Michael Decker, managing director and co-head of municipal securities at SIFMA, sets forth his case for not federally regulating underwriters when they provide what he calls “advice” to municipal securities issuers.
Decker, in his commentary in The Bond Buyer Thursday, portrays a near-doomsday scenario in which, if underwriters provide “advice” to issuers, and are required to provide competent advice with the issuers’ best interests at heart, then the world will end — or at least negotiated underwritings will disappear from the face of the earth.
The Regional Bond Dealers Association makes similar arguments in a letter to Sen. Barbara Boxer, D-Calif., regarding legislation she proposed to give federal regulators the authority to enforce underwriters’ and swap dealers’ fiduciary duty under appropriate facts and circumstances.
Decker, a sincere and honorable gentleman, is an articulate advocate for his position. The problem is that it doesn’t fit the facts of the market today.
Underwriters that step beyond the bounds of the underwriting role and seek to induce issuers into relationships of trust and confidence as their advisers already have had recognized fiduciary duties for many years.
The 10th Circuit Court of Appeals, Ninth Circuit Court of Appeals, federal District Court of Arizona, New York Court of Appeals, and Delaware Chancery Court all held years ago that a dealer purporting to act as a principal has a fiduciary duty when creating facts and circumstances as an adviser or agent that lead the issuer to believe it is acting in the issuer’s best interests.
Treatises similarly state that, under appropriate facts and circumstances, an underwriter can have a fiduciary duty to the issuer. Moreover, underwriters have entered into disadvantageous settlements regarding that issue in Florida and Missouri.
Additionally, the New Hampshire Bureau of Securities recently achieved a successful settlement of charges that an underwriter violated its fiduciary duty to state student-loan issuers.
And yet negotiated underwriting has continued to flourish.
There is little that is new here. As RBDA states: “The concept of fiduciary obligations has been around for centuries. … The concept has been broadened to … situations in which there is a relationship of trust and one person relies on another’s expertise or representations.”
Recalling the Wall Street mantra that greed is a virtue, I have no doubt that imaginative investment bankers can find ways to continue to deal with this issue just as they have for the past decade.
So what’s the problem? The fiduciary duty that underwriters already have under state law has not destroyed the dealers’ negotiated underwriting businesses. What would change is the addition of regulators as enforcers of that duty.
Enforcement would help small issuers that have been damaged and have to spend hundreds of thousands — even millions — of dollars to assert claims against wealthy, aggressive banking firms experienced in litigation. The banking firms are able to drag out litigation and raise the costs so that it becomes prohibitive for any other than the most determined local governments to protect their interests effectively.
Actually, I think there is not as much room for disagreement between Decker and myself as might first meet the eye. I believe he makes a number of valid and very important points.
We can both agree that an underwriter serving in a true arms-length role as a principal engaging in commercial buyer-and-seller transactions should not have a fiduciary duty to an issuer.
We can both agree that an underwriter should not have a fiduciary responsibility to an issuer when they provide “information” regarding market conditions, the availability of particular transactional structures, their capabilities to sell various securities structures and the relative benefits of each, and how investors will react to particular terms of a security.
“There are circumstances where a fiduciary duty for a dealer is appropriate,” Decker says, and I agree with him.
He expresses another valid concern, namely that in the course of providing “information” to issuers, dealers’ communications may be misinterpreted as “advice” as to what is in the issuers’ best interests.
Yet, if underwriters are concerned that an issuer might misinterpret the communications, it is easy for them to inform the issuers’ policy makers explicitly that they are not undertaking to assist the issuers in determining what is in their best interests. The exposure draft of SIFMA’s own Model Bond Purchase Agreement provides for explicit discussions with issuers along those lines.
These kinds of discussions are especially necessary in the municipal securities market, where there are tens of thousands of unsophisticated issuers, with local officials — everyday citizens — who are significantly inexperienced in municipal finance and who often are replaced as soon as they gain even a modicum of knowledge about this arcane area.
Many of these officials do not have the slightest understanding of how an underwriter differs from a financial adviser. Naturally they rely heavily on financial experts who appear before them without a hint of arms-length dealings.
Local counsel generally fail to understand these issues. Bond counsel typically do not step between the issuers and underwriters because they also rely upon the underwriters for business.
What happens with such an issuer in the unusual case when the underwriter steps beyond an appropriate informational role and actually undertakes to act in the issuer’s best interests?
Should we exclude these small and even medium-sized issuers from the public market? I think it is coming to that. Unless the nondealer financial advisory and dealer communities and other market participants wake up, they will find unsophisticated issuers gravitating further into the non-public, privately placed lease-purchase “shadow market” or turning to direct loans from banks.
This need not occur. It is easy to prevent misunderstandings between underwriters and issuers regarding the appropriate role of the underwriter.
If Decker is able to acknowledge that unfortunate facts and circumstances can arise, as I think he does, and if SIFMA, the Government Finance Officers Association and other groups and individuals can concentrate on preventing such misunderstandings, then Decker and I might even come to full agreement.
Underlying this discussion is the realization that there is a weak financial advisory community populated by a number of less than competent — and occasionally less than fully honest — financial advisory firms that are badly in need of regulation. Underwriters can be tempted to fill the void.
The market and regulators need to grow a fully-competent financial community to serve issuers. This is a unique opportunity to improve the market that should not be missed.
It is high time to regulate issuers’ financial advisers. It means eliminating FA conflicts of interest and creating a new regulatory structure for them based upon qualifications, testing, continuing education, and definition and enforcement of their fiduciary duty.
And that means all financial advisers, including not only dealer advisers and unregulated nondealer advisers, but also those few underwriters that want to double up and serve simultaneously in both principal and advisory roles.
Robert Doty is president of American Governmental Financial Services in Sacramento.
