United States: Public Finance Alert - SEC Proposes Rules To Require Registration Of "Municipal Advisors"

SEC proposes rules to require registration of "municipal advisors"; municipal advisors defined broadly to potentially include appointed board members of municipal entities and conduit borrowers, employees of conduit borrowers, banks, underwriters, lawyers and others

Summary

On December 20, 2010, the Securities and Exchange Commission (SEC or Commission) voted to propose Rules 15Ba1-1 through 15Ba1-7 (collectively, the Proposed Rules) to, among other things, establish a permanent registration regime with the Commission for municipal advisors and impose certain record-keeping requirements on such advisors. The Proposed Rules, set forth in SEC Release No. 34-63576, are promulgated in accordance with Section 975 of Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), which amended Section 15B of the Securities Exchange Act of 1934 (as amended by the Dodd-Frank Act, the Exchange Act) to require municipal advisors to register with the SEC effective October 1, 2010. On September 1, 2010, the Commission adopted an interim final temporary rule to establish a registration system to allow municipal advisors to satisfy temporarily the requirement that they register with the Commission by October 1, 2010. The interim registration procedures will be replaced by the new procedures established pursuant to the Proposed Rules, as adopted, and all municipal advisors will be required to register anew under the new system.

As discussed below, the definition of the term "municipal advisor" is broad and the implications of qualifying as a "municipal advisor" for purposes of the Exchange Act are significant and will subject persons qualifying as municipal advisors to regulation by the Commission and the Municipal Securities Rulemaking Board (the MSRB). For example, the Proposed Rules suggest that an appointed board member of a municipal entity or of a 501(c)(3) corporation or other conduit borrower that is an "obligated person" may qualify as a "municipal advisor" under certain circumstances. In addition, unlike employees of municipal entities, employees of such "obligated persons" are not excluded from the definition of "municipal advisor." Finally, banks are not specifically excluded on any basis, and professionals such as lawyers and accountants as well as underwriters are excluded on only a limited basis.

What/Who is a municipal advisor?

Generally

The term "municipal advisor" is defined in the Exchange Act as a person (who is not a municipal entity or an employee of a municipal entity) that:

There are a few limited categories of exclusions from this definition; otherwise, all persons taking action as described in (i) or (ii) will be encompassed by this definition. This includes banks, accountants, engineers and underwriters providing "advice" and lawyers not representing the municipal entity or conduit borrower who are deemed to be providing "advice" to the municipal entity or conduit borrower, such as underwriter's counsel, bank counsel, or swap counsel.

For purposes of the definition of a "municipal advisor," the Commission clarifies in the Proposed Rules that the definition of "municipal entity" includes, but is not limited to, public pension funds, local government investment pools, and other state and local government entities or funds, as well as participant-directed investment programs or plans such as 529, 403(b), and 457 plans. The Commission has also confirmed in the Proposed Rules that the term "obligated person" is consistent with the defined term in Rule 15c2-12 and therefore does not include providers of municipal bond insurance, letters of credit, or other liquidity facilities. This means that entities acting as conduit borrowers such as private universities, non-profit hospitals and other 501(c)(3) organizations, and private corporations, all of which are obligated persons under Rule 15c2-12, will be impacted by the use of this term in the definition of "municipal advisor."

The term "advice" is not defined in the Proposed Rules or the Exchange Act. As a result, if the meaning of the term "advice" is not clarified by the Commission in the final rules, rules of statutory construction will need to be applied to determine the meaning of the term "advice" for purposes of Section 15B of the Exchange Act.

Employees of a municipal entity excluded, but certain appointed board members of a municipal entity not excluded

Under the Exchange Act, the term "municipal advisor" specifically excludes "employees of a municipal entity." According to the Commission, the exclusion from the definition of a "municipal advisor" for "employees of a municipal entity" should include any person serving as an elected member of the governing body of the municipal entity to the extent that person is acting within the scope of his or her role as an elected member of the governing body of the municipal entity. In addition, the Commission states that "employees of a municipal entity" should also include (i) appointed members of a governing body to the extent such appointed members are ex officio members of the governing body by virtue of holding an elective office and (ii) persons appointed to fill the remainder of the term for an elective office.

Importantly, however, the Commission takes the position that appointed members of a governing body of a municipal entity who are not elected ex officio members should be included in the definition of a "municipal advisor." According to the Commission, this interpretation is appropriate because employees and elected members are accountable to the municipal entity for their actions. In addition, the Commission is concerned that appointed members, unlike elected officials and elected ex officio members, are not directly accountable for their performance to the citizens of the municipal entity. The Commission states that whether a municipal advisor is compensated for providing advice should not factor into the determination regarding whether the municipal advisor must register with the Commission.

As mentioned above, the term "advice" is not clarified and could include a board member's participation in a meeting about alternative structures or timing of a bond transaction or execution of a swap or guaranteed investment contract. The term "advice" could possibly be interpreted so broadly that it would encompass action taken by a governing board to approve such a bond transaction or financial product even if there is no further discussion.

The Commission's position is significant because it would require most appointed board members of an authority, public university or other municipal entity who provide advice in connection with a municipal borrowing or financing instrument to register with the SEC, with the implications discussed below. This could have a significant chilling effect on the willingness to serve of the tens of thousands of volunteer board members on whom many municipal entities depend for governance.

Employees and appointed board members of 501(c)(3) corporations and other obligated persons not excluded

The Exchange Act and the Proposed Rules do not exclude from the definition of "municipal advisor" employees or board members of an "obligated person" for purposes of a conduit bond issuance. Therefore, if the Proposed Rules are adopted in their current form, employees and board members of 501(c)(3) corporations or other obligated persons would qualify as "municipal advisors" subject to the registration requirements of the Proposed Rules if they provide advice to or on behalf of such obligated person with respect to municipal financial products or the issuance of municipal securities. Since the term "advice" is not defined in the Proposed Rules or in the Exchange Act, it is unclear whether a chief financial officer, or other employee, of an obligated person becomes a municipal advisor subject to the registration requirements of the Proposed Rules simply by performing services with respect to municipal financial products or in connection with the issuance of municipal securities that are part of day to day responsibilities. The applicability of the Proposed Rules to the board members of a 501(c)(3) corporation or other obligated person is also unclear, and it is possible that any action taken by the board in connection with a loan agreement relating to a bond issuance, swaps or other municipal financial products would be considered "advice." As noted above, the chilling effect on the willingness of volunteer board members to serve on nonprofit boards would be significant under the Proposed Rules.

Banks, underwriters and professionals may be considered "municipal advisors" subject to registration with the commission

Banks are not excluded from the definition of "municipal advisor" and would be required to register under the Proposed Rules if their agreement to purchase bonds, offer investment products, serve as trustee or provide other services are considered by the Commission to be "advice" to a municipal entity. Similarly, while accountants who prepare financial statements or issue comfort letters are excluded, other accountants such as those providing verification reports or revenue forecasts may be subject to the registration requirements of the Proposed Rules. The Commission proposes to exclude lawyers from the definition only when the legal services are "to a client of the attorney that is a municipal entity or obligated person." This limitation could have significant implications for lawyers representing other parties in municipal financing transactions. Finally, the definition of "municipal advisor" does not exclude broker-dealers in connection with actions such as bidding or recommending investments to the extent considered "advice" by the Commission.

Implications of municipal advisor registration with the commission

A municipal advisor required under the Exchange Act to register with the Commission will 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 the rules of the MSRB. Violations of the rules of the MSRB or the Commission could subject municipal advisors to criminal and civil liability.

To register with the Commission, a municipal advisor will be required to file with the Commission a form that requires the disclosure of, among other things: (i) personal information and employment history; (ii) information regarding past felony charges or convictions, violations of securities rules and regulations, and civil judicial actions or settlements involving the violation of investment or municipal advisor statutes or regulations; (iii) information regarding consumer complaints or arbitrations regarding investment-related matters; and (iv) information regarding bankruptcy or similar proceedings in the last ten years, judgments, or denial of any bonds. Such information is to be maintained by the Commission and will be accessible by the public. A municipal advisor will also be required to certify that such municipal advisor and every natural person associated with such advisor has met or will meet within the required timeframes such standards of training, experience, and competence, and such other qualifications, including testing, as are required by the MSRB or the Commission. Municipal advisors will also need to comply with certain recording-keeping requirements required under the Proposed Rules, which, among other things, will require municipal advisors to make and keep current records for at least five years. The Commission has the power to grant or deny the registration of municipal advisors.

In addition, a municipal advisor will be required to appoint certain officials as agents for service of process in states where the advisor maintains its principal office or place of business. The appointment for service of process would allow private parties and the Commission to bring actions against the municipal advisor by delivering the necessary papers to the appointed agent. The agent could also receive service for investigation and administrative proceedings.

Further actions

The MSRB has recently amended certain rules, including Rule G-17 (the "fair dealing" rule), so that they are applicable to municipal advisors. The MSRB has indicated that it will be developing additional rules for municipal advisors in the future. The MSRB expects to adopt a rule governing "pay to play" in a manner comparable to existing Rule G-37 and a rule on gifts and gratuities. The MSRB has also stated that it expects to begin the development of professional qualifications tests and continuing education requirements for municipal advisors in the near future.

Comment period with respect to the proposed rules

The Commission is requesting comments with respect to the Proposed Rules from all members of the public and, in particular, persons who must register as municipal advisors, municipal entities, obligated persons, investors and other regulators. Comments on the Proposed Rules may be submitted within 45 days after publication thereof in the Federal Register. The Proposed Rules were published in the Federal Register on January 6, 2011.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.