The Securities and Exchange Commission recently issued proposed
rules (the Proposed Rules)* that define who must register as a
"Municipal Advisor" under the Dodd-Frank Wall Street
Reform and Consumer Protection Act (Dodd-Frank), establish a
permanent registration regime for Municipal Advisors and impose
certain recordkeeping requirements on Municipal Advisors.
Dodd-Frank also granted the Municipal Securities Rulemaking Board
(MSRB) regulatory authority over Municipal Advisors and imposed
upon Municipal Advisors a fiduciary duty when advising Municipal
Entities (defined below). Registration requirements for the MSRB
are in addition to registration requirements for the SEC.
The Proposed Rules broaden the definition of Municipal Advisor and
the activities that constitute Municipal Advisory Activities
(defined below). The Proposed Rules should be of particular
interest to persons engaging in any activity with Municipal
Entities because the broad definition of Municipal Advisory
Activities may require registration with the SEC as a Municipal
Advisor, both by entities currently registered with government
regulators with respect to other activities (such as certain
investment advisers that are registered with the SEC) and by
entities currently not registered with any government regulators.
Indeed, certain activities that previously were performed by
registered investment advisers may now require such advisers to
also register as Municipal Advisors.
Background
Before Dodd-Frank was adopted, the activities of Municipal
Advisors were largely unregulated and most Municipal Advisors
generally were not required to register with the SEC, the MSRB or
other government entity with respect to their Municipal Advisory
Activities. The Securities Act of 1933, as amended and the
Securities Exchange Act of 1934, as amended (the Exchange Act)
provide broad exemptions for municipal securities from their
provisions except for the antifraud provisions. Indeed, some
entities, such as brokers, dealers, municipal securities dealers,
investment advisers and banks were subject to registration by other
government regulators, but not with respect to their activities as
Municipal Advisors. Under the Proposed Rules, these entities would
have to register as Municipal Advisors with respect to their
Municipal Advisory Activities.
Title IX of Dodd-Frank amended Section 15B of the Exchange Act
(which sets forth the registration requirements for Municipal
Advisors) to (a) make it unlawful, absent certain exemptions, for
Municipal Advisors to provide certain advice to, or solicit,
Municipal Entities or certain other persons without registering
with the SEC, and (b) require Municipal Advisors to register with
the SEC effective October 1, 2010. To enable these advisors to
fulfill Dodd-Frank's mandate, the SEC previously adopted an
interim final temporary rule and form that provided a transitional
step toward implementing a permanent registration regime for
Municipal Advisors that will expire by December 31, 2011.
Statutory Proscription for Municipal Advisors
Section 15B(a)(1) of the Exchange Act, as amended by Dodd-Frank, makes it "unlawful for a municipal advisor to provide advice to or on behalf of a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities, or to undertake a solicitation of a municipal entity or obligated person, unless the municipal advisor is registered."
Proposed Rules Clarify Scope of Persons Included within the Definition of Municipal Advisor
Municipal Advisor
The statutory definition of "Municipal Advisor" is broad
and includes persons that traditionally have not been considered
municipal financial advisors, including financial advisors,
guaranteed investment contract brokers, third-party marketers,
placement agents, solicitors, finders and swap advisors that engage
in Municipal Advisory Activities. Unless one of the exclusions
described below applies, the Proposed Rules state that these
persons are included in the definition of Municipal Advisor if they
provide advice to or on behalf of a Municipal Entity or Obligated
Person (defined below) with respect to Municipal Financial Products
(defined below), the issuance of municipal securities (including
advice with respect to the structure, timing, terms and other
similar matters) or undertake a solicitation of a Municipal Entity
("Municipal Advisory Activities"). Also included would be
persons that provide advice with respect to plans, programs or
pools of assets and investment funds held by, or on behalf of, a
Municipal Entity, such as a 529 college plan or a public pension
plan. The issue of whether a person is compensated for providing
municipal advice is not determinative as to whether the person is a
Municipal Advisor.
According to the Proposed Rules, there are three distinct
categories of Municipal Advisors that offer different services:
- financial advisors (including broker-dealers already registered with the SEC) that provide advice to Municipal Entities with respect to their issuance of municipal securities and their use of Municipal Financial Products;
- investment advisers that advise municipal pension funds and other Municipal Entities on the investment of funds held by or on behalf of Municipal Entities (subject to certain exclusions); and
- third-party marketers and solicitors.
There are several exclusions from the definition of Municipal
Advisor that are described below in the "Exclusions"
section.
Municipal Entity/Obligated Person
In addition to a state, political subdivisions of a state and its
instrumentalities and any agency of the state, "Municipal
Entity" includes any plan, program or pool of assets sponsored
by the state or its instrumentalities (including public pension
funds and participant-directed investment programs or plans such as
529 plans) and any other issuer of municipal securities.
"Obligated Person" means any person, including an issuer
of municipal securities, who is committed by contract or other
arrangement to support the payment of all or part of the obligation
of the municipal securities to be sold in an offering of municipal
securities. The Proposed Rules provide that Obligated Persons can
include entities acting as conduit borrowers, such as private
universities, nonprofit hospitals and private corporations, but
would not include providers of municipal bond insurance, letters of
credit or other liquidity facilities.
Municipal Financial Products/Investment Strategies
"Municipal Financial Products" means municipal
derivatives, guaranteed investment contracts and "Investment
Strategies." The Proposed Rules interpret Investment
Strategies to mean the investment of the proceeds of municipal
securities and to include plans, programs or pools of assets that
invest funds "held by or on behalf of a [M]unicipal
[E]ntity." Therefore, any person that provides advice with
respect to plans, programs or pools of assets that invest funds
held by, or on behalf of, a Municipal Entity must register as a
Municipal Advisor unless it is covered by one of the exclusions
discussed below.
In this regard, the Proposed Rules raise certain questions that
require clarification. For example, every bank account of a
Municipal Entity is comprised of funds "held by or on behalf
of a [M]unicipal [E]ntity." Under those circumstances, would a
money manager providing advice to a Municipal Entity with respect
to its bank accounts be deemed to be a Municipal Advisor and thus
be required to register?
Of comfort to fund managers and investment advisers is the
SEC's statement in the Proposed Rules that to the extent a
person is providing advice to a pooled investment vehicle in which
a Municipal Entity has invested along with other non-municipal
entities, the pooled investment vehicle would not be considered
funds "held by or on behalf of a [M]unicipal [E]ntity,"
and the person providing advice to the pooled investment vehicle
would not be required to register as a Municipal Advisor. The SEC
requested comments on whether this pooled investment vehicle
interpretation should be limited to situations where the
non-municipal investors are the primary investors or determined by
the amount of investment by the Municipal Entity in the pooled
investment vehicle. Of course, an investment adviser providing
advice directly to a Municipal Entity (for example, a separately
managed account) would have to register as a Municipal
Advisor.
Solicitation of a Municipal Entity/Obligated Person
"Solicitation of Municipal Entity or Obligated Person"
means a communication with a Municipal Entity or Obligated Person
made for compensation on behalf of a broker, dealer, municipal
securities dealer, Municipal Advisor or unaffiliated investment
adviser for the purpose of obtaining or retaining an engagement by
a Municipal Entity or Obligated Person of a broker, dealer,
municipal securities dealer or Municipal Advisor in connection with
Municipal Financial Products, the issuance of municipal securities
or of an investment adviser to provide investment advisory services
to or on behalf of a Municipal Entity.
According to the Proposed Rules, absent an exclusion, any
third-party solicitor that seeks business on behalf of a broker,
dealer, municipal securities dealer, Municipal Advisor or
investment adviser from a Municipal Entity or Obligated Person must
register as a Municipal Advisor. Accordingly, a third-party
solicitor that seeks business on behalf of an investment adviser
from a municipal pension fund or a government investment pool would
be required to register as a Municipal Advisor. Neither the number
nor the size of investments solicited is a factor in determining
whether solicitation of a Municipal Entity requires registration as
a Municipal Advisor. Indeed, the Proposed Rules provide that
solicitation of even a single investment of any amount in a
Municipal Entity or Obligated Person would require the person
soliciting that entity to register as a Municipal Advisor.
Persons soliciting a Municipal Entity or Obligated Person on behalf
of affiliated entities would not fall within the definition of
Municipal Advisor and would not be required to register as such,
although an affiliated person could voluntarily register as a
Municipal Advisor (and subject itself to the regulatory regime for
Municipal Advisors). Although the Proposed Rules do not elaborate,
the reason an affiliated entity would not be required to register
as a Municipal Advisor presumably is that the underlying entity on
whose behalf it is soliciting would already be registered as a
Municipal Advisor (or be excluded from that definition and would
not be so registered). Similarly, the Proposed Rules also do not
elaborate on whether a registered investment adviser would be
required to register as a Municipal Advisor if it solicits a
Municipal Entity on its own behalf (as opposed to providing advice
to a Municipal Entity).
In this context, it should be noted that in its Proposed Rules
Implementing Amendments to the Advisers Act (which is the subject
of a previous
Katten Client Advisory), the SEC is proposing to amend
Rule 206(4) of the Investment Advisers Act of 1940, as amended (the
Advisers Act) to permit investment advisers to pay a
"regulated Municipal Advisor" to solicit government
entities on its behalf.1 Such solicitors may include
entities affiliated with the investment adviser.
Exclusions from the Definition of Municipal Advisor
The Proposed Rules provide that the following would be excluded from the definition of Municipal Advisor:
a) An investment adviser registered under the Advisers Act and its associated persons, to the extent that it provides investment advice that would subject such adviser to the Advisers Act. However, an SEC-registered investment adviser or its associated persons would have to register as a Municipal Advisor if the investment adviser or its associated persons engage in any Municipal Advisory Activities that would not be investment advice subject to the Advisers Act. For example, an SEC-registered investment adviser that provides advice with respect to how a Municipal Entity should issue municipal securities, or solicits a Municipal Entity on behalf of an unaffiliated Municipal Advisor, would be required to register as a Municipal Advisor. The Proposed Rules distinguish between advisory services performed by an SEC-registered investment adviser that fall within the purview of an investment adviser's traditional activities that are subject to the Advisers Act and those activities that fall outside that purview. Further, the Proposed Rules do not specifically exempt a state-registered investment adviser from registration as a Municipal Advisor, to the extent it is engaged in Municipal Advisory Activities. The SEC requested comments on whether these stateregistered investment advisers should be exempt from the definition of Municipal Advisor to the extent (similar to SEC-registered investment advisers) they are providing advice that otherwise would be subject to the Advisers Act.
b) A commodity trading advisor (CTA) registered under the Commodity Exchange Act and its associated persons, to the extent that it provides advice relating to swaps. However, the exclusion would not apply to a CTA to the extent it engages in municipal activities other than providing advice relating to swaps, in which case, it would have to register as a Municipal Advisor. For example, a CTA providing advice to a Municipal Entity with respect to engaging in a swap transaction and providing advice to the Municipal Entity with respect to the structure of a municipal securities offering would have to register as a Municipal Advisor.
c) An employee of a Municipal Entity (although the exclusion would not apply to appointed members of the governing body of a Municipal Entity, as those persons are not directly accountable for their performance to the citizens of the Municipal Entity).
d) A broker, dealer or municipal securities dealer serving as an underwriter on behalf of a Municipal Entity or Obligated Person in connection with the issuance of municipal securities (although the exclusion would not apply to a brokerdealer advising a Municipal Entity with respect to the investment of bond proceeds or acting as a placement agent for a private equity fund).
e) Professionals, including lawyers, engineers and accountants, but only to the extent to which they are providing traditional advice not constituting Municipal Advisory Activities.
The SEC requested comments on whether an entity that as part of its ongoing ordinary communications provides to clients (including Municipal Entities) investment advice, such as research information and generic ideas or commentary, and that does not purport to meet the needs of specific clients, should be excluded from the definition of Municipal Advisor.
Application for Municipal Advisor Registration
Any person that falls within the definition of Municipal Advisor
but does not fit into the exclusions discussed above would be
required to register as a Municipal Advisor with with the SEC and
with the MSRB.
The Proposed Rules would establish procedures for Municipal
Advisors to apply for registration with the SEC. The SEC would have
45 days either to (a) grant registration or (b) institute
proceedings to determine whether registration should be denied. An
application for registration as a Municipal Advisor would be filed
electronically on proposed new Form MA (for Municipal Advisory
firms) or Form MA-I (for natural person Municipal Advisors) and
would be publicly available. The proposed forms are similar to Form
ADV Part 1 and FINRA's Form U-4, with appropriate changes to
reflect the activities of Municipal Advisors, and include a
self-certification that the information is true and correct and
that the Municipal Advisor is able to meet its regulatory
obligations. The proposed forms would be required to be amended or
recertified at least annually and more frequently if the
information becomes inaccurate.
Recent Changes to MSRB Regulations and Requirements Applicable to Municipal Advisors Disciplinary Actions
The MSRB has amended Rule G-5 to provide that Municipal Advisors and their associated persons may not engage in Municipal Advisory Activities in violation of any restrictions imposed thereupon by the SEC.
Fair Dealing
The MSRB has amended Rule G-17 to provide that Municipal Advisors shall be required to deal fairly with all persons and not engage in any deceptive, dishonest or unfair practice.
Pay to Play
The MSRB has proposed the adoption of Rule G-42, modeled after
Rule G-37, which would put into place certain "pay to
play" restrictions on Municipal Advisors. The proposed rule
would prohibit Municipal Advisors from engaging in Municipal
Advisory Activities with a Municipal Entity for compensation,
soliciting third-party business from a Municipal Entity for
compensation or receiving compensation for the solicitation of
third-party business from a Municipal Entity, within two years
after any contribution to an official of such Municipal Entity. The
compensation restrictions would begin on the date of the
contribution and run for two years after the Municipal Advisor
stops working for the Municipal Entity. For third-party solicitors,
the compensation restrictions would run for the two-year period
after they make a contribution.
The proposed rule would require Municipal Advisors to submit Board
Form G-42 to the MSRB detailing contributions made by or on behalf
of the Municipal Advisor in each quarter in which any applicable
contributions were made.
The proposed rule would contain a two-year look-back period, but
only for contributions made after the rule's effective date.
The proposed rule would also have an exception for contributions of
up to $250 to officials for whom the Municipal Advisor is entitled
to vote.
*The Proposed Rules were published in the Federal Register, Volume 76, No. 4 (January 6, 2011) as Release No. 34-63576, and are available at http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=2011_register&docid=%5bDOCID:fr06ja11-16%5d.pdf.
Footnote
1.A person that solicits investors to invest in securities also may need to consider whether it is acting as a broker and is required to register as such.
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.