We continue to hear increasing discussion about the “need” to regulate municipal financial advisers.
As the chief executive officer of PFM, a firm that for the past thirty-plus years has succeeded based on a reputation for independence and strict fiduciary responsibility to our local, state, and regional government clients, I would like to provide my perspective on what kind of oversight is needed — and just as importantly, what is not.
The marketplace for municipal financial advisory services, which is controlled by sophisticated financial professionals, has always demanded higher levels of quality and fidelity than regulators would require. Proposed federal regulation that would subject FAs to remedies already available under the federal securities laws is, therefore, completely unnecessary.
That said, independent financial advisers do not fear regulation. Leading independent financial advisory firms like PFM have no apprehension of regulations that prescribe qualification standards and ethical codes.
But in the present intense pressure to subject all participants in the municipal securities process to federal regulation, there has been very little attention given to what financial advisers really do, and no apparent focus at all on the fact that it is the independent FAs who work to protect the peoples’ treasury from the broker-dealers’ greed.
This is not to say that all bankers are motivated solely by greed, but the record shows that some are, and that such motivation has never been stopped by regulation. In fact, regulated entities have been involved in every major scandal that has touched the municipal bond market, be it pay-to-play, guaranteed investment contract bid-fixing or yield burning.
The independent financial adviser actually performs an infinite variety of roles, many of which take the form of quiet counsel that supports the planning of efficient government.
In the most recognized roles, our functions center on advice to a government in structuring indebtedness to take best advantage of interest rate and debt-management opportunities presented by the market, and to assist in their negotiations with underwriters concerning such opportunities. We have no conflicts of interest, as we gain no financial advantage in the execution of the transactions on which we offer our advice.
Financial advisers are not brokers or underwriters, either under the definitions that have been applied effectively in the federal securities laws for nearly three-quarters of a century, or in the everyday understanding of the brokerage business.
FAs do not pocket the “spread” between what the public pays to the broker and what the broker pays to the governmental issuer. They do not carry out transactions with other intermediaries. We have only one class of client. Our fees are fixed and known by our clients in advance.
Financial advisers are the business adversaries of brokers in the forum of negotiating the fees and profits of brokers and the terms of underwritings. Placing us both under the same regulator — the Municipal Securities Rulemaking Board, created to regulate muni dealers — and under the same set of rules and supervision makes no sense and will not make the municipal bond business any safer.
This, unfortunately, seems to be the direction of the legislation currently pending in the U.S. Senate, although the House has proposed the preferable solution of housing regulation of financial advisers at the Securities and Exchange Commission.
Where misconduct or negligence by an FA could cause a loss to public investors or a governmental entity, the injured party has always had a full remedy under the antifraud provisions of the Exchange Act or the enormously broad state common and statutory laws.
If the proposed federal remedies in the bills are merely to establish sanctions for failing to keep required books and records, their insignificance speaks for itself. In short, the panoply of securities registration, regulation, reporting, and examination should not be brought into play to create a small stick to beat a small number of companies for minor and often non-material infractions.
Are firms like PFM completely opposed to regulation? No, we are not. There are several aspects of the regulatory juggernaut that the financial advisory community and the entire securities regulation establishment should assure are accomplished correctly.
First, if there is to be federal regulation of municipal FAs, it must be universal and not diluted by exceptions as to business size and business focus. If there is any harm that financial advisers can do, it can be done by the smallest and most specialized advisers as well as by larger firms.
By way of example, for several years there has been a drumbeat from the broker community that independent FAs have an unfair advantage over brokers because the advisers are not subject to federal rules prohibiting pay-to-play practices. We believe this concern is unfounded with regard to firms like PFM and our principal national competitors — those of size who maintain responsible internal controls.
This same confidence is not necessarily justified at the local level. Where there are no state-law barriers to entry, as is true of local municipal FAs, a federal regulatory program must be universal, as is the case under the Exchange Act. Otherwise, the existence of regulation with exceptions can be self-defeating.
A second requirement of intelligent regulation is that the rules and enforcement mechanisms don’t homogenize municipal financial advisers with securities brokers.
Whatever view one may hold of the MSRB (and of its future in what promises to be a mammoth financial regulatory establishment), it clearly is not the suitable venue for creating the regulations to be applied to municipal FAs.
Even if public representation on the MSRB is increased, as some proposals contemplate, the board will remain a captive — in focus if not in voting power — of the municipal bond underwriters or broker-dealers. Muni issuers, their taxpaying constituents and their advocates, the independent municipal FAs, will continue to lack a compelling voice.
If the SEC supports the federal regulation of muni financial advisers, as it appears it will, it should be prepared to craft and interpret appropriate standards for improvement of the $400 billion a year municipal finance market.
The commission should also employ its own enforcement powers and not harness itself to other agencies that may be subject to influence by the very people they are to regulate.
My suggestion is that an advisory board comprised of public officials who are issuers, staffed by the SEC, and appointed by the president and Congress, oversee the regulation of financial advisers.
Finally, I want to voice my strong opinion that the impassioned commentary on the role and duties of muni FAs and other participants in municipal finance has, unfortunately, been badly tainted by cliché and jargon.
Various proposals now promise to spread “fiduciary duty” all over the financial regulatory system, even to the point where intermediaries could be charged with having a fiduciary duty to both buyer and seller in the same transaction — clearly an impossible situation.
PFM has absolutely no concerns when it comes to fulfilling a fiduciary duty to our clients, the governmental entities who engage us. Our concern is, first, that any laws or rules written do not proceed from a premise that financial advisers owe a fiduciary duty to everybody, and, second, that the law of federal fiduciary duty be clearly delimited.
Fiduciary duty has a developed meaning under state law relating to persons who are entrusted with the affairs of others who are entitled to rely on them. But if fiduciary duties are brought into play in the advisory context under federal securities practice — where the adviser does not have control over its client’s funds or the right to bind the client to a transaction — the adviser has the right to know exactly what fiduciary duty means.
In conclusion, the financial advisory community, of which I am a proud member, already has clear and recognized fiduciary duty to our clients. We offer issuers the only truly independent representation in this business, unlike the broker-dealers and bankers who often represent both investors and issuers in a transaction, and advise on its structure as well.
Any legislation that seeks to regulate independent FAs on the same basis as underwriters and broker-dealers is misguided. Any exceptions to proposed regulation that exclude smaller local firms is a mistake. Both would increase costs to issuers without adding an ounce of protection, and would end up harming the very entities they wish to protect.
F. John White is chief executive officer of the PFM Group.
