WASHINGTON — In a surprise move, the Municipal Securities Rulemaking Board pulled five proposed municipal advisor rules that had been pending with the Securities and Exchange Commission on Monday, following complaints by dealers and other market participants that the SEC had not yet defined the term municipal advisor. The board also issued an advisory on bank loans.
In a one-page notice posted on the board’s website, the MSRB said it has withdrawn five muni advisor-rule proposals, previously filed with the SEC, including: G-20 on gifts and gratuities, G-42 on political contributions, G-36 on fiduciary duty, G-17 on fair dealing, and proposed new Rule A-11 and new Form A-11 on muni advisor assessments.
Proposed Rule G-44 on supervision of muni advisor activities was already undergoing revisions and “will not be refiled at this time,” the board’s notice said.
In a statement, the board cited “substantial concern” about the timing of the SEC’s adoption of a permanent municipal advisor definition, as well as concerns that some individuals and firms might not participate in the SEC comment process due to uncertainty about who qualifies as a municipal advisor.
The board’s move comes amid criticism among market participants that the MSRB had floated several rule proposals for comment, and then filed some of them with the SEC, before the commission adopted a final muni advisor-registration scheme and definition.
Dealers, FAs, and issuers have urged the MSRB to defer issuing proposed rules and filing them with the commission until the SEC finalized the muni advisor definition so that they could comment on any changes.
Earlier this summer, Hotchkiss said she expected the SEC to finalize the muni advisor definition this fall. But in an interview Monday, Hotchkiss said “the exact timing” of the final definition falls within the purview and discretion of the SEC.
She also said the MSRB withdrew the proposals “on the off chance” that the final definition could capture market participants not covered by the definition floated late last year, in the SEC’s proposed muni advisor-registration scheme. The SEC received more than 1,000 comment letters on that proposal.
Hypothetically, Hotchkiss said, such market participants might not necessarily be tracking the board’s notices and comment periods on proposed muni advisor rules, but could be potentially subject to the board’s oversight, according to Hotchkiss.
“We’re just being conservative,” she said.
After the SEC adopts the final definition, the board will amend the proposals, if needed, and resubmit them “in short order” to the SEC, which would release them for comment, she added.
Asked about the SEC’s timing, commission spokesman Kevin Callahan referred to a link on the SEC’s website, which says the “planned” date for adopting a permanent municipal advisor-registration rule, including the definition, is between August and December 2011.
Last month, in a request for comments on the board’s proposed amendments to Rule G-20, on gifts and gratuities, the SEC asked market participants to weigh in on whether they could “effectively comment on the proposed rule change prior to the date of final adoption” of the commission’s permanent registration rule and definition.
Market participants hailed the MSRB’s decision.
“I think it would be helpful for all to see what the SEC’s final definition of municipal advisor is,” said Paul Maco, a partner at Vinson & Elkins LLP in Washington.
A dealer group agreed. “I think it’s a good idea and a recognition by the MSRB that we need to know who municipal advisors are before we can regulate them,” said William Daly, senior vice president of government relations at Bond Dealers of America.
The Securities Industry and Financial Markets Association echoed this view.
“SIFMA voiced the difficulty associated with commenting on a regulatory compliance regime for municipal advisors in a vacuum when the definition is not final as to who is a municipal advisor or what types of activities are covered,” said Leslie Norwood, co-head of SIFMA’s municipal securities division.
Separately, the MSRB alerted muni market participants that certain “bank products” and “bank loans” could be municipal securities and that broker-dealers and municipal advisors who participate in such transactions could “inadvertently violate” MSRB rules and other federal securities laws.
In a two-page notice, posted on the MSRB’s website, the board said many state and local governments have turned to private placements of municipal securities with banks as an alternative to public offerings.
In many cases, the board noted, the shift was prompted by pending expirations of letters of credit and standby bond-purchase agreements providing liquidity for variable-rate demand obligations.
Specifically, the board said, if a broker-dealer serves as a placement agent for a direct purchase by a bank of municipal securities or as a placement agent for a bank loan that is a municipal security, the broker-dealer “is subject to” MSRB rules and other federal securities laws, even if the broker-dealer is an affiliate of the bank.
For example, the board said, a broker-dealer acting as placement agent might engage in a direct purchase of VRDOs by its bank affiliate, followed by a restructuring of the VRDOs.
In some cases, such a restructuring might be “so significant” that it is a primary offering of municipal securities and a broker-dealer might be obligated to report the transaction to the MSRB under Rule G-32, on disclosures in connection with primary offerings.
A municipal advisor is also subject to the MSRB’s rules, as well as a congressionally mandated fiduciary duty, if it provides advice to a state or local government about either: entering into a bank loan that is a municipal security; or a direct purchase by a bank of the issuer’s securities, followed by a restructuring that is considered a primary offering, the advisory said. Generally, a fiduciary must put a client’s interests ahead of its own.
In addition, the advisory said bank loans could be municipal securities when banks lend funds to a state or local government issuer to purchase their own securities. But, the board noted, whether such loans are municipal securities “can be a difficult question.”
Under the U.S. Supreme Court’s 1990 decision in Reves v. Ernst & Young Inc., a note is presumed to be a security unless it is identified as a non-security, such as a note delivered in a consumer financing, a note secured by a home mortgage, or short-term notes secured by a lien on a small business.
Some notes that bear a “strong family resemblance” to these non-security notes may also be a security depending on four factors: the motivations of the buyer and seller; the plan of distribution; the reasonable expectations of the investing public; and the existence of an alternate regulatory regime that significantly reduces the risk of the instrument, the board said.
“I view this as a step in the right direction,” said Robert Doty, president of the independent advisory firm American Governmental Financial Services Co. in Sacramento. “It’s better for everybody to be following the same set of rules.”