Omnibus Bill to Impose 'Fiduciary' FA Standard

WASHINGTON - House Financial Services Committee chairman Barney Frank plans to hold a hearing May 21 on an omnibus municipal bond bill his staff is drafting that is expected to include a provision to impose a "fiduciary" standard on financial advisers in the muni market.

Frank announced the hearing date and talked about the fiduciary provision at a hearing yesterday that focused mostly on the losses suffered by state and local governments that invested in debt issued by Lehman Brothers.

In addition to requiring muni financial advisers to adhere to a fiduciary duty, the forthcoming bill also will likely require them to register with a federal regulator, possibly the Securities and Exchange Commission, a congressional source said.

The source stressed that the committee staff members are beginning to discuss the matter and do not yet know if they will impose a fiduciary duty on all FAs, including those already registered as dealers, or just FAs that are currently unregulated at the federal level.

The purpose of the provision is to eliminate conflicts of interest among FAs, including those that advise on interest rate swap transactions, the source said. Political contributions from some unregulated firms are believed to be the focus of ongoing pay-to-play investigations by U.S. attorneys.

John Nester, a spokesman for the SEC, declined to comment on the Frank bill, but said: "We share chairman Frank's interest in strengthening protections for investors in municipal securities, and look forward to working with Congress on these issues."

SEC chairman Mary Schapiro said earlier this year that she would seek oversight of unregulated muni market intermediaries such as financial and swap advisers - authority currently being sought by the Municipal Securities Rulemaking Board as well.

But the congressional source said there have not yet been any discussions about expanding the MSRB's authority as part of the proposal. Earlier this year, the board proposed a system of dual registration under which FAs would be required to register with the SEC but also would be subject to the more prescriptive rules of the board, which is made up mostly of securities and bank firm representatives.

There is no existing national fiduciary standard for FAs, though "prudent man" standards, which vary from state to state, generally require a fiduciary to treat a client's money or interests prudently and as if they were his or her own, according to Jeffrey Blumenfeld, a partner at WolfBlock LLP in Philadelphia.

Blumenfeld said Frank appears to be using the "fiduciary" term in a short-hand manner "for imposing special relationship-like duties between an FA and a client akin to the duties between a lawyer and a client."

As previously reported in The Bond Buyer, Frank decided not to include a separate provision in the omnibus muni bill that would have provided federal guarantees for general obligation debt sold by states and localities.

Now, the bill is expected to include a temporary federal liquidity facility for variable-rate demand obligations, a temporary reinsurance program for revenue bonds, a requirement that municipal and corporate debt be rated on a "global" scale based on the likelihood of timely repayment to the creditor, and the requirement that FAs be held to a fiduciary standard.

Yesterday's hearing on losses suffered by states and localities from Lehman-related investments revolved around a bill introduced in January by two California Democrats, Reps. Jackie Speier and Anna Eshoo. The legislation would require the Treasury Department to use a portion of the $700 billion Troubled Asset Relief Program to purchase at par the nearly worthless Lehman debt still held by states and localities and other public entities.

State and local governments nationwide are said to have lost at least $1.67 billion from Lehman-issued debt that was highly rated at the time of Lehman Brothers Holdings Inc.'s bankruptcy filing Sept. 15, according to supporters of the bill.

Frank and other Democratic lawmakers believe the Lehman debt should be considered "troubled" and are dismayed by the Treasury's refusal to assist states and localities, which they consider innocent victims of the Lehman collapse.

Frank said the federal government has been inconsistent in making creditors of insurance giant American International Group Inc. whole when that firm was on the verge of collapse, but not providing any help to Lehman's creditors when it collapsed a few days earlier.

"There is no principle of any sort that justifies that result," he said.

But Republican lawmakers decried the proposal to bail out states and localities. Alabama Rep. Spencer Bachus, the committee's ranking Republican, said that he is sympathetic with their plight but that "taxpayers are saddled with too many obligations on investment decisions gone bad."

Supporters of the bill said it would require that just a fraction of the overall TARP funds go towards bailing out states and localities that did no wrong by investing in Lehman debt, which was highly rated and appeared to be safe.

"The decision to treat Lehman Brothers' financial situation differently than other financial institutions resulted in devastating consequences on state and local governments," said Karen Rushing, clerk of the circuit court and comptroller for Sarasota County, Fla. The county lost about $40 million of Lehman bonds when the firm filed for bankruptcy, she said.

Meanwhile, Ron Galatolo, chancellor of the San Mateo, Calif., Community College District, said losses on Lehman assets wiped out the district's reserves and forced it to cut its budget by 10%.

"As a result of our reserves being eliminated by the Lehman bankruptcy, we have no viable option other than to immediately reduce our teachers and support staff in addition to our shrinking academic programs and services," Galatolo said.

Upcoming Events

Already a subscriber? Log in here
Please note you must now log in with your email address and password.