FORT LAUDERDALE, Fla. The Government Finance Officers Association's debt committee on Saturday proposed guidance that strongly discourages an issuer from allowing a dealer-financial adviser to switch roles and become the underwriter in a negotiated municipal bond transaction.
The guidance, which the committee proposed as additions to two recommended practices because of concerns about "inherent conflicts of interest" in such role switching, would go further than the Municipal Securities Rulemaking Board's Rule G-23 and is opposed by bond dealer trade groups.
However the revisions to the recommended practices one on the selection of FAs and the other on the selection of underwriters for negotiated transactions must be approved by the GFOA's executive board, which is expected to take them up at a meeting in the fall, in order for them to become guidance.
The MSRB's Rule G-23 permits such a role change as long as the dealer-FA discloses to the issuer that conflicts of interest might exist and obtains its consent for the switch, among other things.
The National Association of Independent Public Finance Advisors has repeatedly pushed the MSRB in recent years to tighten the rule and make it more restrictive, but the board has declined to do so.
For more than a decade, the GFOA has warned in its existing recommended practice on the selection of financial advisers that dealer-FAs that become underwriters in the same negotiated deals pose real conflicts if interest. The group has urged issuers to enact written policies on whether, and under what circumstances, they will permit a dealer-FA to switch roles.
In a separate RP on the selection of underwriters for negotiated bond sales, the committee has also stressed that issuers should be aware that the roles of the underwriter and the FA are "separate" and "adversarial."
But on Saturday, the debt committee moved to strengthen its warning about such conflicts of interest by editing the background sections of each RPs and adding the statement: "It is the intent of this RP to set a higher standard than is required under MSRB Rule G-23, because disclosure and consent are not sufficient to cure the inherent conflict of interest."
The issue comes before the GFOA after the MSRB has twice since 2005 declined to adopt NAIPFA recommendations and revise G-23 to require a dealer-FA contemplating a role switch to: disclose to the issuer that conflicts of interest exist (rather than that they might exist); obtain explicit, formal consent from the issuer's policy makers that the role switch and conflicts of interest are acceptable; and completely terminate its financal adviser role with the issuer once it becomes underwriter, unless the issuer contemporaneously employs more than one FA. On both occasions, most recently last fall, the MSRB said that there was no evidence of systemic problems that warranted changing the rule.
But at the debt committee meeting, several committee members said they feel it is "inappropriate" for a financial adviser on a negotiated sale to resign his position and become the transaction's underwriter.
Offering a counter-view, one member of the committee said there are lots of small transactions done by small- and medium-sized issuers in which a role switch may make business sense. An issuer should be able to decide if it is in his interest to allow it, he said.
And representatives of the broker-dealer community strongly urged the committee to resist adding overly restrictive advice to issuers.
Leslie Norwood, managing director and associate general counsel at the Securities Industry and Financial Markets Association, complained that the proposed language in both RPs suggests that an issuer should hire a financial adviser, which creates a presumption that the governmental entity has acted improperly if it has legally consented to a dealer resigning as its FA and then serving as underwriter.
Addressing the committee meeting, she noted that dealer-FAs unlike independent FAs are regulated by both the Securities and Exchange Commission and the MSRB, whose Rule G-20 on gifts limits contributions in excess of $100 per year to issuer officials or other outside persons in relation to municipal securities activities.
To level the regulatory playing field between dealer-FAs and independent FAs, she urged the committee to include in its RP on FAs the $100 cap on gifts that is in Rule G-20.
Ultimately, the committee added language to that RP that said issuers, when soliciting requests for proposals from FAs, should consider whether to require the disclosure of gifts, political contributions, or other financial arrangements in compliance with state and local government laws. But they declined to include the $100 cap in deference to a variety of state laws, some of which are less restrictive and contain $50 caps, committee members said.
In a statement released Sunday, the securities industry group said: "SIFMA is pleased that the GFOA's Debt Committee today approved changes to the Recommended Practice for Selecting Financial Advisors that begin to level the playing field between regulated broker-dealers serving as financial advisers and unregulated financial advisers.
Regulated broker-dealers, pursuant to MSRB rules, are banned from using consultants to obtain municipal securities business, are generally prohibited from giving political contributions to issuer officials and are covered by gift limitations. Unregulated financial advisers are not covered by these rules; disclosure of such activities is important for governmental issuers of municipal bonds to be aware of potential conflicts of interest from those firms vying to be their financial adviser."
Michael Decker, the co-chief executive officer of the Regional Bond Dealers Association, took issue with another noteworthy addition to the RP on FAs that recommends contracts with dealer-FAs feature so-called lockout periods that would prevent dealer-FAs from serving as underwriters on the same negotiated deals where they were FAs.
Decker, who also addressed the committee as an observer, said that the lockout provision could have the unintended effect of requiring dealers to choose between being solely an FA or an underwriter, which would limit competition among dealers and could lead to higher costs for issuers.
Despite Decker's concerns, the committee approved the RP with the lockout language intact.