Issuers and independent financial advisers heralded the Securities and Exchange Commission’s endorsement of a proposed rule that would bar dealer-financial advisers from acting as an underwriter and a muni adviser on the same transaction.
Broker-dealer groups, meanwhile, questioned the need for the rule changes and worried they went too far.
“I’m glad to see this day come,” said Frank Hoadley, Wisconsin’s capital finance director and the former chair of the Government Finance Officers Association’s governmental debt-management committee. “I have pushed on this for years.”
Late last week, the SEC approved proposed amendments to the Municipal Securities Rulemaking Board’s G-23, capping a lengthy rulemaking process that exposed deep fissures among muni market participants. As approved, the rule would prohibit municipal securities dealers from acting as an FA to a municipal entity on a new issuance and later acting as an underwriter on the same issue. The rule would apply to new issues sold on both a negotiated and a competitive bid basis.
Under the existing Rule G-23, dealer financial advisers can become underwriters in negotiated muni transactions if they terminate their FA role, disclose to the issuer possible conflicts of interest stemming from the role switch as well as their expected compensation, and obtain the issuer’s consent.
The MSRB’s proposed G-23 amendments, filed with the SEC in February, contained interpretive guidance that said a dealer would not be considered an FA for purposes of the role-switching ban if it clearly identified itself as an underwriter from “the earliest stages of its relationship with the issuer.”
In comment letters filed with the SEC, groups representing issuers and independent FAs urged the commission to tighten the proposed G-23 amendments, saying they failed to recognize the distinct roles played by FAs and underwriters and their differing obligations to issuers.
Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, FAs are treated as muni advisers who are subject to the SEC’s proposed registration scheme and have an obligation to put their clients’ interests ahead of their own. But Dodd-Frank exempts broker-dealers serving as underwriters from the muni-adviser definition and registration requirements, and thus from the fiduciary standard.
The G-23 proposal approved by the SEC Friday addressed some of those concerns, referring to and synthesizing the various comment letters.
The MSRB filed a partial amendment to its G-23 proposal with the SEC last week.
Specifically, Rule G-23, as amended by the MSRB and approved by the SEC, clarifies that an underwriter may provide certain advice to an issuer without violating the role-switching ban if it clearly identifies itself in writing as an underwriter “from the earliest stages of its relationship with the issuer” on that issue. It must disclose that it is in an arms-length relationship with the issuer, and that its interests differ from those of the issuer. The underwriter cannot engage in conduct inconsistent with an arms-length relationship.
An independent FA welcomed the proposed role-switching ban.
“I commend the board for a positive contribution that is sensitive to the needs of issuers,” said Robert Doty, president of American Governmental Financial Services Co. in Sacramento.
A spokesman for the National Association of Independent Public Finance Advisers did not respond to a request for comment.
Industry groups, however, signaled frustration with the SEC’s G-23 approval order and the commission’s failure to incorporate their suggestions to exempt small municipal issuers and competitive transactions from the role-switching ban.
“None of those were in the approval,” said Leslie Norwood, managing director and associate general counsel of the Securities Industry and Financial Markets Association. “Therefore, we are disappointed for many reasons with respect to this approval.”
Norwood said SIFMA thought the existing rule adequately managed potential conflicts of interest.
“Clearly, the regulators felt that rule was not sufficient,” she said.
SIFMA is weighing whether to file another Rule G-23 comment letter with the commission, Norwood added.
Although the SEC approved the proposed G-23 changes Friday, the agency is seeking additional comments on the amendments. The comment period will end 21 days after the commission’s approval order is published in the Federal Register.
The Bond Dealers of America also voiced support for the existing rule and reservations about the new one.
“We are glad, at least, to see that the new rule recognizes that underwriters are an important source of advice for issuers, but continue to have serious concerns about prohibiting any firm from bidding in a competitive bid situation,” said William Daly, the BDA’s senior vice president of government relations.
Still, confusion remains about the scope of an underwriter’s obligations to a municipal issuer, including when a broker-dealer might be required to act as a fiduciary and put a client’s interests ahead of its own.
The SEC’s approval order did not address this issue directly.
Rather, the it said, G-23, a conflict-of-interest rule, “does not set normative standards for dealer conduct.” The commission added that “other laws or rules” may set such standards for activities allowed by the proposed rule.
The SEC also suggested applying proposed Rule G-23 “on an issue-by-issue basis.”
But one muni issuer pointed to a need for clarification. “I think this is one of the areas where the complexity has become pretty apparent,” said Hoadley.
The G-23 changes will become effective Nov. 27.
