WASHINGTON — The Municipal Securities Rulemaking Board Tuesday said it is contemplating a rule change that would prohibit dealers from underwriting new negotiated or competitive bond issues if they have served as the issuer’s financial adviser on the transaction.
The MSRB is seeking public comment on the
The proposal comes at the request of the Securities and Exchange Commission chairman Mary Schapiro, who said in a May speech: “This is a classic example of conflict of interest. … The board should change G-23 and forbid this practice.”
MSRB executive director Lynnette Hotchkiss also noted that the draft changes come three weeks after financial regulatory reform legislation was enacted requiring that the board oversee muni financial advisers and require them to adhere to a fiduciary duty rule.
“All financial advisers — dealers that act as advisers as well as independent advisers — will have a fiduciary duty to their issuer clients under the new federal financial reform law and removing any real or perceived conflicts of interest in such transactions is more important than ever,” Hotchkiss said in a statement.
Though industry groups have said they believe the existing rule is fair and effective, issuers and non-dealer FAs have echoed Schapiro in warning that such role switching is fraught with conflicts of interest. Guidance approved by the Government Finance Officers Association in 2008 warns of an “inherent” conflict while the National Association of Independent Public Finance Advisors has routinely called on the MSRB to tighten the rule. Since 2006, the board has twice declined to do so.
Currently, the rule allows dealer-FAs to become underwriters in negotiated transactions if they disclose to the issuer possible conflicts of interest stemming from the role switch, disclose their expected compensation, and obtain the issuer’s consent to the switch. In competitive deals, dealer-FAs must obtain the issuer’s written consent before bidding on the bonds.
The rule also currently requires dealer-financial advisers that become underwriters or syndicate members to disclose the existence of their FA relationship with the issuer to customers who want to purchase the bonds.
But in seeking to prohibit such role-switching, the provisions regarding disclosures, terminations and consents become “unnecessary and are eliminated,” the board said in a notice Tuesday morning describing the draft proposal.
However, the draft proposal would add language to the rule that would allow dealer-FAs to switch roles in narrow circumstances, such as for certain financing transactions with governmental entities, like local government bond banks, where an FA may assist in placing an issuer’s note or bond with a governmental entity. But this role-switching would only be allowed if the dealer-FA does not receive compensation other than for its FA work and does not receive compensation for underwriting any contemporaneous transaction “directly or indirectly” related to the placement with the government agency.
Though no dealer-FA would be allowed to serve as a remarketing agent on a new issue for which it has worked as financial adviser, the dealer-FA would be allowed to serve as “successor remarketing agent” on the issue at a later date as long as the FA relationship has been terminated for at least one year.
The board is seeking comment on several specific topics, including whether a dealer should be precluded for a specific timeframe from entering into an FA relationship with an issuer after underwriting one of the issuer’s prior debt offerings. It also asks if there should be an exception from role-switching for dealer-FAs that participate in competitively bid transactions.
“Should a financial adviser be allowed to bid in a competitively bid transaction in which a failed bid had occurred?” the MSRB also asked. “How would the situation be handled in which there is a failed bid and the financial adviser cannot step in to buy the bonds because of the prohibition? Is this a common occurrence?”
