What You Need to Know about the New SEC Municipal Advisor Rule
IMGCAP(1)]Nonprofit and for-profit corporations that borrow through the issuance of taxable or tax exempt municipal debt have a new rule about who can give them financial advice.
A municipal advisor is a qualified financial professional who gives municipalities and nonprofits advice on financial deals such as bond offerings. Under the municipal advisor rule that the SEC approved last September, that person must now be registered through the SEC as a municipal advisor and cannot have any other interest in the deal. They now have a federal fiduciary duty to their clients and will be held to new professional qualification and business conduct standards.
The SEC municipal advisor rule requires that people who provide “advice” to a municipal entity or “obligated person” with respect to investment strategies register with the SEC if such advice relates to (i) the issuance of municipal securities, (ii) the investment of proceeds of municipal securities, or (iii) municipal derivatives. Under the rule, the term “obligated persons” includes traditional conduit borrowers such as, traditional 501(c)3’s, nonprofit health care providers and universities that are obligated to repay amounts borrowed through a municipal securities offering.
There are numerous consequences for issuers and market participants, as some of the traditional business practices to which governments have become accustomed will have to change. Historically, it was common for those orchestrating the transaction to also dish out advice and counsel to the municipality or nonprofit entering into the deal. The problem with this model was that while most underwriters or brokers are fair and reasonable, entrusting a financial professional to give advice to a municipality or nonprofit when that professional could potentially benefit greatly if the municipality or nonprofit enters into the deal, creates an inherent conflict of interest. Unless an exemption is met, issuers will only be able to receive advice or recommendations from municipal advisors (those professionals with a fiduciary duty to the government or nonprofit), and not other parties, such as underwriters.
Whether someone gives advice to a municipal entity or obligated person is based on “all of the relevant facts and circumstances,” including whether the advice: (i) involves a recommendation to a municipal entity, (ii) is particularized to the specific needs of a municipal entity, or (iii) relates to municipal financial products or the issuance of municipal securities. While underwriters and other professionals may not provide recommendations or advice to issuers unless an exemption is met, underwriters may talk with the issuer about “general market information.”
The SEC has stated that general information “cannot contain or express subjective assumptions, opinions, or views or constitute a recommendation.” However, general information includes market information, available products and even “information regarding a municipal entity’s particular outstanding bonds, such as current market prices and yields, without this information constituting a recommendation.”
Many governments and nonprofits are considering whether to retain a municipal advisor on an ongoing basis to make it easier for underwriters or bankers to approach a government or nonprofit with a deal that might be good for them (like refinancing debt at a lower interest rate). But that’s not a solution that will work for everyone, as many governments and nonprofits are used to seeking advice from different people depending on their expertise and the type of deal.
The rule limits the ability of underwriters to discuss with issuers specific recommendations related to a transaction or possible transaction unless the issuer has hired an MA or has an RFP out for response. This includes limiting the ability for underwriters and others to help advise governments on the investment of bond proceeds.
When an issuer has an MA but wants to receive advice or recommendations from an underwriter that it has not hired, the issuer must represent in writing that they will rely on the advice of an MA.
The SEC has further clarified that the term “rely on” means that the municipal entity or obligated person will seek and consider the advice, analysis and perspective of the municipal advisor. However, for purposes of this exemption, “rely on” does not mean that the municipal entity or obligated person must follow the advice of the independent registered municipal advisor.
Underwriters may include recommendations and advice when responding to an issuer’s RFP if the RFP is about a specific financing, the RFP has been sent to at least three reasonably competitive firms or is posted on the issuer’s Web site, and has a response timeframe of less than six months. When an underwriter is engaged by the issuer on a transaction, it may discuss with the issuer a wide variety of items related to the issuance, including its structure, timing, terms and other similar matters.
The SEC’s final rule also exempts underwriters and other professionals from the municipal advisor definition if they provide advice to a municipal entity or obligated person that is being represented by, and will rely upon the advice of, an independent registered municipal advisor. For the exemption to apply, the municipal entity or obligated person must provide a written representation stating that it is relying on an independent registered municipal advisor, and the underwriter or other professional must provide written disclosure stating that, by receiving such a written representation, the underwriter or other professional is not a municipal advisor. A copy of the written disclosure must also be provided to the independent registered municipal advisor.
Douglass Dalton leads McGuire Sponsel’s Financing and Economic Incentives practice, specializing in economic incentives, project financing, and swap and debt advisory services.