Request for Comment on Draft MSRB Rule G-36 (on Fiduciary Duty of Municipal Advisors) and Draft Interpretive Notice
The Municipal Securities Rulemaking Board (“MSRB”) is requesting comment on draft Rule G-36 concerning the fiduciary duty of municipal advisors, and a draft interpretive notice under Rule G-36.
Comments should be submitted no later than April 11, 2011. Comments should be sent via e-mail to CommentLetters@msrb.org. Please indicate the notice number in the subject line of the e-mail. To submit comments via regular mail, please send them to Ronald W. Smith, Corporate Secretary, MSRB, 1900 Duke Street, Alexandria, VA 22314. Written comments will be available for public inspection on the MSRB’s web site.[1] The MSRB will hold an informational webinar on draft Rule G-36 and the draft interpretive notice on March 1 at 3:00 p.m. The webinar will also address MSRB Notice 2011-13 (February 14, 2011) on the application of Rule G-17 to municipal advisors advising obligated persons and municipal advisors soliciting business from municipal entities on behalf of others. Register for the webinar.
Questions about this notice should be directed to Peg Henry, Deputy General Counsel, or Karen Du Brul, Associate General Counsel, at 703-797-6600.
BACKGROUND
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub. Law No. 111-203) (“Dodd-Frank Act”) amended Section 15B(c)(1) of the Securities Exchange Act of 1934 (“Exchange Act”) to provide that municipal advisors[2] have a fiduciary duty to their municipal entity[3] clients. Section 15B(b)(2)(L)(i) of the Exchange Act directs the MSRB to establish rules with respect to municipal advisors that “prescribe means reasonably designed to prevent acts, practices, and courses of business as are not consistent with a municipal advisor’s fiduciary duty to its clients.”
REQUEST FOR COMMENT
Accordingly, the MSRB requests comment on draft Rule G-36 and the draft interpretive notice.
Draft Rule G-36 (on fiduciary duty of municipal advisors) provides:
In the conduct of its municipal activities on behalf of municipal entities, a municipal advisor shall be subject to a fiduciary duty, which shall include a duty of loyalty and a duty of care.
The interpretive notice provides that the Rule G-36 duty of loyalty requires the municipal advisor to deal honestly and in good faith with the municipal entity and to act in the municipal entity’s best interests without regard to financial or other interests of the municipal advisor. It requires a municipal advisor to make clear, written disclosure of all material conflicts of interest, such as those that might impair its ability to satisfy the duty of loyalty, and to receive the written, informed consent of officials of the municipal entity with the authority to bind the municipal entity by contract with the municipal advisor. Such disclosure must be made before the municipal advisor may provide municipal advisory services to the municipal entity or, in the case of conflicts arising after the municipal advisory relationship has commenced, before the municipal advisor may continue to provide such services.
The notice provides that under Rule G-36 a municipal advisor may not undertake an engagement if certain unmanageable conflicts exist, including (i) kickbacks and certain fee-splitting arrangements with the providers of investments or services to municipal entities, (ii) payments by municipal advisors made for the purpose of obtaining or retaining municipal advisory business other than reasonable fees paid to a municipal advisor for solicitation activities regulated by the MSRB, and (iii) acting as a principal in matters concerning the municipal advisory engagement (except when Internal Revenue Service competitive bidding guidelines for establishing fair market value are satisfied). The notice also provides that, in certain cases, the compensation received by a municipal advisor may be so disproportionate to the nature of the municipal advisory services performed that it is inconsistent with the Rule G-36 duty of loyalty and represents an unmanageable conflict.
The notice provides that the Rule G-36 duty of care requires that a municipal advisor act competently and provide advice to the municipal entity after inquiry into reasonably feasible alternatives to the financings or products proposed (unless the engagement is of a limited nature).
Commenters should note that the interpretive notice is based upon the statutory definition of municipal advisor set forth in the Dodd-Frank Act without regard to any interpretation of that term proposed by the Securities and Exchange Commission (“SEC”) in its proposed permanent registration rule for municipal advisors (Securities Exchange Act Release No. 34-63576 (December 20, 2010). If the SEC’s permanent registration rule is adopted in its current form, the MSRB may request comment on revisions to the draft interpretive notice. For example, should certain brokerage activities be construed to be the provision of advice on investment strategies and, therefore, make the brokers municipal advisors, the Board would reconsider the provisions of the notice concerning limitations on principal transactions.
TEXT OF DRAFT RULE G-36
MSRB Rule G-36 (on fiduciary duty of municipal advisors)
In the conduct of its municipal advisory activities on behalf of municipal entities, a municipal advisor shall be subject to a fiduciary duty, which shall include a duty of loyalty and a duty of care.
TEXT OF DRAFT INTERPRETIVE NOTICE
FIDUCIARY DUTY OF A MUNICIPAL ADVISOR
Section 15B(c)(1) of the Securities Exchange Act of 1934 (the “Exchange Act”) provides that:
A municipal advisor and any person associated with such municipal advisor shall be deemed to have a fiduciary duty to any municipal entity for whom such municipal advisor acts as a municipal advisor, and no municipal advisor may engage in any act, practice, or course of business which is not consistent with a municipal advisor’s fiduciary duty or that is in contravention of any rule of the Board.
Section 15B(b)(2)(L)(i) of the Exchange Act provides that the Municipal Securities Rulemaking Board (“MSRB”) shall establish rules with respect to municipal advisors that “prescribe means reasonably designed to prevent acts, practices, and courses of business as are not consistent with a municipal advisor’s fiduciary duty to its clients.”
In furtherance of this statutory directive, the MSRB promulgated MSRB Rule G-36, on fiduciary duty of municipal advisors, which provides:
In the conduct of its municipal advisory activities[1] on behalf of municipal entities,[2] a municipal advisor shall be subject to a fiduciary duty, which shall include a duty of loyalty and a duty of care.
In addition, this notice provides interpretive guidance on the meaning of “fiduciary duty” for purposes of Rule G-36 and describes conduct that would or could breach that Rule G-36 fiduciary duty. This duty is derived from Exchange Act Section 15B(c)(1), which imposes a fiduciary duty on municipal advisors.[3]
In addition to its Rule G-36 fiduciary duty to its municipal entity clients, MSRB Rule G-17 requires that municipal advisors, in the conduct of their municipal advisory activities, deal fairly with all persons and not engage in any deceptive, dishonest, or unfair practice.[4] In the case of its municipal entity clients, this Rule G-17 duty of fair dealing is subsumed within the municipal advisor’s fiduciary duty, and a violation of Rule G-17 with respect to a municipal entity client would necessarily be a violation of Rule G-36.
DUTY OF LOYALTY
As provided in Rule G-36, a municipal advisor’s fiduciary duty to its municipal entity client includes a duty of loyalty. That duty requires the municipal advisor to deal honestly and in good faith with the municipal entity and to act in the municipal entity’s best interests without regard to financial or other interests of the municipal advisor.
Conflicts of Interest
Disclosure Obligations. Under Rule G-36, a municipal advisor must disclose all material conflicts of interest, such as those that might impair its ability to satisfy the duty of loyalty to its municipal entity client.[5] All disclosures of conflicts must be made in writing to officials of the municipal entity with the authority to bind the municipal entity by contract with the municipal advisor in a manner sufficiently detailed to inform the municipal entity of the nature and implications of the conflict. The following are examples of the types of conflicts that must be disclosed by the municipal advisor, but this list is not intended to be exhaustive:
(i) payments by municipal advisors made for the purpose of obtaining or retaining municipal advisory business;[6]
(ii) payments from third parties to the municipal advisor in relation to the municipal advisory engagement;[7]
(iii) payments from third parties to enlist the municipal advisor’s recommendation of their services to the municipal entity;[8]
(iv) whether the municipal advisor or an affiliate of the municipal advisor is acting as a principal in matters concerning the municipal advisory engagement;[9]
(v) form of compensation;[10] and
(vi) other engagements or relationships that might impair the municipal advisor’s ability to act only in the best interests of its municipal entity client.
Informed Consent. Under Rule G-36, the municipal advisor must receive written consent to its conflicts by officials of the municipal entity with the authority to bind the municipal entity by contract with the municipal advisor before the municipal advisor may provide municipal advisory services to the municipal entity or, in the case of conflicts arising after the municipal advisory relationship has commenced, before the municipal advisor may continue to provide such services. For purposes of Rule G-36, a municipal entity will be deemed to have consented to conflicts that are clearly described in its engagement letter or other written contract with the municipal advisor, if the municipal entity expressly acknowledges the existence of such conflicts. If the officials of the municipal entity agree to proceed with the municipal advisory engagement after receipt of the conflicts disclosure but will not provide written acknowledgement of such conflicts, the municipal advisor may proceed with the engagement after documenting with specificity why it was unable to obtain their written acknowledgement. See, however, “Unmanageable Conflicts” for a description of certain conflicts that will preclude a municipal advisor from undertaking an engagement with a municipal entity, despite disclosure and consent.
Disclosure of conflicts, coupled with written consent, will not satisfy the requirements of Rule G-36 in instances in which the municipal advisor has reason to believe that such consent is not informed. In such cases, a municipal advisor should make additional efforts reasonably designed to inform the officials of the municipal entity of the nature and implications of the municipal advisor’s conflicts. Additionally, disclosures to officials who are themselves parties to the conflict of interest (such as recipients of payments from municipal advisors) will not suffice to satisfy the requirements of Rule G-36.
Unmanageable Conflicts. Pursuant to its duty of loyalty under Rule G-36, a municipal advisor must not engage in municipal advisory activities with respect to a municipal entity client if it cannot manage its conflicts in a manner that will permit it to act only in the municipal entity’s best interests. Some conflicts are not manageable because, when fully informed of the nature and potential consequences of the conflicts, an official of a municipal entity could not provide informed consent.[11] The following are examples of conflicts that fall into this category, but this list is not intended to be exhaustive:
(i) kickback arrangements, or certain fee-splitting arrangements, with the providers of investments or services to municipal entities,[12]
(ii) payments by municipal advisors made for the purpose of obtaining or retaining municipal advisory business other than reasonable fees paid to a municipal advisor described in Section 15B(e)(9) of the Exchange Act,[13] and
(iii) except as provided below, acting as a principal in matters concerning the municipal advisory engagement.[14]
In most cases under Rule G-36, a municipal advisor that acts as a principal with its municipal entity client on the same transaction will be considered to have an unmanageable conflict. This will also be the case if an affiliate of the municipal advisor acts as a principal with the municipal entity on the same transaction. However, Rule G-36 does permit a municipal advisor or its affiliate to act as a principal in the following limited situation. A municipal advisor to an issuer of municipal securities or its affiliate may provide investments of bond proceeds as a principal if it is the lowest cost provider and the fair market value of the investments has been determined in a bidding process that satisfies the Internal Revenue Service safe harbor for establishing fair market value for guaranteed investment contracts and investments purchased for a yield-restricted defeasance escrow.[15] Neither the municipal advisor, nor its affiliate may provide any of the minimum number of bids required by that safe harbor.
Compensation
Excessive Compensation. While the MSRB recognizes that what is considered reasonable compensation for a municipal advisor will vary according to the municipal advisor’s expertise and the nature of the financing, in certain cases, a municipal advisor’s compensation may be so disproportionate to the nature of the municipal advisory services performed as to indicate that the municipal advisor is not acting in the municipal entity’s best interests as required by Rule G-36. Such excessive compensation would constitute a violation of the municipal advisor’s duty of loyalty, even if such compensation has been disclosed.[16]
Forms of Compensation. The manner in which municipal advisors are compensated varies according to the nature of the engagement and applicable state and local laws and policies. Pursuant to Rule G-36, a municipal advisor must provide written disclosure to its municipal entity client of what the amount (in dollars and to the extent it can be quantified) of its direct compensation and indirect compensation (e.g., amounts paid to affiliates) from the engagement will be, or is projected to be, as well as the scope of services to be provided for that compensation. Additionally, the municipal advisor must provide written disclosure to its client of the conflicts of interest with various forms of compensation, including the form of compensation applicable to its engagement, even if the client has required that a particular form of compensation be used. One way in which a municipal advisor may satisfy its obligation to provide written disclosure of the conflicts with various forms of compensation is to provide its client with the document entitled “Disclosure of Conflicts of Interest With Various Forms of Compensation,” attached as Appendix A to this notice (the “Compensation Disclosure Document”). The disclosures described in this paragraph must be provided as described above under “Duty of Loyalty/Conflicts of Interest/Disclosure Obligations.” Provision by the municipal advisor to its client of the Compensation Disclosure Document will not satisfy the municipal advisor’s obligation to disclose conflicts of interest not addressed in the Compensation Disclosure Document, such as payments from third parties.
A municipal advisor’s duty of loyalty under Rule G-36 requires it to manage any conflicts of interest that may result from its form of compensation so that it acts in the best interests of its municipal entity client. For example, except as discussed below under “Permissible Limitations on Scope of Engagement,” a municipal advisor that reasonably believes that a proposed financing or product is not in its municipal entity client’s best interests, must so advise the municipal entity pursuant to its duty of loyalty, even if such advice adversely affects the municipal advisor’s compensation.
DUTY OF CARE
As provided in Rule G-36, a municipal advisor’s fiduciary duty to its municipal entity client also includes a duty of care. That is, under Rule G-36 a municipal advisor should exercise due care in performing its responsibilities.
Necessary Qualifications
Pursuant to that duty of care required by Rule G-36, the municipal advisor should not undertake a municipal advisory engagement for which the advisor does not possess the degree of knowledge and expertise needed to provide the municipal entity with informed advice.[17] For example, a municipal advisor should not undertake a swap advisory engagement unless it has sufficient knowledge to evaluate the transaction and its risks, as well as the pricing and appropriateness of the transaction.[18]
Consideration of Alternatives
Unless that duty has been expressly disclaimed as provided below, under Rule G-36 a municipal advisor has a duty to investigate and advise the municipal entity of alternatives to the proposed financing structure or product that are then reasonably feasible based on the issuer’s financial circumstances and market conditions at the time, if those alternatives would better serve the interests of the municipal entity.[19]
Duty of Inquiry
Under Rule G-36, a municipal advisor must make a reasonable inquiry as to the facts that are relevant to a municipal entity’s determination of whether to proceed with a course of action (e.g., the issuance of municipal securities, entering into a derivative contract, or making an investment). Similarly, when asked to provide a certificate that will be relied upon by the municipal entity or by investors in the municipal entity’s securities, the municipal advisor must make a reasonable inquiry as to the pertinent facts.[20] Furthermore, when a municipal advisor undertakes the preparation of an official statement for a municipal securities issue, the municipal advisor must exercise due diligence as to the facts that are material to the offering.[21]
Advisor Not a Guarantor
The duty of care under Rule G-36 requires only that the municipal advisor act competently and provide advice to the municipal entity after making reasonable inquiry into the representations of the municipal entity’s counterparties, as well as then reasonably feasible alternatives to the financings or products proposed that might better serve the interests of its municipal entity client. However, a municipal advisor’s duty of care does not make the municipal advisor a guarantor of a successful financing or a guarantor that there are no facts material to a municipal entity’s decisionmaking process other than the ones known by the municipal advisor and disclosed to the municipal entity.
PERMISSIBLE LIMITATIONS ON SCOPE OF ENGAGEMENT
Municipal advisors may be retained by municipal entity clients for limited engagements and may, accordingly, limit the scope of the engagement to which their fiduciary duty applies.[22] In some cases, a municipal entity may have already reached a decision that a particular type of financing or financial product is appropriate for it and not find it necessary for the advisor to advise it on appropriateness. In that case, under Rule G-36 the advisor’s engagement should reflect the limitations on its role. If there is no engagement letter, the advisor should be specific about that limitation in a written communication to the municipal entity. In either case, these limitations must be disclosed prior to the commencement of the engagement. If the advisor has already formed a judgment that the financing or product is not appropriate for the municipal entity, it should inform the municipal entity in a written communication. If the advisor has taken these steps and does not by course of conduct cause the municipal entity to expect that the advisor will be advising on appropriateness,[23] the fact that the transaction thereafter proves to have been inappropriate for the municipal entity will not mean that the advisor has breached its fiduciary duty to the municipal entity under Rule G-36.
APPENDIX A
DISCLOSURE OF CONFLICTS OF INTEREST WITH VARIOUS FORMS OF COMPENSATION
The Municipal Securities Rulemaking Board (MSRB) requires us, as your municipal advisor, to provide written disclosure to you about the actual or potential conflicts of interest presented by various forms of compensation. We must provide this disclosure even if you have already chosen a particular form of compensation. The municipal advisor’s client should select a form of compensation that best meets its needs and the agreed upon scope of services.
Forms of Compensation; Potential Conflicts. The forms of compensation for municipal advisors vary according to the nature of the engagement and requirements of the client, among other factors. Various forms of compensation present actual or potential conflicts of interest because they may create an incentive for an advisor to recommend one course of action over another if it is more beneficial to the advisor to do so. This document discusses various forms of compensation and the timing of payments to the advisor.
Fixed fee. Under a fixed fee form of compensation, the municipal advisor is paid a fixed amount established at the outset of the transaction. The amount is usually based upon an analysis by the client and the advisor of, among other things, the expected duration and complexity of the transaction and the agreed-upon scope of work that the advisor will perform. This form of compensation presents a potential conflict of interest because, if the transaction requires more work than originally contemplated, the advisor may suffer a loss. Thus, the advisor may recommend less time-consuming alternatives, or fail to do a thorough analysis of alternatives. There may be additional conflicts of interest if the municipal advisor’s fee is contingent upon the successful completion of a financing, as described below.
Hourly fee. Under an hourly fee form of compensation, the municipal advisor is paid an amount equal to the number of hours worked by the advisor times an agreed-upon hourly billing rate. This form of compensation presents a potential conflict of interest if the client and the advisor do not agree on a reasonable maximum amount at the outset of the engagement, because the advisor does not have a financial incentive to recommend alternatives that would result in fewer hours worked. In some cases, an hourly fee may be applied against a retainer (e.g., a retainer payable monthly), in which case it is payable whether or not a financing closes. Alternatively, it may be contingent upon the successful completion of a financing, in which case there may be additional conflicts of interest, as described below.
Fee contingent upon the completion of a financing or other transaction. Under a contingent fee form of compensation, payment of an advisor’s fee is dependent upon the successful completion of a financing or other transaction. Although this form of compensation may be customary for the client, it presents a conflict because the advisor may have an incentive to recommend unnecessary financings or financings that are disadvantageous to the client. For example, when facts or circumstances arise that could cause the financing or other transaction to be delayed or fail to close, an advisor may have an incentive to discourage a full consideration of such facts and circumstances, or to discourage consideration of alternatives that may result in the cancellation of the financing or other transaction.
Fee paid under a retainer agreement . Under a retainer agreement, fees are paid to a municipal advisor periodically (e.g., monthly) and are not contingent upon the completion of a financing or other transaction. Fees paid under a retainer agreement may be calculated on a fixed fee basis (e.g., a fixed fee per month regardless of the number of hours worked) or an hourly basis (e.g., a minimum monthly payment, with additional amounts payable if a certain number of hours worked is exceeded). A retainer agreement does not present the conflicts associated with a contingent fee arrangement (described above).
Fee based upon principal or notional amount and term of transaction. Under this form of compensation, the municipal advisor’s fee is based upon a percentage of the principal amount of an issue of securities (e.g., bonds) or, in the case of a derivative, the present value of or notional amount and term of the derivative. This form of compensation presents a conflict of interest because the advisor may have an incentive to advise the client to increase the size of the securities issue or modify the derivative for the purpose of increasing the advisor’s compensation.
[If applicable, describe other form of compensation for the engagement and associated conflicts with a comparable level of specificity].
Acknowledgement
The undersigned hereby acknowledges that he/she has received this disclosure and that he/she has been given the opportunity to raise questions and discuss the foregoing matters with the advisor.
________________________ [name of client]
By: ______________________
Name: ___________________
Title:____________________
Date:____________________
[1] The term “municipal advisory activities” is defined by MSRB Rule D-13 to mean the activities described in Section 15B(e)(4)(A)(i) and (ii) of the Exchange Act.
[2] The term “municipal entity” is defined by Section 15B(e)(8) of the Exchange Act as: “any State, political subdivision of a State, or municipal corporate instrumentality of a State, including -- (A) any agency, authority, or instrumentality of the State, political subdivision, or municipal corporate instrumentality; (B) any plan, program, or pool of assets sponsored or established by the State, political subdivision, or municipal corporate instrumentality or any agency, authority, or instrumentality thereof; and (C) any other issuer of municipal securities.”
[3] This fiduciary duty in Exchange Act Section 15B(c)(1) is in addition to any state or other fiduciary duty laws. This notice cites cases and administrative proceedings involving breach of fiduciary duty under the Investment Advisers Act (the “Advisers Act”) and state fiduciary duty laws, as well as violations of Section 17(a) of the Securities Act of 1933 (the “Securities Act”) and Section 10(b) of the Exchange Act concerning the fraudulent behavior of fiduciaries. These citations are included only for purposes of illustration of the conduct that would be considered a breach by a municipal advisor of its Rule G-36 fiduciary duty, which is an independent duty created by Section 15B(c)(1) of the Exchange Act.
[4] The MSRB notes that the Commission has brought enforcement actions concerning financial advisors for violations of Rule G-17. See, e.g., In the Matter of Lazard Freres and Merrill Lynch, SEC Rel. No. 34-36419 (Oct. 26, 1995) (settlement in connection with alleged violation of Rule G-17 for failure of underwriter and financial advisor to disclose payments made by underwriter to financial advisor); In re Wheat, First Securities, Inc., SEC Initial Dec. Rel. No. 155 (Dec. 17, 1999) (administrative law judge found violation of Rule G-17 and Florida fiduciary duty law for financial advisor’s false disclosure to municipal entity that it had not employed a lobbyist to secure its advisory contract with the county and that it had not entered into an arrangement with a third party to make payments contingent upon its securing the advisory contract); In re Pryor, McClendon, Counts & Co., Inc. et al., Exchange Act Release No. 48095 (Jun. 26, 2003) (settlement in connection with alleged violation of Rule G-17 for financial advisor’s failure to disclose payment to government official made to secure advisory assignment).
[5] See, e.g., Securities and Exchange Commission v. Capital Gains, 375 U.S. 180 (1963) (adviser breached fiduciary duty under Advisers Act by failing to act in his clients’ best interests and failing to disclose the short-term profits it made, and the impact of his actions on the clients, by recommending certain securities to his clients after purchasing them for his own account, a practice known as “scalping”).
[6] See, e.g., Monetta Financial Services, Inc. v. Securities and Exchange Commission, 390 F.3d 952 (7th Cir. 2004) (investment adviser breached fiduciary duty under Advisers Act by failing to disclose allocation of valuable IPO shares to directors of its investment company clients); In re Wheat, First Securities, Inc. and In re Pryor, McClendon, Counts & Co., Inc., supra.
[7] See, e.g., In re O’Brien Partners, Inc., Exchange Act Release No. 7594 (Oct. 27, 1998) (settlement in connection with alleged breach of fiduciary duty under Advisers Act, California law, Wisconsin law, and New York law by investment adviser for failure to disclose to state and municipal clients that it received “referral fees” from a finder that assisted in the reinvestment of municipal bond proceeds in guaranteed investment contracts, repurchase agreements and forwards; referral fees allegedly totaled $450,000 and represented 50-60% of finder commission); In the Matter of Mark S. Ferber, Exchange Act Release No. 38102 (Dec. 31, 1996) (settlement in connection with alleged breach of fiduciary duty by financial advisor for failure to disclose to state and municipal clients payments from broker-dealer totaling almost $6 million over two years in exchange for recommendations that his clients select that broker-dealer as underwriter or provider of other financial services, including interest rate swaps); In the Matter of Arthurs Lestrange & Co., Inc. and Michael Bova, SEC Release Nos. 33-7775, 34-42148 (Nov. 17, 1999) (settlement in connection with alleged breach of fiduciary duty by financial advisor for failure to disclose true nature of fee splitting arrangement; financial advisor allegedly contributed its financial advisory fee of $210,000 to pool of advisory and brokerage service compensation, received $1.5 million from the investment broker, and paid $500,000 to a finder); In the Matter of William R. Hough & Co., SEC Release Nos. 33-7826, 34-42632 (Apr. 6, 2000) (settlement in connection with alleged breach of fiduciary duty by financial advisor for failure to disclose excessive mark-ups and fee-splitting with investment providers; in one case, financial advisor allegedly received $35,000 for its financial advisory services and $400,000 from the investment provider; in the other, financial advisor allegedly received $300,000 from a forward supply contract provider for “developing a forward supply assignment program”); In the Matter of John S. Reger and Business & Financial Advisors, Inc., SEC Rel. No. 33-7973 (Apr. 23, 2001) (settlement in connection with alleged breach of fiduciary duty by financial advisor for failure to disclose to issuer that it received $129,000 kickback from escrow securities provider, representing 40% of escrow provider’s profit; financial advisor also participated in preparation of official statement and allegedly violated Sections 17(a)(2) and (3) of the Securities Act by failing to disclose the payments).
[8] See, e.g., Securities and Exchange Commission v. DiBella, 587 F.3d 553 (2d Cir. 2009) (investment adviser breached fiduciary duty under Advisers Act by failing to disclose payment to state senator on state pension fund investment advisory board made to influence state treasurer’s decision to invest state pension fund moneys with adviser); U.S. v. deVegter, 198 F. 3d 1324 (11th Cir. 1999) (financial advisor breached fiduciary duty to issuer by accepting payments from underwriter to manipulate competitive bidding process for refunding of bonds; financial advisor incorporated underwriter’s comments in order to make request for proposals more favorable for underwriter, sent bids of other competitors to underwriter, and ordered bids to be re-ranked so underwriter was highest ranked bidder).
[9] See, e.g., Securities and Exchange Commission v. Rauscher Pierce Refsnes, Inc., 17 F. Supp. 2d 985 (D. Ariz. 1998) (financial advisor breached its fiduciary duty under Arizona law by making false statements in tax certificate for advance refunding bonds, failing to disclose that its government securities desk was acting as a principal in the provision of escrow securities, and failing to disclose excessive mark-ups).
[10] See “Compensation/Forms of Compensation” herein.
[11] See, e.g., Prohibition on the Use of Brokerage Commissions to Finance Distribution, SEC Rel. No. 26591 (Sept. 2, 2004), at Section VII.E (explaining that the Commission’s adoption in 2004 of Investment Company Act Rule 12b-1(h), which, among other things, prohibits a fund from using brokerage commissions to pay for the distribution of the fund’s shares, was based on a conclusion that the practice of trading brokerage business for sales of fund shares poses conflicts of interest that the Commission believed to be “largely unmanageable”).
[12] See, e.g., the cases at note 7, supra. Rule G-36 does not preclude a municipal advisor from receiving payment for its municipal advisory services from a third party, as long as the municipal advisor discloses, and the municipal entity provides its informed written consent to, such payment arrangement and the amount of such payment. As with the disclosure of other conflicts of interest, such disclosure should be made before the municipal advisory engagement is entered into, or at the time the conflict arises, if later.
[13] See the cases at note 6, supra. Municipal advisors that are described in Section 15B(e)(9) of the Exchange Act because they solicit business from municipal entities on behalf of other municipal advisors are subject to all MSRB rules for municipal advisors.
[14] See, e.g., Securities and Exchange Commission v. Rauscher Pierce Refsnes, Inc., supra; In the Matter of Lazard Freres & Co., SEC Rel. Nos. 33-7671, 34-41318 (Apr. 21, 1999) (settlement in connection with financial advisor alleged to have failed to disclose excessive mark-ups on escrow securities it provided as principal; financial advisor alleged to have received $700,000 on the sale of the Treasuries, in addition to its $200,000 advisory fee).
[15] Treas. Reg. § 1.148-5(d)(6). In addition, a municipal advisor will not violate Rule G-36 solely because it provides investments to a municipal entity on a temporary basis to ensure the delivery of such securities on the closing date for a bond issue, provided that its compensation attributable to the provision of the securities is limited to the reimbursement of its cost of carry, such arrangement and compensation is disclosed to the municipal entity, and the municipal entity provides its informed written consent.
[16] Payments from third parties are included in determining whether compensation is excessive. See, e.g., the cases at note 7, supra, for examples of excessive compensation arrangements. Municipal advisors subject to hourly billing arrangements must not submit bills that do not accurately reflect the nature of the services performed and the personnel performing them. Similarly, municipal advisors should not submit inflated expenses.
[17] See, e.g., the cases at note 20, infra.
[18] Section 4s(h)(5) of the Dodd-Frank Act requires that a swap dealer with a special entity client (including states, local governments, and public pension funds) must have a reasonable basis to believe that the special entity has an independent representative that satisfies these criteria, among others.
[19] See, e.g., O’Brien Partners, supra (duty to advise issuer on whether to invest bond proceeds and whether to invest in securities); In re Lazard Freres, supra (duty to investigate whether advisory client could obtain a more favorable price than the one offered by financial advisor for escrow securities).
[20] See, e.g., In the Matter of Dwight Allen, SEC Rel. Nos. 33-7456, 34-39122 (Sept. 24, 1997) (settlement in connection with independent financial consultant alleged to have violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act by acting recklessly in certifying that certain municipal obligations met a “minimum credit requirement” based on the value to lien ratio calculated on the value of land; lacking experience with these types of obligations, calculating the value to lien ratio, or the land appraisal process, he allegedly simply relied on one appraisal of the land, which was based on the estimated build-out value if the land was fully developed and did not reflect current market value); In re Milbrodt, SEC Rel. Nos. 33-7455, 34-39121 (Sept. 24, 1997) (settlement in connection with financial advisor alleged to have certified that land-based bonds to be acquired by pool bond issuer met minimum credit requirements despite the lack of an independent appraisal of the current market value of the land and without reviewing the governing documents, the governing test for investments of pool bond issuers, or the official statements of land-based bond issuers); In the Matter of the County of Nevada (McKay), SEC Rel. Nos. 33-7556, 34-40225 (July 17, 1998) (settlement in connection with appraiser in Dwight Allen and Milbrodt cases alleged to have failed to exercise due care in its appraisals used in official statements and violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act).
[21] See, e.g., In the Matter of County of Nevada (Virginia Horler), SEC Init. Dec. Rel. No. 153 (Oct. 29, 1999) (administrative law judge found financial advisor tasked with preparation of official statement for Mello-Roos issue stepped into the shoes of the underwriter and violated Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Exchange Act by failing to exercise due diligence and inquire into the finances or personal financial condition of developers and financial condition of development company, which was experiencing negative cash flow and failed to pay taxes in 1990, ultimately leading to bankruptcy).
[22] See, e.g., Joyce v. Morgan Stanley, 538 F. 3d 797 (10th Cir. 2008) (claim by shareholder denied because financial advisor had limited its fiduciary duty to the corporation itself and its engagement letter had expressly disclaimed the duty to advise on the possible change in value of stock of the acquiring corporation in the period between announcement of the merger and the closing).
[23] See, e.g., In re Daisy Systems Corp. (97 F. 3d 1171 (9th Cir. 1996) (financial advisor’s engagement letter not dispositive of scope of financial advisory relationship because it did not expressly limit the nature of the advice to be provided).
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[1] All comments received will be made publicly available without change. Personal identifying information, such as names or e-mail addresses, will not be edited from submissions. Therefore, commenters should submit only information that they wish to make publicly available.
[2] “Municipal advisor” is defined in Section 15B(e)(4) of the Exchange Act as “a person (who is not a municipal entity or an employee of a municipal entity) that: (i) 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 (ii) undertakes a solicitation of a municipal entity.
[3] The term “municipal entity” is defined by Section 15B(e)(8) of the Exchange Act as: “any State, political subdivision of a State, or municipal corporate instrumentality of a State, including -- (A) any agency, authority, or instrumentality of the State, political subdivision, or municipal corporate instrumentality; (B) any plan, program, or pool of assets sponsored or established by the State, political subdivision, or municipal corporate instrumentality or any agency, authority, or instrumentality thereof; and (C) any other issuer of municipal securities.”
