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MSRB Strongly Defends Proposed Fair-Dealing Guidance

WASHINGTON — In a direct rebuke to industry groups and a push-back against two Republican Securities and Exchange Commission members who engaged in stalling tactics, the Municipal Securities Rulemaking Board on Monday vigorously defended its proposed guidance on fair-dealing for underwriters.

That proposal to revise the board’s Rule G-17, floated by the SEC for a fourth round of comments in December, would prohibit dealers from telling issuers not to hire a financial advisor. It would also require underwriters to inform issuers that, unlike municipal advisors, they are not fiduciaries. A fiduciary generally must put a client’s interests ahead of its own.

Citing the recent bankruptcy filing by Jefferson County, Ala., and the Justice Department’s ongoing probe of muni market bid-rigging, the MSRB told the SEC that undisclosed third-party payments are undermining muni market integrity and its Rule G-17 is “the cornerstone” of the board’s regulation efforts.

The MSRB also said commenters have “greatly overstated” the proposal’s potential burdens and costs, noting that issuers and their advisors must understand conflicts of interest “that might color” an underwriter’s recommendations.

“Municipal securities offerings borne of self-interested advice or in the context of conflicting interests or undisclosed payments to third parties are much more likely to be the issues that later experience financial or legal stress or otherwise perform poorly as investments, resulting in significant harm to investors and issuers, including increased costs to taxpayers,” wrote Margaret Henry, the board’s general counsel for market regulation.

The board’s letter comes after the SEC’s Republican commissioners, Troy Paredes and Daniel Gallagher, stalled the proposal in December, saying they needed more time to analyze the guidance, which a dealer group and an industry group have criticized.

The proposal had already withstood three rounds of public comments, one at the MSRB and two at the SEC. Only the third version, floated in November, contained the controversial provisions.

Those requirements were added after the SEC fielded input from the Government Finance Officers Association, which requested the revision in an October letter, and from an independent FA firm, Public Financial Management Inc.

In an Oct. 6 letter to commissioner Elisse Walter, John Bonow, PFM’s chief executive officer, warned the SEC that underwriters often prod issuers not to hire an FA and, if an issuer insists on engaging one, underwriters will push for a dealer-FA, not an independent one.

Under the Dodd-Frank Act, the SEC had to act on the MSRB’s proposed amendments by Dec. 8, which was 90 days after the original proposal’s publication in the Federal Register. Instead, the commission issued an order instituting proceedings to determine whether to disapprove the proposal, saying it had not reached any conclusions about the issues involved, and calling for more public comments.

The SEC’s order also said the proposal raised concerns about whether the proposed disclosures were “sufficiently balanced” to protect investors and issuers “'without being overly burdensome for underwriters,’” the MSRB noted.

The G-17 proposal would require two types of disclosure: the underwriter’s role and its potential or actual material conflicts, and the material financial risks and characteristics of financings recommended by the underwriter, the board wrote.

But the MSRB saw “no reasonable argument” that the proposed disclosure would prove “overly burdensome” to underwriters, who could standardize the warning by tracking the proposal’s exact language, Henry wrote.

In addition, the board told the SEC, respondants had “greatly overstated the burden” of disclosing material financial risks of recommended financings. In most cases, such disclosure would only be required in complex municipal financings, such as variable-rate demand obligations or swaps, the board said.

For routine financings, disclosures would only be required if the underwriter reasonably believed issuer personnel lacked knowledge or expertise with such structures, and would only be necessary for material aspects of the financings, the MSRB said.

Still, a dealer group and an industry group urged the SEC to refrain from acting on G-17 until the commission finalizes its permanent muni advisor registration scheme and definition.

“The single thing that is on their plate that could most improve the muni market is getting that definition out [for] municipal advisors,” William Daly, senior vice president of government relations at Bond Dealers of America, said in an interview.

Independent financial advisors figured in the Jefferson County and Harrisburg, Pa., bankruptcy filings as well as bid-rigging convictions by former employees of CDR Financial Products Inc., BDA noted in its letter.

Market participants had expected the SEC to finalize the muni advisor definition by late 2010, but in late December, the agency extended its temporary registration scheme until Sept. 30.

The rule will be finalized between July and December, according to the SEC’s website. An industry group, meanwhile, said the proposal raised “serious concerns,” including its timing and costs.

“It is of concern that the proposal is overly broad and burdensome and is not likely to produce a benefit commensurate with the associated costs,” wrote Leslie Norwood, managing director and co-head of the muni division at the Securities Industry and Financial Markets Association.

The FA, not the underwriter, should analyze the material risks and characteristics of a particular transaction and tailor any required disclosure to the issuer’s sophistication, according to SIFMA.

But the National Association of Independent Public Finance Advisors, an independent FA group, urged the SEC to adopt the G-17 proposal, so issuers could rely on “unbiased advice” and remain “in control of their debt-issuance process.”

The guidance would only apply to underwriters and would not be affected by the muni advisor definition, so there was “no rational correlation” between adopting the guidance and a final definition, wrote NAIPFA president Colette Irwin-Knott, a partner at H.J. Umbaugh & Associates LLP in Indianapolis.

An issuer group also urged the SEC to finalize the G-17 proposal quickly, saying it would protect issuers and investors from potentially fraudulent activity by dealers.

“It’s an additional burden but we don’t think it’s an unreasonable one, given the benefits to issuers,” said Eric Johansen, Portland, Ore.’s city treasurer and chairman of the Government Finance Officers Association’s debt management committee.

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