The Government Finance Officers Association's executive board on Friday adopted 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, stemming from concerns about "inherent conflicts of interest" in such role switching, was formally adopted Friday at the group's board meeting in Chicago. It came about four months after the group's committee on governmental debt management proposed it in two recommended practices - one on the selection of FAs and the other on the selection of underwriters for negotiated transactions.
Adoption of the GFOA guidance is noteworthy because bond dealer trade groups oppose it and because it goes further than the warnings in the Municipal Securities Rulemaking Board's Rule G-23, which says only that conflicts may exist.
The Securities Industry and Financial Markets Association has criticized the language in both RPs that suggests that an issuer should hire another FA if the dealer-FA resigns in a negotiated sale to become underwriter, because it creates the presumption that the governmental entity has acted improperly if it has legally consented to the dealer's switch in roles.
Still, the guidance was met with a supporting resolution on Friday from the National Association of Independent Public Finance Advisors, which has repeatedly pushed the MSRB in recent years to make Rule G-23 more restrictive. The board has declined to so, contending such changes are not warranted.
For more than a decade, the GFOA has warned that dealer-FAs that become underwriters in the same negotiated deals pose real conflicts of 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.
The group has also stressed that issuers should be aware that the roles of the underwriter and the FA are "separate" and "adversarial."
But the GFOA debt committee moved over the past year and a half to strengthen its warnings about such conflicts of interest by breaking up a single RP on requests for proposals for the selection of FAs and underwriters for negotiated bond sales into two separate documents. They now now each include this 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."
Frank Hoadley, the Wisconsin capital finance director and chairman of the debt committee, said yesterday that the intent in separating the single RP into two documents was to better distinguish the difference in the fiduciary responsibilities of the two roles.
Meanwhile, the GFOA action comes 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 financial adviser role with the issuer once it becomes underwriter, unless the issuer simultaneously employs more than one FA.
Robert Doty, president of the financial advisory firm American Governmental Financial Services Co. in Sacramento and former vice president of NAIPFA, said there are several dealers who "follow the routine practice" of using their status as an FA as "an employment device," signing on as FA in order to obtain business as the issuer's underwriter.
"There are some dealers who do this, and I'm not going to name any names, but there are certain segments of the country where it is accepted practice," he said.
But Leslie Norwood, SIFMA's managing director and associate general counsel, said yesterday that the broker-dealer group believes there should be a level playing field between dealer-FAs, which are regulated by the Securities and Exchange Commission and the MSRB, and independent FAs, which are not. She added that G-23 was adequate for managing potential conflicts of interest.
"Part of working in the financial markets is managing potential conflicts of interest," she said. "They exist everywhere, and as long as there's enforcement of G-23, which SIFMA believes there is, we feel that that provides an adequate safeguard and disclosure regime for managing potential the conflicts of interest."