WASHINGTON — The Municipal Securities Rulemaking Board plans to soon file rule changes with the Securities and Exchange Commission that would eliminate the current practice of allowing a dealer-financial adviser to resign as FA and then underwrite the same muni securities transaction.
The proposed changes to Rule G-23 will be essentially the same as draft changes floated in August to ban role-switching for both negotiated and competitive transactions, MSRB general counsel Ernesto Lanza told reporters Monday in a conference call to discuss the highlights of the board’s meeting last week at its Alexandria, Va., headquarters.
However, Lanza said the MSRB would propose a delayed phase-in to allow for “orderly change” to issuers that already have transactions lined up.
Once the rule is submitted to the SEC, it will be subject to another round of public comments before it can be implemented.
Last week’s meeting was the 21-member board’s first since it was reconstituted as a majority-public self-regulator on Oct. 1 under the Dodd-Frank Wall Street Reform and Consumer Protection Act and temporarily expanded from 15 members.
The board also now oversees municipal advisers — including FAs, swap advisers, placement agents and guaranteed investment contract brokers — and must protect issuers as well as investors as part of its congressional mandate.
The MSRB had reviewed Rule G-23 twice in the past four years, in 2006 and in 2008, and each time found no “systemic problems” that warranted a change, in May. But SEC chairman Mary Schapiro called on the board to alter the rule, deriding such role-switching as a classic conflict of interest.
Many dealer-FA firms and bond attorneys had asked the MSRB for an exemption from any role-switching ban for small, competitively priced transactions.
But MSRB chairman and First Southwest Co. vice chairman Michael Bartolotta, who led the call, said the board decided a full ban was “the best approach for market integrity” and would “eliminate what could be perceived as a conflict of interest for dealers, and I stress the words 'could be perceived.’ ”
The Government Finance Officers Association has drafted guidance that already goes beyond Rule G-23, warning against role-switching because of its concerns about the ability of dealer-FAs to hold issuers’ best interests ahead of their own. Many issuers avoid this concern altogether by hiring independent, non-dealer FAs, the GFOA noted in a comment letter filed with the board in September.
But Leslie Norwood, managing director and associate general counsel at the Securities Industry and Financial Markets Association, said that while SIFMA is eager to see the text of the rule that will be proposed to the SEC, it believes the existing one already represents “a comprehensive and balanced approach to conflicts of interest and has a long history of success.”
Norwood said SIFMA had hoped that the draft would contain exemptions for small issuers and conduit borrowers, as well as a transition period. In its comment letter to the board, SIFMA suggested the current rule apply to financial adviser relationships that are in place when the proposed rule is adopted and continue for their duration.
Bill Daly, senior vice president of government relations at Bond Dealers of America, said there is no reason to restrict financial advisers from bidding on competitive deals. He said the MSRB could require enough notice to the public so that there is fair competition and the dealer-FA wouldn’t have an unfair advantage in bidding on the transaction.
“We also think that in many cases, as issues get smaller, the number of bidders gets less and less,” Daly said. “If you exclude the FA from being a bidder on small deals, you’re cutting into or restricting the competition.”
Specifically, the rule allows a dealer-FA to become underwriter on the same negotiated bond deal if it discloses to the issuer possible conflicts of interest stemming from the role switch, as well as its expected compensation, and if it obtains the issuer’s consent.
For competitive deals, dealer-FAs must obtain the issuer’s written consent before bidding on the bonds.
Bartolotta also said the board agreed to several administrative rule changes that will apply to municipal advisory firms, which the MSRB began to oversee at the beginning of the month.
He said the board will establish a registration system for advisers by about the middle of November.
The registration system for advisers comes on top of a system already established by the SEC.
The MSRB decided to propose requiring adviser firms to pay an initial fee of $100 and an annual fee of $500 under Rules A-12 and A-14 respectively.
Other administrative and definitional rules that the board will propose to extend to advisers include Rule G-17 on fair dealing, Rule A-7 on the board’s assessment authority, and Rule A-8 on rulemaking.
Officials said the board expects to file the rule changes with the SEC early next month. It also is working on elaborating on a fiduciary duty that went into effect Oct. 1, but only touched on that discussion at its meeting last week, Lanza said.
Asked about how the MSRB will juggle its mandate to protect issuers with its existing mission of protecting investors, given that the two different groups often disagree on many hot-button issues like disclosure, Bartolotta said “it’s going to be a fine line.”
“First of all, we don’t regulate issuers,” he said. “Right now, we’re doing kind of information collection ... on things we can do to help issuers, possibly giving them alerts to things that are happening, like, 'Take a look at your rating contract before asking for a rating.’ Stuff of that nature, things that we see in the industry as informational.
“But right now we’re in the very embryonic stage of figuring out what issuer protection is and means,” he added.
Bartolotta noted that the new board met separately with SEC commissioner Elisse Walter, who is leading the agency’s muni field hearings, as well as Financial Industry Regulatory Authority chairman and chief executive officer Richard Ketchum.
The meetings were designed largely to introduce the officials to the new board members and to discuss “how to go about working together” on their new mandates under the Dodd-Frank law, Bartolotta said.
Faced with a packed schedule for the coming year, the MSRB plans to hold an extra meeting at the beginning of December, on top of its regular quarterly meeting in January, he said.
The board also plans to hold two outreach events for market participants, one in New York on Nov. 2 and another in Chicago on Dec. 6.
