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Aiming to Fill Financial Adviser Regulatory Loopholes

WASHINGTON — With the Senate Banking Committee scheduled to begin marking up draft financial regulatory reform language as early as today, market participants are hopeful that lawmakers will be keen to fill potential loopholes in the bill’s provisions calling for the regulation of municipal market advisers.

Under the proposal, which was released a week ago by Senate Banking Committee chairman Christopher Dodd, D-Conn., non-dealer financial advisers and other market intermediaries would for the first time be subject to Securities and Exchange Commission regulation and Municipal Securities Rulemaking Board rules.

However, in an apparent ­oversight, the FA regulations would only apply to advisers of municipal issuers, and not of “obligated persons,” such as conduit borrowers.

Speaking at The Bond Buyer and Regional Bond Dealer Association’s municipal bond summit in Doral, Fla., on Friday, Mary Simpkins, senior special counsel in the SEC’s office of municipal securities, said the commission believes it is important that all of these advisers be covered by any new regulatory proposal, including advisers to conduit borrowers, who are on the hook for the bonds but are not the actual issuers of the debt.

Separately, Simpkins argued that municipal continuing disclosures should be closer to what is available in the taxable market since muni borrowers are now selling much more taxable debt with the advent of Build America Bonds.

She also noted that issuers are moving more towards the same corporate rating scale, an apparent reference to Moody’s Investors Service’s announcement last week that it would migrate all of its municipal credit ratings to a uniform, or global, scale beginning in mid-April.

“We’re hopeful that taxable Build America Bonds will encourage better and more timely disclosure by municipal investors because taxable investors typically look for corporate disclosure practices,” she said.

Asked about her remarks, however, bond attorneys said Friday that they do not know of any BAB deal in which issuers have elected to use more corporate-style disclosures.

The issue of adviser regulation is one that appears to have no significant opposition, as even non-dealer FA groups are supportive of regulations.

However, the National Association of Independent Public Finance Advisors said they prefer the language in a separate financial regulatory reform bill the House passed in December that would allow the SEC, rather than the MSRB, to regulate advisers.

The House bill also includes a fiduciary standard for advisers, which essentially says advisers must put their client’s interests ahead of their own, that the FAs fault the Senate proposal for not including.

“We certainly think that all advisers should be covered, but that’s why we support the House bill,” said Steven Apfelbacher, president of NAIPFA and of Roseville, Minn.-based Ehlers and Associates in a brief interview Friday.

Apfelbacher, who was not at Friday’s conference, said NAIPFA is concerned that in making the MSRB a majority public self-regulatory organization, the ­Senate bill would only require that one of the seven industry slots on a reconstituted board be filled by a non-dealer adviser, meaning that adviser voices could very easily be overshadowed by the six ­dealers.

The 15-member board is currently comprised of at least 10 dealer representatives, plus five members of the public, including one issuer official and one investor representative.

Meanwhile, Robert Doty, the president of American Governmental Financial Services in Sacramento, who also was not at the conference, said that he is troubled by the omission of a fiduciary duty from Dodd’s proposal.

The oversight is significant, he said, because the MSRB has “fallen sadly short” when it comes to applying the fiduciary duty of advisers.

While Doty said he is “very complimentary” of a lot of actions the MSRB has taken, including the development of its Electronic Municipal Market Access system, he said the board has repeatedly refused to alter its Rule G-23 on dealer FAs, which currently only states that there “may” be a conflict of interest if a dealer-adviser switches roles to become the underwriter on a negotiated transaction.

For several years, non-dealer FAs have asked the MSRB to amend the rule’s language to say a conflict does exist, but the board has repeatedly declined.

MSRB executive director Lynnette Hotchkiss, who spoke on the panel with Simpkins, acknowledged the MSRB’s approach to dealer-adviser role-switching — which requires issuer consent prior to the switch — “is clearly one of the most contentious issues at the board.”

But she said studies of trade data are inconclusive that there are any unusual pricing spreads issuers receive on negotiated transactions in which the dealer-adviser has resigned as adviser to underwrite the deal.

She added: “When we seek public comment [on G-23], we have many, many issuers who say, 'Please don’t change the rule because in our locality we don’t have 50 investment bankers looking for our business.’ ”

Apfelbacher warned that the board’s rule is inconsistent with issuers’ recommended practices, pointing to guidance released in 2008 by the Government Finance Officers Association that warns of “the inherent conflicts of interest” in such role switching.

Doty said the conflicts are not present only in pricing, but also revolve around whether an issuer should even be engaged in a transaction and what kind of risks the issuer should be taking.

“It’s much more than just pricing,” he said, adding it is misleading to argue the issue is about issuer choice and not disclosure to issuers.

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