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Underwriters Push Issuers Not to Use FAs, Firm Warned SEC

Underwriters often push municipal issuers not to hire financial advisors and, if an issuer insists on working with one, prod them to retain broker-dealer FAs, an independent FA firm warned a Securities and Exchange Commission member earlier this month.

John Bonow, a managing director at Public Financial Management,Inc. in Seattle, told SEC commissioner Elisse Walter in an Oct. 6 letter that the pressure stems from the “economic interplay” at work in municipal financings.

Specifically, he said, FAs make their living by counseling potential issuers on the most effective debt profile and capital funding mix, which may run counter to the transactions proposed by prospective underwriters, who have their eye on the new-issue market. FAs also negotiate the best price for issuers, which directly affects the underwriters’ profits, Bonow said.

“And when the issuer insists on having a financial advisor to argue its cause with the underwriter, the underwriter would prefer that that advisor be another broker, who next time may turn up in the underwriting syndicate with financial arrangements with other banks, rather than an independent firm, like Public Financial, which has no clients other than issuers,” Bonow wrote.

PFM, based in Philadelphia, is the largest financial advisor in the muni market. The firm ranked first among all financial advisors for the first nine months of 2011, working on $26.3 billion in 536 issues, according to Thomson Reuters. In 2010, PFM was also ranked first, with $57.5 billion in 988 issues.

Bonow’s remarks come as Walter is spearheading an agency-wide review of the muni market, with commission staff working to finalize a report that will recommend legislative and regulatory changes.

Bonow had hoped to speak with Walter at a muni bond summit held in New York by the Securities Industry and Financial Markets Association. Walter was originally scheduled to speak at the conference, but addressed the gathering by video from the SEC’s Washington, D.C., headquarters.

Bonow instead followed up with the letter, asking Walter or her staff to meet with him and PFM chief executive officer John White. He said he wanted to speak to her about “recent structural changes in municipal finance,” such as “substantial direct lending by banks.”

Until recently, the SEC could “step in when something went seriously wrong — by way of disclosure to investors, or where brokers engaged in manipulative conduct,” Bonow wrote.

But under the Dodd-Frank Wall Street Reform and Consumer Protection Act, he noted, the SEC must “take account of the economic forces which shape the municipal bond market.”

An independent FA group, of which PFM is the largest member, hailed Bonow’s comments.

“We fully support their participation in helping educate and have discussions with commissioner Walter in terms of the public finance market, its attributes and the perspective of an independent advisor,” said Colette Irwin-Knott, president of the National Association of Independent Public Finance Advisors and a partner at H.J. Umbaugh & Associates LLP in Indianapolis.

An issuer, meanwhile, said while underwriters had not pressed him to refrain from working with an independent FA, he was not surprised to learn of such a concern.

In particular, according to Frank Hoadley, Wisconsin’s capital finance director and a member of the Government Finance Officers Association’s debt management committee, some broker-dealers have opposed recent changes to the Municipal Securities Rulemaking Board’s Rule G-23 on role-switching, which become effective Nov. 27.

The G-23 revisions, approved by the SEC this spring, prohibit municipal securities dealers from acting as an FA to a muni entity for a new issue and then becoming underwriter on the same issue.

Previously, dealer-FAs could become underwriters in a negotiated muni transaction if they terminated their financial advisory role, disclosed to the issuer possible conflicts of interest stemming from the role switch and obtained the issuer’s consent. But the MSRB made the rule more restrictive at the urging of the SEC.

To an extent, Hoadley added, the G-23 revisions recognize that some broker-dealers may prey on smaller, less sophisticated issuers, who might need an independent FA sitting in their corner.

“The reality is, you have to say there’s an element of truth to that in some cases,” Hoadley said.

SIFMA spokesman Andrew DeSouza declined to comment on Bonow’s letter.

But Bond Dealers of America, a dealer group, objected to his comments, saying they foster an inaccurate portrayal of underwriters’ role in the municipal bond market.

“We find it outrageous for nondealer financial advisors to say that underwriters do not want financial advisors or municipal advisors to be involved to assist in coordination and planning of an underwriting,” BDA’s senior vice president of government relations, William Daly, wrote in an email.

“For anyone to imply that underwriters would routinely violate both the basic tenets of good business practice and the requirements of the SEC and MSRB regulations is unprecedented,” he said. “Firms that are engaged in the day-to-day trading of securities can provide a much better evaluation of the market to issuers than can nondealer financial advisory firms.”

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