Dodd Bill Would Bring Munis to Forefront
WASHINGTON — Senate Banking Committee chairman Christopher Dodd yesterday introduced a massive, reworked financial regulatory reform bill that would require the head of the Securities and Exchange Commission’s municipal securities office to report directly to the SEC chairman, significantly raising the profile of the muni market.
While the municipal securities section is not a major portion of the 1,336-page draft bill, it would fundamentally change the way the market is regulated by requiring muni financial advisers, swap advisers, and investment brokers to register with the SEC and comply with rules issued by the Municipal Securities Rulemaking Board.
The measure includes broad language that could be interpreted to suggest the MSRB may have regulatory authority over state and local pension fund placement agents, though it was unclear yesterday if that was the intent of the bill.
While some Republicans had called for a longer deliberative process, Dodd said during a press conference that financial regulatory reform must move forward because there is actually very little time left — only about 60 or 70 legislative days before the Senate adjourns ahead of the November mid-term elections. The Connecticut Democrat vowed the Senate would pass a bill this year and said he expects the committee to begin voting on the measure next week.
However, one crucial piece of the bill on the regulation of over-the-counter derivatives is still being fleshed out by Sen. Jack Reed, D-R.I., and Sen. Judd Gregg, R-N.H. Sources said yesterday that a new version of the OTC derivatives language would be proposed by the two senators as early as Friday, ahead of next week’s markup.
Under the original proposal, states and localities would only be deemed eligible contract participants for interest-rate swap and other OTC derivatives transactions if they held $50 million in discretionary investments, excluding bond proceeds. Several market participants warned this provision would restrict too many issuers from hedging their debt and said it makes little sense to base a municipality’s sophistication on the size of its investments instead of the amount of bonds they sell.
Dodd’s proposal maintains the same composition of the 15-member MSRB as he originally floated in an earlier draft of the bill in November. Under his proposal, the board will consist of no fewer than eight “public” members, including at least one representative of institutional or retail investors, one issuer official, and one muni expert.
The remaining seven members would consist of at least one representative from a securities firm, one from a bank firm, and one from a non-dealer municipal adviser.
By statute, the MSRB is currently comprised of representatives of 10 dealer firms, plus five public members, including one representative of investors and one of issuers.
The new proposal generated measured reaction from non-dealer FAs, some of whom had pushed lawmakers to give them the same number of seats as dealers on the MSRB. Dodd’s staff rejected that idea late last week, though it appeared to gain some degree of support among Republican members of the banking committee.
Sen. Bob Corker, R-Tenn., Dodd’s primary Republican negotiating partner, said there are several provisions in the bill’s major sections that he cannot not support, but that he will continue to work with Dodd to achieve bipartisan support for the bill.
One independent FA who asked not to be named cautioned the proposal would not regulate advisers to “obligated persons” or borrowers — potentially a big loophole, in that advisers for conduit borrowers would be excluded from MSRB regulations. The FA added, however, that this may simply be a drafting error.
Robert Doty, president of the American Governmental Financial Services in Sacramento, said his preliminary view of the new proposal is that it reflects progress in some areas, but added: “We still have a ways to go to professionalize the municipal advisory profession the way that we need it to be professionalized.” He declined to address specifics of the proposal until he has had more time to review the bill.
An MSRB spokeswoman declined to comment, saying the board is still reviewing the proposal.
The decision to elevate the SEC’s office of municipal securities was a surprise addition to the bill that significantly alters the importance of the office because it ensures the muni director has the ear of the SEC chairman. The proposal had not been included in Dodd’s draft bill, nor in the House’s bill that cleared that chamber in December.
In addition to reporting to the chairman, Dodd calls for the SEC’s muni chief to coordinate with the MSRB for “rulemaking and enforcement actions as required by law.”
Currently the office is part of the SEC’s division of trading and markets, and is made up of just two full-time employees, Martha Mahan Haines, its director, and Mary Simpkins, senior special counsel. The office recently began looking for two attorney-fellows to fill two-year positions that could be renewed for an additional two years at the option of the commission.
Former SEC chairman Arthur Levitt yesterday praised the proposal to heighten the priority of the muni office as “a very constructive part of the bill” that establishes the importance of the office “rather than having it as a backwater, which is what it has been in the past.”
Though the legislation does not recommend specific staffing levels, Levitt said the office should include “many more” people.
“With more and more investors going into muni bonds, it’s essential that they get the same protection that investors in any other kind of investments receive ... and that means the SEC has got to have greater responsibility for the muni market, including by having that department report directly to the chairman,” he said.
Levitt, who served as SEC chairman from 1993 to 2001, created a stand-alone muni office that reported to him in March 1995, in the midst of a campaign to reform the municipal market by increasing disclosure and price transparency and by cracking down on conflicts of interest and other abuses.
But in 2000, after the departure of its director, Paul Maco, now a partner at Vinson & Elkins LLP here, the office was merged into the SEC’s division of market regulation, now the division of trading and markets. Since then, the staff of the office has been cut from a one-time high of seven people.
Maco said of the new office: “It will allow the director to bring matters to the attention of the chairman and the commissioners unfiltered through the potentially different priorities of several layers of supervisors.”
The muni section sidesteps some of the more controversial calls for reform in the municipal market, such as the repeal of the so-called Tower Amendment, which was added to the Securities and Exchange Act of 1934 and restricts the MSRB and SEC from collecting offering documents prior to bond sales.
Instead, it would direct the Government Accountability Office to submit a report within one year of enactment that compares muni and corporate disclosure requirements and evaluates the costs and benefits to issuers of requiring them to improve disclosure. The report must also recommend whether Tower should be repealed.
The GAO also would have 180 days to conduct a study of the municipal securities markets, including how to improve the transparency, efficiency, fairness, and liquidity of trading of the municipal securities market, by examining the quality of trade executions, market transparency of trade reporting, price discovery, settlement clearing, and credit enhancements. The study appears much broader than one on trading transparency that Dodd originally called for in his November draft.
The GAO also would have 270 days to examine the Governmental Accounting Standards Board, its funding, and whether legislative or other changes are needed.q
The bill also would create a new Office of Credit Ratings at the SEC without its own compliance staff and the authority to fine the agencies. The commission would be required to examine national recognized statistical rating organizations at least once a year and make key findings public.
The rating agencies would have to disclose their methodologies, their use of third parties for due diligence efforts, and their rating track records. Their compliance officers would be prohibited from working on ratings, methodologies, or sales. Investors would be able to sue rating agencies for a knowing or reckless failure to conduct a reasonable investigation of the facts or to obtain analysis from an independent source. Regulators would have to remove unnecessary references to NRSRO ratings in their regulations.
In addition, under the bill the SEC would be self-funded and would no longer be subject to the annual appropriations process. The bill also would create a program within the SEC that would reward whistleblowers with up to 30% of the funds recovered from information they provided.
The bill would require the commission to study whether brokers who give investment advice should be held to the same fiduciary standard as investment advisers and should have to act in their clients’ best interest.