MSRB Filing Details MAs' Fiduciary Duties to Clients

WASHINGTON — The Municipal Securities Rulemaking Board has filed a proposed rule and interpretive notice with the Securities and Exchange Commission that details how municipal advisors would have to comply with their fiduciary duty to put the interests of issuers and other clients first.

Independent and dealer muni advisors acquired a fiduciary duty to clients on Oct. 1, 2010, under the Dodd-Frank Act. But proposed Rule G-36 and the interpretative notice, which contain requirements for carrying out that provision, would not take effect until either the effective date of the SEC's final registration rules that define the term "municipal advisor," or a later date, if that is when the commission approves the proposed rule.

"We are proposing that municipal advisors be required to put the interests of state and local governments first," said MSRB executive director Lynnette Hotchkiss. "This goes a long way in ensuring the interests of state and local governments are protected and lays a solid foundation for disclosing conflicts of interest and establishing an appropriate duty of care for financial transactions."

The proposed Rule G-36 is very simple, stating: "In the conduct of its municipal advisory activities on behalf of municipal entity clients, a municipal advisor shall be subject to a fiduciary duty, which shall include a duty of loyalty and a duty of care."

Municipal entities would include issuers and pension funds, but would not include corporate borrowers in conduit deals, so muni advisors would not owe corporate borrowers a fiduciary duty.

The interpretative notice, which is similar to the draft the MSRB issued in February, contains detailed requirements for carrying out the fiduciary duty.

Under the duty of loyalty, the notice says a muni advisor must disclose material manageable conflicts of interest "of which it is aware after reasonable inquiry" and obtain written consent for them from the issuer, pension fund, or other municipal entity client. The kinds of conflicts that must be disclosed include muni advisory payments made to obtain or retain advisory business; payments from third parties to enlist the advisor's recommendation of their services to an issuer; the form of compensation for an advisory engagement; and other engagements or relationships that might impair the muni advisor's ability to act in the best interests of its issuer or other clients.

Muni advisors would be prohibited from engaging in activities that create unmanageable conflicts of interest, such as kickback or fee-sharing arrangements with providers of investments or other services to issuers. They also would be barred from acting as principals with issuers on the same transactions on which they are advising, with certain exceptions — an expanded list from the draft rule.

One exception is that if a muni advisor has a limited advisory role and is providing advice on investments, it can sell the issuer the securities for investment. An advisor also could engage in activity permitted under G-23 on financial advisor activities, and it could serve as a swap counterparty to an issuer if the issuer is represented by an independent swap advisor.

A muni advisor also would have to disclose in writing the compensation it receives as well as any received by affiliates and scope of services to be performed. The MSRB warns muni advisors that they would violate G-36 if they obtain "excessive compensation."

Under the duty of care, the MSRB notice warns advisors that they must only undertake engagements for which they have the necessary expertise. A muni advisor, for example, would not be able to advise an issuer on a swap unless it has sufficient knowledge to be able to evaluate the transaction, its risks, pricing, and appropriateness.

Advisors also would have a duty to investigate and advise issuers on reasonably feasible alternatives to proposed financing structures or products if they would better serve the interest of the issuers.

An advisor would have to make a "reasonable inquiry" as to the facts relevant to an issuer's determination to proceed with a transaction or when certifying something that is to be relied on by the issuer. If an advisor helps prepare an official statement, it "owes a duty" to the issuer to make "reasonable inquiries" to ensure the appropriate disclosures are made, the notice said.

However, the proposed rule would permit a muni advisor to limit the scope of an engagement to which its fiduciary duty would apply. For example, if an advisor was retained to advise an issuer on pricing in connection with a financial structure that the issuer had already decided was appropriate, the advisor would not have to advise the issuer on the appropriateness of the financial structure. But the advisor would have to disclose the limitations of its engagement to the issuer.

The proposed rule also would make clear that an advisor is not a guarantor.

Both Colette Irwin-Knott, president of the National Association of Independent Public Finance Advisors, and Robert Doty, president of American Governmental Financial Services Co. in Sacramento, Calif., applauded the proposed rule after a brief look at it.

"Fiduciary duty is a hallmark of what NAIPFA stands for. The duty of care and the duty of loyalty are an integral part of what independent financial advisors do," said Irwin-Knott, a principal at Umbaugh in Indianapolis.

"Fiduciary duty is central to the municipal advisor concept. In the market we have tens of thousands of issuers who are not especially sophisticated about municipal finance or who have no sophistication at all," Doty said. "Over the years, this is going to be a developing area that will have a substantial impact on the conduct of municipal advisors."

Doty said he expects the MSRB will further define conflicts of interest in the future as more experience in this area is gained and that this rule and notice will benefit muni issuers.

Leslie Norwood, a managing director and co-head of the municipal securities division of the Securities Industry and Financial Markets Association, said SIFMA "is happy about certain of the changes, including that they've clarified some of the limitations to the fiduciary duty." But she said SIFMA is disappointed that it will not be able to comment on G-36 after the SEC defines the term "municipal advisor."

Bill Daly, Bond Dealers of America's senior vice president for government relations, said: "The BDA is concerned that the proposed G-36 would impose vague requirements, some of which overlap with other requirements such as G-17 [on fair dealing], on an as-yet-undefined group of people. The MSRB and other regulatory agencies need to provide clear guidance about what is okay and what is not."

For reprint and licensing requests for this article, click here.
Washington
MORE FROM BOND BUYER