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Muni Adviser Rule’s Scope at Issue

WASHINGTON — Just one day after the Municipal Securities Rulemaking Board issued a draft rule on muni advisers’ fiduciary duties, market participants are questioning the scope of the rule and whether it would apply to brokers engaged in certain activities such as recommending securities in which states and localities could invest general funds.

At the Bond Buyer’s annual Texas Public Finance Conference in Austin, Paul Maco, a partner with Vinson & Elkins LLC who moderated a panel, noted that the Securities and Exchange Commission may not clarify which individuals or firms are muni advisers and therefore subject to registration requirements until late this year.

“Bottom line, it takes a long time,” Maco said after Peg Henry, the MSRB’s deputy general counsel who was also on the panel, explained the draft rule.

The draft rule, issued Monday, provides guidance on fiduciary-duty obligations that were imposed on muni advisers under the Dodd-Frank Wall Street Reform and Consumer Protection Act.

As currently written, the board’s Rule G-36 relies on Dodd-Frank’s definition of muni adviser and does not extend to brokers. Under Dodd-Frank, persons are muni advisers who must be registered if they provide advice to or on behalf of a municipal entity or other borrower with respect to municipal financial products or the issuance of municipal securities. The act defines muni financial products to mean muni derivatives, guaranteed investment contracts and investment strategies. It says investment strategies may include plans or programs for the investment of the proceeds of muni securities, GICs and the recommendation and brokerage of securities for advance refunding escrows.

Under the act, muni advisers include financial advisers, guaranteed investment contract brokers, third-party marketers, placement agents, solicitors, finders, and swap advisors. They do not include underwriters or attorneys offering legal advice.

But in its proposed rules for a permanent registration system for muni advisers that it issued on Dec. 20, the SEC interpreted investment strategies broadly. The SEC said it did not believe Congress intended to limit adviser registration requirements only to those persons providing advice on the investment of municipal securities proceeds. The commission suggested money managers providing advice to municipal entities on the investment of their general funds could be muni advisers.  The SEC is seeking public comments on them through Feb. 22.

Market participants note that it may take months for the SEC to sift through dozens of ­comments and come up with final rules.

Meanwhile, the commission is currently operating an interim registration system for municipal advisers under a temporary rule that is slated to expire on Dec. 31.

If the SEC requires brokers engaging in certain activities to register as muni advisers, the MSRB has said it will revise its interpretative notice on draft Rule G-36 on fiduciary duties and re-propose it for comments. It is currently collecting comments on the draft rule through April 11.

Under Dodd-Frank, muni advisers became subject to the oversight of the board and the SEC on Oct. 1. The law delegated to the MSRB the task of delineating the scope of their fiduciary duties.

Generally, a fiduciary duty means an adviser must put its clients’ interests ahead of its own and the draft rule and interpretative notice seek to shed light on what that means.

“I think most people understand, as a theoretical matter, and now as a legal matter, when you get tagged with a fiduciary duty, you’re supposed to put your client’s interests ahead of your own,” Leonard Weiser-Varon, a public-finance lawyer at Mintz Levin, said in an interview.

Others, however, are concerned the MSRB has not provided enough guidance in a second threshold area: what constitutes “advice” for purposes of Rule G-36 while they are conducting “municipal advisory activities.”

“What are the limits of what you can and can’t say?” asked William L. Hirata, a partner at Parker Poe. “Is it fair to attach a fiduciary duty when you haven’t defined what advice is?”

At The Bond Buyer conference, Henry tried to address some of those concerns. According to Henry, the board will likely file a comment letter with the SEC on the proposed permanent registration rule, expressing the board’s thinking about how to interpret Dodd-Frank and how some of its terms should be defined. Ultimately, though, she said the board may need to reconsider some of its proposed rules and interpretations, depending on the scope of the SEC’s final registration rules.

“The board, in general will be looking to the SEC to define the term muni adviser, just as, for example, the board looks to the SEC to define the terms broker and dealer,” Henry said. “The board is very concerned to make sure that it understands exactly who will be subject to the rules it is promulgating and not having any unintended consequences.”

Henry said that if the SEC interprets certain brokerage activities to be providing advice on investment strategies and requires those brokers to register as muni advisers,  “that certainly would have implications for MSRB rules.”

For some market participants, delay may not necessarily be a bad thing, especially if the SEC and the MSRB sharpen their requirements in response to public comments.

“There are a lot of head-scratchers out there,” said Hirata. “It’s healthy to have the discussion.”

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