Reform Bill Will Shake Up Market

WASHINGTON — Financial regulatory reform legislation that House and Senate lawmakers hope will be ready for President Obama's signature at the end of the week is expected to authorize sweeping changes to the way the municipal market is regulated.

The 2,000-page bill, which was released Saturday, is the product of weeks of work by House and Senate conferees to reconcile competing versions of the legislation, which culminated in party-line votes by conferees early Friday morning.

House conferees approved the bill 20 to 11 while Senate conferees voted 7 to 5 in its favor.

If signed into law, the bill would direct the Municipal Securities Rulemaking Board to oversee non-dealer financial advisers and other unregulated market intermediaries. The MSRB would have to draft continuing education requirements and professional standards for advisers, as well as rules stipulating that they must hold their clients' interests ahead of their own.

In addition, a majority of the board’s 15 member’s would have to consist of “independent” officials, including one issuer, one representative of retail or institutional investors, and one muni expert. Currently, dealer representatives hold 10 of the board’s seats.

The bill also would provide for a stable funding source for the Governmental Accounting Standards Board. Specifically, the Securities and Exchange Commission would have the authority to direct the Financial Industry Regulatory Authority to collect assessments from muni dealers to fund the accounting-standards setter.

In addition, Congress’ watchdog, the Government Accountability Office, would have to conduct a study of GASB funding and determine if additional legislation is needed.

GASB is currently funded through voluntary contributions from state and local governments, as well as revenue from the sales of its publications. But it is constantly short of funds and its dependence on issuers is seen as a conflict.

On derivatives, conferees late last week eliminated proposed language to impose a fiduciary duty on dealers that enter into swaps with public entities like states, local governments, and pension funds. In lieu of a fiduciary duty, the bill would require the Commodity Futures Trading Commission to develop a code of conduct for dealer firms that enter into swaps with public entities, referred to in the legislation as “special entities.”

The code of conduct was seen as a middle ground to ensure that less sophisticated public entities are not taken advantage of by dealers. In voting on the code of conduct during the conference committee’s 20-hour finale that ended Friday morning, House Financial Services Committee chairman Barney Frank, D-Mass., said pension funds had sought the provision.

More generally, the bill would require standardized, or routine, swaps to be centrally cleared and traded on a clearing platform. But it would permit the CFTC to create exceptions for swaps that are nonstandardized — or highly tailored contracts-- that are not suited for clearing. The exceptions would apply to interest-rate swaps used by states and localities.

In addition, the proposed bill clarifies that a "commercial end-user" exemption from central clearing of swaps would apply to municipalities and small banks. The exemption is designed to apply to entities that use swaps to hedge and not to dealers and traders that use them for speculative purposes. But industry officials had complained that the definition of a commercial end-user was too broad.

The bill sidesteps some of the more controversial issues in the municipal market, such as a repeal of the so-called Tower Amendment, which prohibits the SEC or the MSRB from collecting documents prior to bond sales. Instead, it directs the GAO to study the issue within 24 months of the bill’s enactment.

But the bill aims to mandate that munis remain a top priority of the SEC by mandated an office of municipal securities and that its director report directly to the chairman of the commission.

Currently, the SEC’s muni office is housed within its division of trading and markets and has two only full-time employees — Martha Mahan Haines, its chief, and Mary Simpkins, senior special counsel. The bill would require the SEC to staff the office “sufficiently to carry out the requirements” of the muni section in the proposed legislation.

The provision aims to elevate muni issues to the position they held under former chairman Arthur Levitt, who headed the SEC from 1993 to 2001. Levitt created the muni office and had its direct report to him.

But some market participants believe munis are already elevated in importance. Last month, SEC chairman Mary Schapiro announced plans for a series of field hearings throughout the country conducted by commissioner Elisse Walter, who is also working on the first interpretive guidance to address legal ambiguities in the commission’s Rule 15c2-12 on disclosure. In addition, in January the enforcement division created five new specialized units to investigate and develop cases in key areas, including one unit that will focus exclusively on muni and public pensions.

Among other provisions, the bill would establish the nine-member Financial Stability Oversight Council, which will have the authority to impose higher capital requirements on financial institutions or place certain non-bank firms under control by the Fed. While the Federal Deposit Insurance Corp. would have the authority to wind down large, failing banks in an orderly fashion, the conferees nixed a $150 billion pre-paid fund that would have paid for such efforts.

Separately, to boost the reliability of ratings and hold rating agencies more accountable, the bill would make it easier for investors to sue rating agencies if they "knowingly and recklessly" fail to conduct a reasonable investigation of the underlying data used in a rating. The liability standard is lower than a "grossly negligent" standard that House conferees had originally proposed.

The committee also agreed to jettison a proposal in the Senate's language that would have created an independent board to assign a rating agency to rate structured products. Instead it would have the SEC study the issue. After the study, the SEC would have to implement the independent board or propose an alternative to Congress.

Championed by Sen. Al Franken, D-Minn., the board was intended to resolve conflicts of interest in the issuer-pay business model of the top rating agencies. But conferees warned it would be impractical to make random assignments to rating agencies.

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