WASHINGTON — The Municipal Securities Rulemaking Board wants the Securities and Exchange Commission to approve proposed guidance that details how underwriters should treat municipal issuers under its fair-dealing rule, despite dealers’ requests for a delay.
In a Feb. 13 letter to the SEC, the MSRB mostly sided with issuers rather than dealers on key aspects of the board’s proposed interpretative guidance for Rule G-17, including issuers’ requests that the guidance be quickly approved.
The board also agreed to consider — separately from the G-17 guidance — issuer requests that it work with other regulators to define and address “flipping” and that it establish suitability standards for the types of financial products that dealers sell to state and local governments.
Flipping occurs when underwriters sell bonds to other dealers or institutional investors and the bonds are traded up, repeatedly resold almost simultaneously at higher prices, before being sold to retail investors.
The MSRB said it will “reach out to these organizations and the commission in an attempt to develop a shared understanding” of flipping, but noted that disclosure requirements in the proposed rule change may already govern some aspects of the practice.
Under the proposed changes to Rule G-17, underwriters for the first time would be required to tell issuers they are not fiduciaries and would be prohibited from telling issuers not to hire FAs. The proposed changes also would require underwriters to disclose to issuers certain financial risks and conflicts of interest.
The MSRB’s letter was a response to the most recent round of public comments on the guidance.
Two dealer groups — the Securities Industry and Financial Markets Association and Bond Dealers of America — had said the proposed guidance was premature, and should not be approved until a comparable notice for muni advisors is approved. SIFMA also said the guidance should be delayed until the Commodity Futures Trading Commission and the SEC have completed new rules governing swaps.
But the board rejected the idea of a delay, noting issuers want the protections now and that most muni-related swaps will fall under the jurisdiction of the CFTC, which finalized its key rule on dealer business conduct standards for muni-related activity on Jan. 11.
The MSRB also rejected suggestions by SIFMA that certain syndicate members be exempted from disclosure requirements and that certain disclosures need not be made to large, frequent, and sophisticated issuers.
The board said conflicts of interest do not relate to the size of a firm and that all issuers experience turnovers in finance personnel.
It noted that the proposed guidance states: “The level of disclosure required may vary according to the issuer’s knowledge or experience with the proposed financing structure or similar structures, capability of evaluating the risks of the recommended financing, and financial ability to bear the risks of the recommended financing, in each case based on the reasonable belief of the underwriter.”
The MSRB also rejected SIFMA’s contention that “plain-vanilla interest swaps” are commonplace and well understood by sophisticated issuers.
“The MSRB expects that the issuers that faced unexpected substantial swap termination payments … would not characterize those swaps as ‘plain vanilla,’” the board said.
While SIFMA had claimed some of the proposed disclosures would be duplicative, burdensome, and unnecessarily costly, the board discounted these concerns as “overstated.”
The proposed guidance would require underwriters’ certificates that disclose the issue price of new bonds to be truthful and accurate without misrepresentations or omission of “material” facts.
SIFMA said this proposed requirement is “not appropriate” because “evaluating the reasonableness of an issue price certificate is better left to the tax authorities than to securities’ self-regulatory authorities.”
But the MSRB countered that the underwriter’s statement on issue price may have a key bearing on whether the issuer is correct in telling investors that the interest earnings from the bonds are tax-exempt.
The MSRB did not always agree with the issuers. The Government Finance Officers Association had requested that it modify the requirement prohibiting underwriters from telling issuers they not hire a financial advisor. The GFOA had suggested the MSRB require underwriters to disclose to issuers that they may choose to engage the services of an independent financial advisor.
The MSRB letter said this would not be necessary. “This provision affirmatively restrains an underwriter from taking action to discourage the use of an advisor rather than simply informing an issuer of a choice it already has,” the board said.
The MSRB said it proposed the interpretative guidance under G-17 because the Dodd-Frank Act directed it to protect issuers and other municipal entities.
Its proposal was initially filed with the SEC last August. The board later revised it and filed amendments.
The proposed guidance was supposed to have been approved by Dec. 8.
Under Dodd-Frank, MSRB rules filed with the SEC must be acted on by the SEC within 90 days of being published in the Federal Register. The SEC’s deadline was Dec. 7.
The only way the commission could get an extension to the 90 days was to issue an order to “institute proceedings to determine whether the proposed rule change should be disapproved.” The SEC issued the order, even though it had no intention of disapproving the proposal at the time.
That action gives the commission another 90 days — until the first full week in March — to decide whether to approve the guidance.