On September 20, 2013, the Securities and Exchange Commission (SEC) published its final regulations regarding the registration of “municipal advisors.” These final regulations create a permanent registration regime in place of the temporary registration requirements which have been in effect since October 1, 2010.
The regulations were adopted pursuant to the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) that impose a new fiduciary duty on “municipal advisors” and direct the SEC to create a registration and recordkeeping system for such advisors.
Traditionally, financial advisors to municipalities have provided advice and recommendations on bond issues and swaps without being regulated by securities regulators. The purpose of these Dodd-Frank mandates is to invest the SEC and Municipal Securities Rulemaking Board (MSRB) with jurisdiction over these largely unregulated financial advisors and other participants in municipal bond transactions and related derivatives transactions.
Dodd-Frank and the regulations make it unlawful for anyone to act as a municipal advisor unless that person has first registered with the SEC. Under the new regulations, a municipal advisor is any “person (who is not a municipal entity or an employee of a municipal entity) that 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 undertakes a solicitation of a municipal entity or an obligated person.” This definition includes almost all participants in municipal finance transactions unless an exemption or exclusion from registration is available, and includes both municipal entities and “obligated persons” on a municipal issuance, for example a nonprofit hospital or university conduit borrower under a revenue bond issue.
Various exclusions or exemptions from registration are provided under the regulations, but the exemptions or exclusions are “function-based” rather than “status-based,” which creates uncertainty as to how they should or will be applied. For example, the regulations exclude from registration brokers, dealers and municipal securities dealers serving as underwriter of a particular issuance of municipal securities, but only to the extent that the broker or dealer is engaging in “activities that are within the scope of an underwriting of such issuance of municipal securities.” Should an underwriter stray from its undefined “core” functions, such as by presumably providing advice with respect to structuring defeasance escrows or other investments of bond proceeds, or providing advice or recommendations regarding any related guaranteed investment or swap products, the exemption may not be available.
Similarly, attorneys, registered investment advisors, registered commodity trading advisors, engineers and accountants are exempted or excluded from having to register as municipal advisors, but only to the extent they are providing core services or advice of a nature related to their respective licensure and function. Persons serving as a member of a governing or advisory board, or acting in a similar official capacity, are also exempted from registration to the extent that the person is acting within the scope of his or her official capacity. These ambiguous function-based exceptions and exclusions are also subject to the same questions of application, and professionals that step outside what the SEC or MSRB considers their traditional roles by providing advice or recommendations as to municipal bond issuances or derivatives products could do so at their own peril.
The potential chilling effect on full and frank discussions between attorneys, accountants and engineers and their respective clients are obvious. Public officials, particularly those who are financial or other professionals in their private lives, may also be hesitant to engage in thorough discussions of municipal finance transactions before their boards for fear of providing what might be construed by regulators as impermissible out-of-scope advice or recommendations to the public body on which they serve.
A limited registration exemption is also provided to banks for traditional banking activities, to the extent the bank provides advice as to: (1) investments in the nature of deposit accounts, savings accounts, certificates of deposit or other deposit instruments issued by the bank; (2) extensions of credit by the bank to a municipal entity or obligated person, including the issuance of a letter of credit, the making of a direct loan or the purchase of a municipal security for its own account; (3) funds held in a sweep account; or (4) investments made by the bank in its capacity of an indenture trustee of similar capacity, such as a trustee for a municipal bond issue. A bank is not exempt from having to register as a municipal advisor if it provides advice as to the structuring of municipal securities, guaranteed investment contracts or municipal derivatives products, or engages in any other activity that constitutes the function of municipal advisor. The regulations allow a functionally discrete operating unit of a bank to be treated separately from the remainder of the institution for purposes of applying the registration requirements or exemptions.
A final exemption is provided to persons or entities engaging in municipal advisory services where the municipal entity or obligated person is otherwise represented by a registered independent municipal advisor with respect to the same aspects of a municipal financial product or an issuance of municipal securities. In other words, if there is a registered independent municipal advisor advising the issuer, then other actors in the transaction, such as the investment banker, can give advice on normally prohibited topics without having to register as a municipal advisor.
For such an exemption to be available, however, the registered municipal advisor providing the advice must be “independent” as defined in the regulations, and the person claiming the exemption must do all of the following: (1) obtain a written representation from the municipal entity or obligated person that it is represented by, and will rely on the advice of, the independent municipal advisor, and have a reasonable basis for relying on that representation; (2) disclose in writing to the municipal entity or obligated person that it is not a municipal advisor and not a fiduciary with respect to the transaction or product; and (3) provide a copy of the municipal or obligated person written disclosure to the independent registered municipal advisor.
Registration as a municipal advisor must be done on forms prescribed by the SEC and set forth in the regulations. Foreign municipal advisors must also file various consent to jurisdiction and appointment of a US service agent forms. The regulations also set forth comprehensive and detailed record keeping requirements concerning the person’s municipal advisory operations, including all communications (such as inter-office memoranda and communications) relating to the operations, financial records, operating policies and procedures, written agreements with municipal entities or their employees, written agreements with obligated persons, all documents material to, or that memorialize, the making of a recommendation to a municipal entity or obligated person and detailed employee records. Books and records must be filed, stored, indexed and accessible as detailed in the regulations.
Instead of simply requiring the previously unregistered and unregulated financial advisors to register and be regulated, the SEC has established a complex and confusing set of regulations which will leave all participants in a bond issue wondering what exactly they can and cannot do.
All persons and entities active in municipal finance should carefully review the new regulations and consider their potential impact. This includes underwriters, broker-dealers, attorneys, swap advisors, financial institutions, investment bankers and financial advisors. The registration requirements are broad and the exemptions narrow; time will tell how the SEC and MSRB intend to implement and interpret the regulations. Hopefully additional written guidance will be forthcoming from the regulators to put a more definitive framework around the rather subjective function-based exemptions and how they will work in practice.
