WASHINGTON — The Municipal Securities Rulemaking Board would for the first time require broker-dealers to disclose to state and local governments that they are not fiduciaries and would prohibit underwriters from telling issuers not to hire financial advisors, under revised rule changes it filed Thursday.
The amendments to the proposed interpretive guidance for underwriters for its G-17 fair-dealing rule, which the board filed with the Securities and Exchange Commission, come after market participants urged the SEC to reject or delay the initial changes the board proposed in August.
In comment letters filed with the SEC last month, independent FAs said the MSRB’s guidance fell short because it did not require broker-dealers to disclose they are acting as underwriters who do not have a fiduciary duty to issuers, unlike advisors.
A fiduciary is generally required to put a client’s interests ahead of its own.
Industry groups, by contrast, balked at the proposed changes, saying they were overly broad and potentially costly to underwriters, and would not benefit issuers.
The board’s amended proposal, however, responded to the concerns of issuers and FAs, boosting the disclosures underwriters must provide to states and localities about their role in a transaction and how they are paid.
“It is important that state and local governments understand in very specific terms what to expect from their underwriters and the financial risks of the transactions underwriters recommend,” Lynnette Hotchkiss, the MSRB’s executive director, said in a statement. “The disclosures required by the notice should help issuers make informed decisions about the transactions they enter into.”
Specifically, in negotiated transactions, underwriters would be required to tell state and local governments that “unlike a municipal advisor,” they do not have a fiduciary duty to the issuer under the federal securities laws, and are not required to act in the issuer’s best interests, the board’s proposal said.
Underwriters would be prohibited from recommending that issuers “not retain a municipal advisor,” the MSRB said. John Bonow, a managing director at Public Financial Management Inc. in Seattle, had warned SEC officials last month that underwriters often push muni issuers not to hire financial advisors. If the issuer insists on an FA, the underwriter will push it to retain a broker-dealer, rather than an independent, FA, he said.
Broker-dealers would also be required to disclose their primary role is to purchase securities with a view to distribute them in an arms-length commercial transaction with the issuer and that their financial and other interests differ from those of the issuer.
As for compensation, underwriters would be required to disclose whether their payment would be contingent on the closing of a transaction, the board said.
They would also have to tell issuers that any compensation contingent upon the closing or size of a deal presents a conflict of interest, “because it may cause the underwriter to recommend a transaction that is unnecessary or to recommend that the size of the transaction be larger than is necessary,” the MSRB said.
Industry groups signaled frustration with the board’s move.
“We continue to have concerns about the risk disclosures as described in the amendment,” said Leslie Norwood, managing director and co-head of the muni division of the Securities Industry and Financial Markets Association. The proposed disclosures are “very extensive and specific,” she added, saying the group’s members would discuss them.
SIFMA also remains concerned about the timing of the board’s proposal, Norwood said, noting the MSRB withdrew its proposed G-17 interpretive notice for muni advisors in September, along with several other proposed muni advisor rules.
The board has said it will repropose the rules after the SEC finalizes a muni advisor registration scheme and definition.
A dealer group, meanwhile, said its members are concerned the MSRB’s amended notice perpetuates the assumption of an adversarial relationship between underwriters and issuers.
“That said, our members support making clear to issuers that, as underwriters, they are counterparties not fiduciaries and that an issuer should retain a competent and informed third-party municipal advisor if the issuer believes a fiduciary is needed,” William Daly, senior vice president of government relations for Bond Dealers of America, wrote in an email.
An issuer and an independent FA welcomed the board’s proposal, saying it incorporated many of their comments.
“Overall, we are extremely pleased with this notice from the MSRB,” said Colette Irwin-Knott, a partner at H.J. Umbaugh & Associates LLP in Indianapolis and president of the National Association of Independent Public Finance Advisors.
An issuer, meanwhile, hailed the board’s clarification that underwriters must disclose they do not have a fiduciary duty to issuers. “The issuers need to know that, because I don’t think that’s well understood by those that are not in the market frequently,” said Eric Johansen, treasurer of Portland, Ore. and chairman of the Government Finance Officers Association’s debt management committee.
The board’s previous G-17 guidance proposed less extensive disclosure obligations for underwriters.
For example, it only would have required underwriters in a negotiated deal that recommends a complex municipal financing, such as a variable rate demand obligation with a swap, to disclose all material risks, characteristics, incentives and conflicts of interest, such as payments from a swap provider.
As amended, the G-17 notice requires broker-dealers to disclose the “arms-length nature” of the relationship “at the earliest stages” of the relationship.
Still, Johansen said he would like the MSRB to require underwriters to disclose that issuers may elect to hire an FA. “I think we’d like to see it go a little farther,” he said.