Recent convictions in a series of bid-rigging trials, and self-congratulations among prosecutors, have provided the municipal market a sense that severely troubling conduct is in the past. Everyone knows not to attempt that again! The market has matured. It now is free of the potential for abusive exploitation. We are amazed that professionals would speak so freely, even if in “code,” when they knew they are recorded.
There is an old Hollywood movie theme, however, that a good way to escape notice is to act in plain view.
Such may be the case in certain California school bond elections. The Municipal Securities Rulemaking Board is taking important steps to collect additional information. Yet, this may be more than typical “pay-to-play” behavior. It also carries important implications for the national market.
Certain school bond election patterns may astound some who are confronted by them for the first time. Nevertheless, it occurs in broad daylight.
A little background may help.
Financial advisors advise municipal securities issuers, including school districts, in the issuance of general obligation bonds. The advisors advise the districts on whether to issue the bonds at a competitive sale, as recommended for such bonds by the Government Finance Officers Association, or through negotiation.
The advisors also generally assist the districts in employing other bond professionals, such as underwriters and bond counsel. One might wonder why a school district with a financial advisor needs an underwriter well in advance of a bond election for bonds that the voters might not approve.
In addition, financial advisors advise districts and negotiate on behalf of districts with underwriters and others in the course of structuring bond issues. Advisors negotiate with underwriters for client districts regarding bond prices and yields, interest-rate structures (current interest versus capital appreciation bonds), redemption features and other bond terms.
As financial professionals dealing at arm’s length, underwriters in negotiated sales are expected to conduct appropriate and impartial due diligence regarding issuers’ disclosures. Of course, one also might wonder why highly rated GO bonds that the GFOA recommends be issued at a competitive sale are instead sold at higher interest rates through negotiated deals.
In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act provided for regulation of financial advisors as part of a larger group termed “municipal advisors.” The act also imposed a statutory fiduciary duty on municipal advisors that already is in effect.
For two years, the Securities and Exchange Commission has been laboring, seemingly to excess, to refine the margins of the “municipal advisor” concept. There is no doubt, however, that financial advisors fall squarely within the definition.
Under Dodd-Frank, the MSRB was assigned the mission of regulating municipal advisors. For most purposes, the board is waiting until the SEC informs it who will be affected by new regulations. The board, however, already has extended its Rule G-17 on fair dealing to advisors. The rule requires advisors to “deal fairly with all persons” and prohibits deception in advisors’ professional activities.
Yet, in California, phenomenally, some still-largely unregulated financial advisors manage school bond election campaigns that the school districts themselves cannot fund legally. The financial advisors solicit contributions to the campaigns. Regulated underwriters and also bond counsel (and construction contractors or managers) make contributions to those campaigns.
These same advisors, who proudly purport to be “independent” despite routinely accepting contingent compensation in bond issues, then are paid noncontingent compensation from the bond election campaigns funded in significant part by underwriters and, to a lesser extent, bond counsel.
How does this occur in plain view? First, both the advisors and underwriters openly advertise on websites and in promotional materials that they provide such “services” to school districts.
In addition, the MSRB requires underwriters — but not yet advisors — to report bond election contributions. The reports are searchable on the board’s online EMMA system by the names of underwriters, but at present not by issuer names.
California law requires election campaign expenditure reports to be filed with county offices. At times, those may be difficult to access easily. Matching the two sets of reports is hard, but not impossible.
It may be, at least sometimes, that school officials — which may or may not include school boards — may know or suspect inappropriate relationships between, on one hand, advisors with a fiduciary duty and fair-dealing responsibility to the issuers and, on the other hand, underwriters.
No one, however, informs the voters or investors. Meanwhile, the definition of the term municipal advisor languishes within the confines of the SEC. Another year’s extension before action is deeply disappointing.
The distortion of bond elections continues in plain view even while this commentary is being written during another active election season. Nothing illustrates more graphically why regulation of financial advisors — especially unregulated advisors — has been, and continues to be, so badly needed.
Those pesky voters, the school districts’ decision-makers who have the ultimate authority at election time as to whether bonds can be issued, remain completely in the dark. So do investors.
The SEC indicates that the municipal market is important. Of course, the commission has much on its plate. A new director is assuming duties in the SEC’s office of municipal securities. In the end, however, actions speak louder than words.