WASHINGTON — Securities and Exchange Commission members voted 3-2 late Friday to approve interpretive guidance that clarifies underwriters’ fair-dealing obligations to state and local issuers and requires them to provide issuers with a host of new disclosures.
The commissioners’ vote on the Municipal Securities Rulemaking Board’s guidance — which has not changed since November and is slated to take effect in August — was split down party lines.
Two Democrats, Elisse Walter and Luis Aguilar, voted to approve the guidance, along with chairman Mary Schapiro, an independent, while two Republicans, Troy Paredes and Daniel Gallagher, voted against it, an SEC spokesman said.
Schapiro, Walter and Aguilar declined to comment; the other two commissioners did not respond to requests for comment.
The MSRB said the guidance clarifies underwriters’ responsibilities under the fair-dealing rule and will help the board protect the interests of state and local bond issuers, a mandate from the Dodd-Frank Act.
Board chairman Alan Polsky called the guidance one of the most important developments in protection of state and local governments since the MSRB was established in 1975. It will help ensure issuers have information they need to understand complex financial transactions and make informed decisions, as well as create a standard for disclosure in the marketplace that will “service everyone better,” he said.
The guidance, among other things, requires an underwriter to disclose to an issuer that, unlike a municipal advisor, it does not have a fiduciary duty to the issuer and therefore is not required to act in the best interest of the issuer. In addition, an underwriter is prohibited from recommending that an issuer not retain a municipal advisor.
The guidance will require an underwriter to also disclose to issuers information about its compensation, and any potential or actual conflicts of interest, as well as the existence of third-party payments, values, credits and profit-sharing arrangements. Underwriters also must tell issuers if they have purchased credit default swaps tied to their muni securities.
The guidance prohibits an underwriter from omitting material facts and requires that oral and written communications with an issuer, including price certificates and proposals, be truthful, accurate and complete.
An underwriter who recommends a complex negotiated financing, such as a variable-rate demand obligation with a swap, must disclose all “material risks, characteristics, incentives and conflicts of interest.”
Underwriters of a routine bond deal will be required to disclose material aspects of an issue if the issuer is unfamiliar with them.
The guidance makes clear that the price an underwriter pays to an issuer for bonds is “fair and reasonable, taking into account consideration of all relevant factors.”
“This notice tries to look at all the different interrelationships between underwriters and issuers, from the initial pitch to the pricing of the deal,” said MSRB general counsel Peg Henry.
The guidance received a mixed reaction, with issuers supporting it and dealer groups calling it premature.
The Bond Dealers of America and the Securities Industry and Financial Markets Association criticized the guidance as premature, saying the SEC should first finalize its definition of independent municipal advisors so the MSRB can move forward with rules for them.
“We continue to believe that a bifurcated system of regulation exists for the industry,” said BDA chief executive officer Mike Nicholas. “Without that definition in place, the commission cannot regulate non-dealer municipal advisors and, as a result, leaves open the opportunity for violations of pay to play, conflict disclosure and inadequate professional standards — all to the detriment of municipal bond issuers.”
Leslie Norwood, co-head of SIFMA’s muni division, said her group is “disappointed that the SEC approved this proposal” and did not delay it until after the muni advisor definition was set.
She added that SIFMA thinks MAs, which have fiduciary responsibilities to issuers, are better suited than underwriters to provide disclosures to issuers and that issuers should hire advisors if they need additional guidance.
Issuers and MAs praised the guidance. Robert Doty, general counsel and senior vice president at Government Financial Strategies, a non-dealer advisory firm, called the guidance “fair and reasonable” and not overly burdensome for underwriters.
Doty said guidance was needed because issuers are usually far less financially savvy than underwriters, dealers and advisors.
“The issuers really need this information in order to discharge their duties,” Doty said. “It’s information that, in most cases, they don’t have right now.” He added that he hopes the SEC next turns its attention to regulation of non-dealer financial advisors.
California state Treasurer Bill Lockyer praised the new regulations, saying they will ultimately benefit taxpayers’ interests by ensuring issuers have information they need to “make better-informed decisions when dealing with Wall Street and the rest of the underwriter community.”
Frank Hoadley, Wisconsin’s capital finance director, said the guidance describes underwriters’ obligations to issuers “more bluntly,” but does not “change his understanding of the obligations of broker-dealers to issuers.”
“To the broker-dealer community, this interpretive release may seem in-your-face. But the rule didn’t change. I don’t think there’s anything new ... other than particular clarity as to the obligations of broker-dealers,” he said.
Kristin Franceschi, president of the board of directors of the National Association of Bond Lawyers, doubts the new regulations will have a significant impact on NABL members, but added that issuers could be inundated with questions from issuers about disclosures they don’t understand.
Colette Irwin-Knott, president of the National Association of Independent Public Finance Advisors, praised the MSRB and SEC for the guidance, calling fair-dealing of underwriting “key to the market functioning as it should.”
She said her group supports the new disclosures, especially the requirement that underwriters disclose if they are serving in an “arms-length transaction,” and if they “have interests that differ from those of the issuer.”
Irwin-Knott, a partner at H.J. Umbaugh & Associates in Indianapolis, also said NAIPFA is pleased that underwriters must disclose if they do not have a fiduciary duty to the issuer. She said she also supports the prohibition against underwriters recommending that issuers not hire municipal advisors.