WASHINGTON — An amendment to financial regulatory reform legislation that would impose a broad fiduciary duty on financial services firms when they give advice and recommendations to public entities and pension funds is pitting dealers against advisers in the municipal market.
Advisers hail the amendment, which was sponsored by Sen. Barbara Boxer, D-Calif., saying that it will bring long-needed protection to issuers who are drawn into a relationship of trust and confidence with dealers.
They argue that it is one thing for dealers to provide general information to issuers, but if they go beyond that and tell them what is in their best interests, they need to accept responsibility for that advice and put the interest of the issuer before their own.
The dealer community warns that Boxer’s proposal would impose an inappropriate or unworkable duty of care for arms-length transactions and will have the effect of ending the process of selling bonds on a negotiated basis. They also argue that dealers acting as advisers already have to follow a fiduciary duty imposed at the state level.
“While Sen. Boxer is trying to provide a degree of protection, really in the end the effect of the amendment would be less choice, poorer market access and higher costs,” said Michael Decker, managing director and co-head of the municipal securities division at the Securities Industry and Financial Markets Association.
Decker’s view is at odds with financial and swap advisers, who contend the amendment would not extend to arms-length transactions. They note that, under the amendment, the fiduciary duty would only be triggered if the financial services provider gives individualized advice or recommendations, and not if they sell a “standard product.”
“Boxer has made it perfectly clear this only speaks to when giving advice tailored to the needs of the issuer and it would not ever apply in the context of an arms-length transaction,” said Robert Doty, president of American Governmental Financial Services Co. in Sacramento, referring to a summary of the amendment released by Boxer’s staff.
But Decker countered that if the amendment were enacted, it would be impossible for dealers to serve as underwriters in a negotiated transaction. Such deals accounted for 85.2%, or $348.9 billion of all muni issues sold last year, according to Thomson Reuters. Dealers in negotiated sales typically provide opinions on the structuring of the security, cash flows, timing and interactions with credit rating agencies — all services that would be considered tailored advice under the amendment, Decker said.
Asked if there is not a way dealers could underwrite a security on a negotiated basis without providing any advice, he said: “If an issuer came to a dealer and said, 'I’ve got this deal, it’s fully structured, cash flows are as described, the bonds have a rating, the disclosure documents are fully prepared — will you buy these bonds from me and underwrite the deal on those terms.’ ”
“That kind of relationship doesn’t exist currently in the market,” Decker added, “and I don’t know that there would be dealer firms that would be willing to participant in the market under those circumstances as negotiated underwriters.”
With more than 120 amendments submitted for consideration by the full Senate, it is unclear when or if the Boxer measure will come up for a vote. Lawmakers hope to pass the full bill before Memorial Day. Boxer’s office did not respond to requests for comment on the timing of a vote.
But the uncertainty of whether the amendment will even come up for a vote is not stopping market participants from voicing their support or opposition for it.
In a letter sent to Boxer yesterday, the Regional Bond Dealers Association said that it strongly opposes the amendment, which it warned would “undermine ... the very nature of a market transaction between two parties.”
“Obviously, parties should deal fairly with one another and can be required to disclose relevant and material facts,” RBDA chief executive officer Michael Nicholas wrote. “In fact, the Municipal Securities Rulemaking Board’s Rule G-17 already requires dealers to deal fairly, which in an arm’s-length transaction is the appropriate standard. Certainly misrepresentation and fraud are already illegal. But imposing a fiduciary relationship goes far beyond those requirements.”
However, Doty, along with Peter Shapiro, managing director of Swap Financial Group in South Orange, N.J., issued a joint release arguing that Boxer’s amendment should “supplant” other fiduciary-duty proposals in regulatory reform legislation, such as one that would require swap dealers to be held to such a duty when they pitch, advise or enter into swap agreements with public entities.
That provision was included in legislation to regulate the over-the-counter derivatives market that cleared the Senate Agriculture Committee last month and is to be merged with broader financial regulatory reform legislation approved by the Senate Banking Committee in March.
The Boxer amendment, Shapiro said, “makes key distinctions that other proposals have missed in terms of the appropriate roles of financial and swap advisors to issuers.”
The amendment “recognizes that the roles of underwriters and swaps dealers serving as principals or counterparties are not fiduciary roles,” he said. “Because earlier proposals have mixed the concepts inappropriately, [this amendment] should supplant all other sections of the financial reform package relating to fiduciary duties of underwriters and financial products marketers.”
Doty said the amendment also is important because there is currently no legal requirement that even suggests an underwriter might provide advice to an issuer, except for the MSRB’s Rule G-23 on dealer-financial advisers. But that rule is silent on the standard of care dealers face for providing advice.
Under G-23, which Doty and Shapiro said would likely have to be repealed if the amendment is signed into law, a dealer-FA is able to resign as FA to underwrite an issuer’s negotiated transaction as long as it discloses conflicts of interest may exist.