Dodd-frank and the genesis of the municipal advisor

As part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Congress created a new class of regulated entities called, “municipal advisors,” and made it illegal for any firm or person not registered as a municipal advisor (MA) to provide “advice” to municipal entities with respect to municipal bond issuance and municipal financial products. Congress drew the statute broadly to include firms that historically have provided this type of advice but also, potentially, to include others who might provide such advice as part of other services on behalf of municipal entities. Congress delegated the authority for regulating MAs to the US Securities and Exchange Commission (SEC). In its final rule on the registration of municipal advisors, the SEC indicates that Congress‘s purpose in regulating MAs was in part to reduce the potential for and impact of municipal market participants participating in “pay-to-play” practices, undisclosed conflicts of interest, advice provided by individuals without adequate qualifications and failures to exercise duties of care and loyalty to municipal entities. Together with Rule G-23 of the Municipal Securities Rulemaking Board (MSRB), the MA regulations also prohibit the all-to-common practice of role switching, where a single firm would provide advice on a transaction, resign and then underwrite the bonds for that same transaction.

The full impact of the MA rule took effective July 1, 2014.

who are “municipal advisors”?

Essentially, anyone can find themselves subject to the municipal advisor rules. The SEC indicates that the rules will be applied broadly. Rather than assigning the municipal advisor tag to specific professions or types of businesses, the SEC indicates it will determine whether the rules apply based upon the facts and circumstances of each situation. This ambiguity is intended to try to avoid regulatory work-arounds that would undermine the MA regime.

The MA rule covers what the municipal bond market has historically called “financial advisors,” but is broader, defining a “municipal advisor” as a person (individual or firm) who:

(1) provides advice to or on behalf of a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities, including advice with respect to the structure, timing, terms, and other similar matters concerning such financial products or issues; or

(2) undertakes a solicitation of a municipal entity to provide advisory services.

The definition of an MA includes financial advisors, guaranteed investment contract brokers, third-party marketers, solicitors, finders, and swap advisors that provide municipal advisory services, unless they are statutorily excluded. “Municipal financial products” include municipal derivatives, guaranteed investment contracts, and investments of municipal bond proceeds, including the brokerage of escrows.

what is “advice”?

In promulgating its MA regulations, the SEC made clear that the definition of “advice” would be construed broadly, based upon the facts and circumstances of each interaction. The rules indicate that advice on municipal bonds and municipal financial products extends “…throughout the life of an issuance of municipal securities, from the pre-issuance planning stage for a debt transaction involving the issuance of municipal securities to the repayment stage for those municipal securities.” The SEC indicates that recommendations that are related to municipal bonds and municipal financial products and are particularlized or individually tailored ot the needs of a municipal issuer are likely to be construed as advice. Almost any interaction related to the issuance of municipal bonds or their repayment, or about municipal financial products could be covered.

The SEC did provide, however, a general market information exclusion from the MA regulations for “the provision of general information that does not involve a recommendation regarding municipal financial products or the issuance of municipal securities (including with respect to the structure, timing, terms and other similar matters concerning such financial products or issues).” SEC guidance indicates that general market information (example: “interest rates are at their lowest levels in years”) and findings and conclusions not specific to an issuer’s particular circumstances (example: “other issuers with bonds issued in 2004 are finding that they can achieve economic benefits from refunding those bonds”) are likely excluded from the definition of advice and, therefore, not covered by the MA regulations. The more detailed the information and the more particularized it is to an issuer’s situation, the more likely it is to be construed as “advice” under the regulations.

Examples of general market information that would, according to the SEC, be excluded from the MA regulations:

• information of a factual nature without subjective assumptions, opinions, or views

• information that is not particularized to a specific municipal entity or type of municipal entity

• information that is widely disseminated for use by the public, clients, or market participants other than municipal entities or obligated persons (typically, conduit borrowers of tax-exempt bonds, such as 501(c)(3) non-profit corporations)

• general information in the nature of educational materials

• efforts to win business, where the person seeking to win business with the municipal entity identifies himself or herself as seeking to obtain business from a municipal entity or obligated person and provides only general information

Examples of interactions with third parties that could be construed as “advice” and, thus, subject to the MA regulations include:

• unsolicited proposals from underwriters to refund outstanding bonds

• proposals from banks and broker-dealers to provide advice on the investment of public funds which might include bond proceeds

• proposals from leasing and finance companies for products that might constitute municipal bonds or municipal financial products

• advice from lawyers on the timing and structure of bond sales, including refundings

• advice from accountants and auditors on the structure of the issuer‘s debt portfolio

• advice from third-parties, including bankers, consultants, accountants, lawyers and engineers on a plan of finance, including the issuance of municipal bonds or the use of municipal financial products, for a particular project or capital program.

what are the obligations of a municipal advisor?

If an issuer has historically used an independent financial advisor, it is likely to find that its FA's role is really unchanged: to assist the issuer with debt, debt management, strategic planning and related maintenance and compliance activities. If an issuer has historically used an underwriting firm as its financial advisor, in many cases the issuer will face a choice: use that dealer as its municipal advisor or use that firm as its underwriter; the same firm can no longer serve in both roles. And, if the issuer his historically not used an FA, it will find itself alone at the table: no other transaction professional can fill the gap that a municipal advisor provides without themselves becoming subject to the MA rules.

Even though the role of the traditional financial advisor won't likely change, the standards to which financial advisory firms are held, however, have changed. Firms serving as a municipal advisor to governmental issuers are duty-bound to provide advice as a fiduciary: MAs have a duty of loyalty (putting your interests above all others, including the MA's own) and a duty of care (ensuring your MA has the capabilities to expertly meet your advisory needs). With the advent of Dodd-Frank and the subsequent rules promulgated by the SEC, municipal advisors are now also subject to a host of regulations, most of which are promulgated and enforced by the MSRB.

resources

The links below provide additional information about municipal advisor regulation. As an independent municipal advisor, Columbia Capital can help you navigate the changing regulatory waters.

• SEC Municipal Advisor Final Rule

• SEC Municipal Advisor Rule Q&A

• MSRB Municipal Advisor Resources

• MSRB List of Registered Municipal Advisors

• Chapman & Cutler Municipal Advisor Whitepaper

• Sample IRMA Notice