WASHINGTON — The Municipal Securities Rulemaking Board is citing almost a half-dozen enforcement actions against municipal securities firms that highlight the need for its new Rule G-17 guidance, which clarifies and expands on underwriters’ fair-dealing obligations to state and local issuers.
The Securities and Exchange Commission and Financial Industry Regulatory Authority enforcement actions, outlined in an MSRB document, took place during the last three years and include firms’ failure to disclose third-party payments or conflicts of interest to issuers, among other things.
The G-17 guidance, which was approved Friday and takes effect in August, requires underwriters to disclose to issuers that, unlike municipal advisors, they do not have fiduciary obligations to issuers and are not required to act in the issuer’s best interests.
Underwriters also must disclose compensation information and conflicts-of-interest to issuers and are prohibited from recommending that an issuer not hire a municipal advisor.
In addition, underwriters must ensure issuers understand details about bond deals, regardless of their complexity.
The cases highlighted by the MSRB include two separate SEC cases in November 2009 against JPMorgan Securities Inc. and two of its former managing directors over $8.2 million the two former officials paid in 2002 and 2003 to local broker-dealers who were friends with Jefferson County, Ala., officials.
The bankers, Charles LeCroy and Douglas MacFaddin, made the payments at the direction of the county officials who selected JPMorgan as the county’s underwriter and swap provider.
JPMorgan settled the case by paying penalties of $75 million. The SEC has sued the bankers.
In another case in 2011, FINRA fined Southwest Securities Inc., now part of SWS Group Inc., $500,000 for paying five individuals, including three former municipal issuer officials in Texas, $200,000 to solicit municipal bond business for it.
The G-17 guidance says underwriters must disclose third-party payments, values, credits, profit-sharing arrangements with investors and credit default swaps.
The guidance also reminds underwriters that “certain lavish gifts and entertainment,” including those associated with issuers’ business trips to meet with credit rating agencies, might violate not only G-17 but also the MSRB’s Rule G-20, which prohibits dealers from giving issuers gifts worth more than $100.
The MSRB described two cases involving gifts and entertainment provided to issuer officials in trips they took to meet with rating agency officials for bond issues.
One was a 2009 case against RBC Capital Markets Corp. in which the SEC said the firm reimbursed itself from bond proceeds for the cost of lavish travel and entertainment for Mesquite, Texas, officials and their family members.
City officials and family members took trips in 2003 and 2004 to meet with rating agency officials. They stayed in expensive hotel suites, dined at high-end restaurants like Le Cirque and Tavern on the Green and attended Broadway shows like Mamma Mia and the Producers.
RBC Capital paid the cost of the trips — $33,452 in 2004 and $42,213 in 2005 — but recouped the money in fees it charged the city to issue bonds.
In 2004, the expenses were 8% of the city’s bond issuance costs, the SEC found.
RBC paid $125,000 to settle the charges.
The MSRB also described a 2009 SEC case against Merchant Capital LLC. in which the firm reimbursed itself from bond proceeds for the cost of issuers’ trips to rating agencies. Those trips were made by issuers, family members and friends in 2002 and 2003.
Merchant paid $55,000 to settle the case.
The MSRB cited the Justice Department’s case against CDR Financial Products and the firm’s founder, David Rubin, who pleaded guilty in December 2011 to participating in schemes to rig bids for investment and other financial contracts related to municipal bonds.
During his plea hearing, Rubin conceded he intentionally provided broker-dealer firms with information to help them win bids for these contracts and also solicited losing bids from other firms in some cases.
The firm signed certificates that falsely claimed the bidding process was competitive when it was not.
False certificates can jeopardize the tax status of the bonds, according to tax experts.
Rubin is awaiting sentencing.
The MSRB cited news stories in which cities, such as Detroit, faced hundreds of millions of dollars of termination fees tied to derivative contracts that jeopardized their finances.
In some of these cases, city officials seemed unaware of the risks that they could end up making termination payments to dealer counterparty firms and that these payments could be large and could hurt their financial condition.
The G-17 guidance requires that, if underwriters recommend complex negotiated financing, they must disclose all “material risks, characteristics, incentives and conflicts of interest.” Complex financing can include a variable-rate demand obligation with a swap.
The guidance also requires underwriters to be truthful, accurate and complete in all communications with issuers, including in written communications, such as price certificates and proposals.