United States: BEWARE: Advice Isn't Just "Advice" Any More

U.S. lawmakers enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") in the wake of the 2008 financial crisis, which among other provisions, imposed registration requirements and a fiduciary duty on municipal advisors ("Municipal Advisors"). Following on the heels of the Dodd-Frank Act, the Securities and Exchange Commission ("SEC") and the Municipal Securities Rulemaking Board ("MSRB") enacted regulations, including the municipal advisor rule ("MA Rule"). The MA Rule requires financial advisors and broker-dealers (those firms serving as underwriter, financial advisor or both) ("Underwriters") who advise municipal entities ("Issuers") (state and local governments and other political subdivisions within a state) to register as Municipal Advisors with the SEC. According to the MA Rule, advice "...includes, without limitation, a recommendation that is particularized to the specific needs, objectives, or circumstances of a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities." In other words, advice is given if the Issuer can reasonably interpret the words as a call to action. Advice is not to be confused with "information," which can be provided at any time during a bond financing. The MA Rule applies throughout the life of an issue of municipal securities (starting with the pre-issuance planning stage and until the bonds mature or are redeemed).

Underwriters are especially impacted by the MA Rule, because a firm serving as a Municipal Advisor on an issuance is prohibited from serving as underwriter on that same issuance due to the fiduciary duty standard of the MA Rule. This presents an obvious question: How is an Underwriter to be engaged by a public entity if it cannot provide advice to that public entity regarding how to proceed with a bond financing? The MA Rule has carved out some narrow exceptions to the rule: (i) if a firm is contractually engaged to serve as underwriter on a specific transaction, advice provided under that engagement (typically concluding at the end of the underwriting period) does not trigger the MA Rule; (ii) dealers are exempt from the MA Rule if the Issuer has engaged an "independent registered Municipal Advisor"; and (iii) dealers are exempt from the MA Rule when responding to an Issuer's request for proposals ("RFPs"). The exceptions put limits on the abilities of Underwriters to market their services. While Underwriters are able to communicate with Issuers about general market issues, facts and ideas, unless an exemption is met, an Underwriter cannot advise an Issuer to take specific action, until the Underwriter is engaged. In other words, the Underwriter can give a general overview of what it can do, but must limit what it tells the Issuer it will do, for fear of advising the Issuer.

The SEC and MSRB believe the MA Rule will provide benefits by enhancing protections to municipal bond Issuers and by providing guidance to Municipal Advisors for complying with the Dodd Frank Act. Issuers often rely on deal suggestions, analysis and related services they receive from Underwriters and/or Municipal Advisors and the MA Rule will provide an important trigger to protect the Issuers, but also allow for Underwriters to provide their tailored services once formally engaged or replying to a RFP submission. The MA Rule also carves out the Issuer's ability to engage both a Municipal Advisor and an Underwriter and subsequently, benefit from the services both can provide for deal suggestions, analysis and related services for bond issuances. Moreover, the MA Rule provides important protections for Issuers, while providing guidance for Municipal Advisors and Underwriters a like.

However, some ways the MA Rule could be drafted to encourage disclosure between Underwriter and Issuer include expanding the scope of advice to include a freer flow of communication from Underwriters to Issuer clients without triggering the MA Rule's fiduciary duty standard or advice component, expanding the engagement requirement to allow Issuers to establish formal, but non-binding agreements with Underwriters (as well as a provision describing how a Municipal Advisor may withdraw from or terminate their Municipal Advisor relationship to comply with fiduciary duty standards), or allowing the RFP process to include general requests for ideas rather than the formal procurement process.

The MA Rule, as written, provides both opportunities and challenges for Issuers to consider. The opportunities provided by the MA Rule include the intention of the rule to protect municipal bond Issuers and the challenges involve the fact it is a newer rule that Issuers must become familiar with in considering whether to engage both a Municipal Advisor and Underwriter, whether to have a RFP submission or engage an Underwriter early on in the municipal bond issuance process.

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.

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