain circumstances. However, these groups are only covered by the exclusion to the extent they are providing advice within the scope of an underwriting, meaning advice with respect to the structure, timing, and terms of the issuance of municipal securities. In order to qualify for this exclusion, there must be a relationship to a particular transaction, preferably established by a contractual engagement by a municipal entity stating that the individual or firm will serve as underwriter for a planned transaction. Under this exclusion, underwriters may advise on tranches that are related to the specific transaction and may give advice about the timing of a sale of a related transaction (even though the underwriter is not engaged on that particular transaction), if such commentary is linked to a transaction for which the underwriter is engaged. Notably, advice on the following subjects is outside the scope of the underwriter exclusion: investment strategy, municipal derivatives, and rating strategy when not tied to a specific transaction. Although broker-dealers are not categorically excluded from being considered municipal advisors, they may qualify for other exemptions as stated in the rule.
Placement agents that do not solicit (on behalf of a third-party broker, dealer, municipal securities dealer, municipal advisor, or investment advisor) an engagement by a municipal entity are not municipal advisors.
Certain best practices can help attorneys, underwriters, and placement agents clarify whether they are operating under an exclusion.
- Engagement Letter: Although there is no statutory requirement that underwriters have a written engagement letter in place, underwriters are encouraged to send a letter of intent to municipal entities. Alternatively, the engagement can be memorialized by a formal letter or by an e-mail exchange. However, a broker-dealer firm that is not assigned to a specific deal, but is instead selected to be part of a pool of underwriters does not qualify for the exclusion. The Securities Industry and Financial Markets Association has provided sample letters of intent as well as sample disclaimers and disclosures for underwriters.
- Engage Team Early: Once the municipal entity decides it will enter the market, it should engage team members and specify roles in an engagement letter. As soon as members are formally hired they can begin providing advice, including structuring advice (provided that team members are not operating under an exemption), immediately.
- Use Disclaimers: Market participants may wish to provide general market information to municipal entities, but should still include a standard disclaimer that the materials provided are general and factual in nature, are not intended as a recommendation of any particular course of action, and do not create a municipal advisor/municipal entity relationship. Such materials should not be customized to represent a specific borrower’s needs.
Recent MSRB Rulemakings
Recently filed proposed Rule G-42 would establish core standards of conduct for municipal advisors, provide guidance on their federal fiduciary duty to state and local governments, and clarify their duties of care and fair dealing to clients. Other MSRB rules on supervision requirements and professional qualification requirements became effective in late April 2015. Finally, the pilot test for the municipal advisor exam (Series 50) is set to take place in the fall of 2015. Although issuers and dealers have called for a sophisticated municipal issuer exemption similar to other exemptions in MSRB rules, regulators have declined saying that it is still too soon to tell whether an additional exemption would be appropriate.
The Schiff Hardin LLP Public Law Group has been active in these important legal developments. We have counseled attorneys, financial advisors, underwriters, and placement agents as to their responsibilities and potential liabilities.