WASHINGTON — Small financial advisory firms face the most challenges adapting to the new rules and guidance governing municipal advisors, with some predicting that many of the smallest MAs will be forced to go out of business.
The Securities and Exchange Commission's municipal advisor registration rule becomes effective July 1, and the Municipal Securities Rulemaking Board has proposed rules governing conduct, supervisory requirements, and qualification exams for MAs.
Although financial advisors who provide advice to state and local governments have known since 2010 that they will be required to register as MAs with the SEC and MSRB, the requirements of the new regime are posing some challenges for firms as the regulations become reality.
"Nobody knows what the final outcome is going to be," said David Medanich, vice chairman and leader of the advisory practice at FirstSouthwest in Fort Worth, Tex. FirstSouthwest has more than 1,700 clients nationwide, Medanich said, and part of the firm's preparation for the effectiveness of the MA rule has been to discuss the issue with its municipal clients. Some larger issuers have said publicly that they'd prefer to live without the restrictions on underwriter-issuer communications imposed by the rule.
Dealers, which have historically pitched deals and transaction options to issuers, are concerned such discussions could now constitute advice in some cases and cause them to become MAs who have a fiduciary duty and could not underwrite any resulting bonds. Some issuers have said they like getting the ideas from bankers, but Medanich said his clients do not seem concerned.
"I've heard some of my clients say: 'these MA rules might not be so bad,'" he said.
Dealer-affiliated advisors like FirstSouthwest have already been subject to some of the MSRB regulations that will soon be imposed on non-dealer advisors for the first time, and have already been required to have supervisory systems in place and to abide by restrictions on political contributions. Even so, they have had to invest time and money in compliance efforts. Medanich said he has sat through a number of meetings about the rules with Securities Industry and Financial Markets Association officials and with John Cross, the head of the SEC's muni office. When the MSRB and then the SEC approve an MA exam rule, Medanich and other dealer MAs will need to take and pass a test.
"I have five securities licenses I have to get continuing education for," Medanich said. "Now it looks like I may get to do another one."
Steve Apfelbacher, a financial advisor and president of non-dealer firm Ehlers in Minnesota, said his office is restructuring to meet the eventualities of MA regulation. Apfelbacher said his firm has designated MA principals responsible for supervision, as the MSRB has proposed requiring, and is in the midst of developing written policies and procedures to ensure compliance with the MA rules.
"I think it's starting to sink in," Apfelbacher said, noting that regulation of MAs will affect the entire muni business. Apfelbacher said that he has made some effort to educate some of his clients on what the rule might mean for them, he does not anticipate the daily working relationships to change. Apfelbacher said the major overhaul could be a financial strain. Unlike dealer advisors, non-dealer advisory firms are not used to having a mandatory framework for extensive rule compliance. Firms will also be required to retain nearly all records of communications with clients for five years, a potentially large effort.
"The question starts to become 'how do you do all this stuff and continue to be profitable?'" Apfelbacher said.
Joy Howard runs one-woman advisory firm WM Financial Strategies in St. Louis, Mo. Howard said the record keeping requirements mean more work time for her. She took some of her record-keeping to electronic platforms in recent years, but her habit has long been to save virtually every scrap of paper from her interactions with clients.
"Now I have to scan it and put it in my file," she said.
Howard also said she is concerned about the possibility of the MSRB's suggestion in its proposed conduct rule that it may require MAs to carry liability insurance, or at least disclose that they do not have such insurance. Howard said that even if she decided to pay for liability insurance she has been unable to locate an insurance company that offers a policy like that.
"I'm not sure that such an animal exists," she said.
Howard said that if the MSRB does end up requiring insurance, she knows some older sole proprietor advisors who have said they would simply retire rather than go through the trouble of compliance.
Robert Doty, president and proprietor of consulting firm AGFS in Annapolis, Md., predicted that many muni advisory firms will disappear in the near future following the implementation of the rules.
"I think there will be a substantial change in the lives of municipal advisors, and for quite a few of them it will be somewhat of a shock," Doty said.
The compliance issues and the increased costs associated with them will cause an immediate impact, Doty said, leading many MAs to shut down.
"I think that a lot of the municipal advisors will merge with other firms to share compliance costs," he said.
Doty merged his own FA business with another firm after the Dodd-Frank Act was enacted, becoming counsel to the executive team at Government Financial Strategies in Sacramento while maintaining AGFS as a separate consulting firm. Dodd-Frank subjected municipal advisors to federal registration, regulation, oversight and enforcement. Doty said the move was made due to time and cost burdens, and because GFS had an infrastructure capable of providing the necessary range of services. Doty left GFS after relocating his business to Annapolis, Md. a few months ago.
Doty also predicted a longer-term impact from the fiduciary duty requirement imposed on MAs by Dodd-Frank, which means that MAs must put the interests of their municipal entity clients ahead of their own. Doty said that while there are many excellent advisory firms, too many others focus on deal-making rather than advising. The SEC has the power to bring enforcement actions against MAs for violating securities laws, including the fiduciary duty, and the Financial Industry Regulatory Authority will be able to penalize firms who violate MSRB rules.
