In October 2009, the Securities and Exchange Commission’s Elisse Walter publicly stated that the conduct of some municipal advisors was “alarming” and that they were engaging in “pay to play,” had undisclosed conflicts of interest, gave advice without adequate training or qualifications, and failed to place the loyalty to their clients ahead of their own interests.
Commissioner Walter asked for the authority to regulate municipal advisors and, nine months later in the Dodd-Frank Act, the SEC received that authority.
A year and a half after Dodd-Frank gave it the authority to implement the rules necessary to address this problem, the SEC has not yet regulated municipal advisors. As a result, state and local governments, their residents and taxpayers, and investors still lack the protection Congress intended them to have and that the Municipal Securities Rulemaking Board has acted to provide.
Despite this, the SEC and MSRB seem to be moving forward with additional restrictions on broker-dealers through proposed changes to the board’s Rule G-17, which would also impose further restrictions on broker-dealer municipal advisors without implementing any regulation of “independent” municipal advisors.
Stated simply, the broker-dealers and financial advisors need to be similarly regulated with appropriate recognition of the fact that financial advisors have a fiduciary duty to their issuer clients.
The first step to fix this situation is for the SEC to define who is a municipal advisor and instruct the Financial Industry Regulatory Authority to enforce the rules as they relate to the advisors.
Broker-dealers, including muni advisors who work for broker-dealers, have been regulated for years. In the meantime, the lack of rules for municipal advisors not only puts state and local governments and investors at risk, it creates a playing field that is not level.
Until this situation is remedied, efforts to revise Rule G-17 should be put on hold.
As indicated, broker-dealers, including municipal advisors who work for broker-dealers, have long been subject to the scrutiny of the SEC, the MSRB and FINRA.
The requirements include licensing requirements, periodic compliance examinations, supervision, and rules related to record retention, disclosure of conflicts, restrictions on political contributions and financial disclosure as well as obligations of fair-dealing and best execution.
There is no reason that the same types of rules should not be extended to municipal advisors, yet until the definition of “municipal advisor” is adopted, that will be the case.
The proper functioning of the market and the protection of issuers can’t be accomplished when one group of participants is regulated and another is not.
Municipal advisors and underwriters interact with each other and they interact with issuers. Issuers are in an uncertain position if underwriters and some financial advisors are regulated, but other FAs are not.
Further restriction of broker-dealers through changes to Rule G-17 before providing rules to identify municipal advisors and implementing rules related to their fiduciary duty and minimum qualifications seems inappropriate.
It is not enough simply to assert that municipal advisors are fiduciaries. Conduct that is inconsistent with being a fiduciary must be spelled out and banned.
Except to the extent covered by Rule G-17 — that is, as a broker-dealer — independent municipal advisors remain essentially unregulated. For example, such advisors have no requirement to disclose conflicts of interest.
An unregulated nondealer municipal advisor may have, or may arrange for, services for its issuer clients. They include investment advice, non-securitized loans, swap advisory services, arbitrage rebate services and recruiting services for municipal professionals — all of which have the potential to influence the advice the nondealer advisor provides.
An unregulated municipal advisor may also contribute to political campaigns without limitation, raising pay-to-play questions.
The statement that municipal advisors have a fiduciary duty would naturally lead an issuer to conclude that they do not engage in, or at least must disclose these types of conflicts.
Unfortunately, until the SEC and MSRB define “municipal advisor” and specify the duties imposed on them, there is nothing that so limits unregulated advisors.
That situation does a great disservice to issuers and can easily mislead them. Given this situation, further ramping up the restrictions on non-fiduciary broker-dealers should not occur at this time. As a result, the situation is worse now than prior to the passage of Dodd-Frank or when Walter gave her speech.
More than one year after the enactment of the Dodd-Frank Act, and despite the work by the MSRB on writing a definition, virtually anyone can claim to be a municipal advisor, regardless of qualifications, political contributions or conflicts of interest. This is exactly the opposite of what Dodd-Frank intended.
The bottom line is that the SEC needs to move forward on a definition of municipal advisor so that investors and state and local governments can get the protection that Congress intended.
Until such rules are put in place, further regulation of broker-dealers under Rule G-17 should be delayed.
Mike Nicholas is chief executive officer of the Bond Dealers of America. The Washington, D.C.- based organization represents securities dealers and banks predominantly focused on the U.S. fixed-income markets.