Dodd Unveils Draft Of Major Regulatory Reforms

WASHINGTON — Senate Banking Committee chairman Christopher Dodd yesterday unveiled a massive draft regulatory reform bill that envisions a more independent and powerful Municipal Securities Rulemaking Board.

Provisions in the 1,136 page “discussion draft” would significantly alter the composition of the MSRB as well as give it new regulatory authority over currently unregulated market intermediaries such as financial advisers and brokers of guaranteed investment contracts, who would also be required for the first time to register with the Securities and Exchange Commission.

Though the SEC would be the primary enforcer of the board’s rules for such intermediaries, the bill would give the MSRB an active role in assisting the SEC in the examination and enforcement process.

The bill also would allow the MSRB to develop, establish, and charge fees for new information systems — possibly for one on municipal derivatives — in conjunction with other regulators and self-regulatory organizations to further improve market transparency. Sources stressed yesterday that those provisions of the bill are not intended to allow the MSRB to charge for its existing EMMA disclosure site, which is free for market participants to file to and download individual documents.

In addition, the draft would restrict smaller, unsophisticated municipalities from participating in derivatives transactions, unlike two bills pending in the House.

Speaking generally on the bill yesterday, Dodd said it is an attempt to create a new architecture to make financial institutions more transparent, more responsible, and more accountable in response to the financial crisis.

“For decades, Washington has failed to deliver the substantial reform we need,” the Connecticut Democrat said. “If we fail again this time, our economy will be vulnerable to another crisis.”

However, the proposal sidesteps several controversial issues in the municipal market, such as some regulators’ call for Congress to repeal the so-called Tower Amendment by directing the Government Accountability Office to conduct a review of muni disclosure within one year of enactment. The study would have to include recommendations on whether Tower should be repealed.

The amendment, which was added to the Securities and Exchange Act of 1934, prohibits the SEC and the MSRB from collecting disclosure documents prior to a bond sale. Several SEC commissioners have said it should be repealed, along with other exemptions for munis in the securities laws, to make municipal disclosure more like corporate disclosure.

There are two additional studies called for by the bill. One would require the MSRB to report on the transparency of trading in the muni market within one year of enactment, while the SEC would have to conduct a study of the Governmental Accounting Standards Board within six months of enactment.

As with a separate bill pending in the House known as the Investor Protection Act, Dodd’s discussion draft would require a majority of the MSRB’s members to be independent. But it provides much more proscriptive requirements for the board’s composition.

Specifically, at least eight of the board’s members would have to be “public,” with three of those representatives of institutional and retail investors and at least two representatives of issuers. At least one would be a “member of the public with knowledge of or experience in the municipal industry.”

Of the seven dealer firm representatives, no fewer than two would have to be from bank-dealer firms, and at least one would have to be associated with a non-dealer municipal adviser, the draft said.

However, the House bill, which was approved by the House Financial Services Committee last week, would only require that a majority of the board’s 15 members are “independent” and that the SEC establish qualifications for MSRB board members to ensure they have financial expertise.

Currently, the board is comprised of five representatives of bank dealer firms, five representatives of securities dealers, and five members of the public, including one representative of issuers and one representative of investors. But the SEC has been pushing SROs to have more independent members on their boards. The MSRB is one of the few SROs that has not made such a change, because its makeup is set by statute and can not be easily changed.

Meanwhile, by giving the MSRB authority over municipal advisers, Dodd is departing from the House’s Investor Protection Act, which would give that authority to the SEC.

Asked about the distinction yesterday, a banking committee staffer said that the MSRB has expertise in the muni market that the SEC does not, and noted that the SEC only has two full-time attorneys in its municipal securities office.

“The MSRB has been doing good things, and they know the industry really well,” he said, adding that the board is much more focused on muni issues than any other regulator.

In a statement, MSRB executive director Lynnette Hotchkiss noted that the legislation would “enhance the coordination and effectiveness of enforcement activities by expanding the MSRB’s support role in enforcement and examinations.

“We are eager to work even more closely with the existing enforcement agencies to bring all of our expertise to bear on this important aspect of market regulation,” Hotchkiss said. She also said that the MSRB recognizes the need to align its board structure with other self-regulatory organizations “and appreciate the recognition that municipal market expertise is essential.”

Matt Fabian, managing director at Municipal Market Advisors, said that moving to a majority independent board will probably raise the profile of the board generally, because it will make munis more visible and more integrated into the regulatory framework.

But Steven Apfelbacher, president of the National Association of Independent Public Finance Advisors, said it would be a “disaster” for the thousands of municipal issuers in the country if the MSRB is given regulatory authority over non-dealer FAs.

“Issuers want to sell debt at the lowest cost, and the broker-dealer wants to sell it at the highest cost, and since there’s a conflict in those interests, it’s really impossible for the same agency to regulate both the FA and broker-dealer,” he said, adding that he does not believe changing the board composition resolves the problem.

Scott DeFife, senior managing director for government affairs at the Securities Industry and Financial Markets Association, said the provisions relating to the municipal securities are generally positive.

But Michael Nicholas, chief executive officer of the Regional Bond Dealers Association, said he hopes the language is changed to ensure that the dealer members of the board are “thoughtfully allocated” between Wall Street and regional dealer firms.

The bill also incorporates language from a bill introduced in September by Sen. Jack Reed, D-R.I., chairman of the Senate Banking securities subcommittee, on the regulation of over-the-counter derivatives. The language would exclude from the definition of eligible contract participants state and local governments or authorities unless than have $50 million or more of discretionary investments.

Bond proceeds could not be counted toward calculating the amount of discretionary investments. The provision would essentially prohibit governments from participating in derivatives transactions because it would force the transactions to be done over exchanges.

In contrast, the OTC derivatives bills pending in the House would consider any municipal government an eligible contract participant as long as it has $50 million in discretionary investments or enters into a contract with any regulated counterparty. 

The draft would create a new Office of Credit Ratings at the SEC with its own compliance staff and the authority to fine agencies. The SEC would have to examine each nationally recognized statistical rating organization at least once a year and make its findings public.

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