The city of Las Cruces

When RBC Capital Markets underwrote $727 million of gas supply revenue refunding bonds earlier this month for a New Mexico authority created by local governments that retain RBC as a financial advisor, some market participants raised their eyebrows.

The MSRB's Rule G-23 was amended in 2011 to prevent an underwriter from "role switching" - serving as financial advisor to a state or local government and then abruptly switching roles to underwrite an issuance of bonds on which it provided advice and possibly even recommended to the issuer. The Dodd-Frank Act and rules implementing it imposes a fiduciary duty on anyone giving advice to a municipality, under which it must put that issuer's interests ahead of its own.

But RBC officials insist that they broke no rules and fully complied with all requirements. They said that the authority, the New Mexico Municipal Energy Acquisition Authority, is a completely separate issuer from the local governments, Las Cruces and Gallup, N.M.

"The firm is fully in compliance with the requirements of the swap and MSRB rules," said an RBC spokesman.  "Prior to any proposals or presentations being provided, we ensured that NMMEAA was represented by its own independent adviser, which representation continued through completion of the financing process. With respect to the participant municipal governments of NMMEAA, which benefitted from the financing, RBC only provided advice related to natural gas acquisition issues within the scope of the municipal advisor exemption as provided by regulation and through its retained independent advisor."

Regulators declined to comment, saying compliance with the rule is based on facts and circumstances and they don't comment on specific transactions.

The New Mexico Municipal Energy Acquisition Authority is a joint powers authority that was created in 2008 by the cities of Las Cruces and Gallup in New Mexico specifically to issue bonds to finance a pre-paid gas contract. This model, which is used extensively in California, allows the participating local governments to purchase natural gas from NMMEAA at a considerable savings vs. a pay-as-you-go approach.

In California, JPAs may include many participating municipalities. The Southern California Public Power Authority, for example, includes the municipal utilities of the cities of Anaheim, Azusa, Banning, Burbank, Cerritos, Colton, Glendale, Los Angeles, Pasadena, Riverside, Vernon, and the Imperial Irrigation District. Muni bonds issued by those JPAs have been underwritten by a number of different dealer firms.

RBC promoted the creation of NMMEAA. RBC financial advisor Kevin Powers, who was working for Gallup, told the Associated Press in 2007 that he hoped to get the authority up and running by the middle of 2008 and touted the potential savings Gallup could obtain from financings.

The NMMEAA's board is governed by a seven-member board of directors: two each appointed by the city councils of Gallup and Las Cruces, two nominated by Farmington and approved by the appointees of the other two cities, and one from the County of Los Alamos who is also approved by Gallup and Las Cruces.

RBC has had longstanding municipal advisory relationships with all of these local governments through its managing director Paul Cassidy and its vice president Erik Harrigan, according to governmental officials and minutes of city and county council meetings.

"It's an ongoing relationship under contract," said Las Cruces Treasurer Mark Krawczyk.

Soon after it was created, the NMMEAA issued almost $781million of gas supply variable rate revenue bonds in to finance the prepayment of a contract for a 30-year supply of natural gas to be sold Las Cruces, Farmington, and Los Alamos County.

RBC Capital Markets, a wholly owned subsidiary of Royal Bank of Canada, was the remarketing agent for the bonds, which were issued in 2009. Royal Bank of Canada was the gas supplier, counterparty to a swap the authority entered into to "hedge its exposure to interest rate fluctuations," and the liquidity facility provider, the official statement said.

RBC officials said The Majors Group was financial advisor in the 2009 deal, but neither the Norristown, Pa.-based firm, nor its owner, George Majors, appear in the official statement for the deal.

At that time, Rule G-23 did not prohibit role-switching, but it required the firm serving as FA to step down from that role before becoming underwriter and to disclose in writing to the issuer potential conflicts of interest and the amounts it was paid. The issuer had to acknowledge in writing that it received the disclosures.

Issuance costs totaled more than $7.32 million, including an underwriter's discount of more than $3.61 million, the premium for the commodity credit instrument, legal fees and other costs, according to the OS.

The 2009 bonds were refunded earlier this month when NMMEAA issued almost $727 million of gas supply revenue refunding bonds. RBC officials said the refunding was done, in part, to comply with new Basel III related rules in Canada.

The deal included $175 million of sub-series 2014A bonds that were initially issued in a long-term interest rate period ending on July 31, 2019. It also included almost $552 million of sub-series 2014B variable rate bonds bearing interest based on the Libor index rate through July 31, 2019. Both series of bonds are subject to a mandatory tender for purchase on Aug. 1, 2019. NMMEAA also entered into a swap "to hedge its exposure to interest rate fluctuations," the official statement said.

The Majors Group is financial advisor to NMMEAA and the gas purchasers, Las Cruces, Farmington and Los Alamos County, according to the OS. RBC Capital Markets is underwriter of the bonds. Royal Bank of Canada is the gas supplier, funding provider, liquidity facility provider, interest rate swap counterparty, calculation agent and index rate determination agent.

Total issuance costs are almost $5.18 million and include the underwriter's discount of $4.15 million, the upfront fee for the liquidity facility, legal fees, and other costs of issuance.

The market participants with concerns say the situation presents conflicts of interest. They say RBC is the sole underwriter of a rich deal for an issuer controlled by its advisory clients and whose existence was recommended by an RBC representative. RBC made at least $7.23 million from the two deals. Its parent company also made a lot of money.

But several securities lawyers say that it's possible the bank could have been in compliance with all Securities and Exchange Commission and Municipal Securities Rulemaking Board rules, even though the arrangement may appear questionable.

"If nothing else, it's a red flag," said one lawyer, cautioning that a situation like this is heavily based on the facts and circumstances, such as who was told what when and by whom.

Dave Sanchez, a former SEC attorney who most recently served as a general counsel to a broker-dealer, said that, as the MSRB and SEC continue to finalize the duties of municipal advisors, arrangements like the one in New Mexico should be examined by the participants.

"This is the kind of arrangement that bears scrutiny by financial advisors and dealers to make sure they are in compliance," Sanchez said.

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