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SEC Delays Municipal Advisor Registration Rule Through July 1, 2014

The SEC announced on January 13, 2014 that compliance with the final municipal advisor registration rules will be phased in beginning July 1, 2014, notwithstanding that the final rules are effective on January 13, 2014 (following their September 30, 2013 adoption date).  Municipal advisors currently registered under the temporary regime (there are currently about 1,100) are required to register under the permanent regime on a phased-in basis.  As set forth in the table below, a municipal advisor’s temporary registration number determines the applicable compliance period during which the municipal advisor is required to register as such on the final registration forms under the final rules.

Temporary Registration Number Range –>Period for Filing Complete Application for Registration

  • 866-00001-00 through 866-00400-00 –> July 1, 2014 to July 31, 2014
  • 866-00401-00 through 866-00800-00 –> August 1, 2014 to August 31, 2014
  • 866-00801-00 through 866-01200-00 –>September 1, 2014 to September 30, 2014
  • after 866-01200-00 –> October 1, 2014 to October 31, 2014

If a person provides regulated “advice” after January 13, 2014, fits the definition of a municipal advisor, does not qualify for an exemption or exclusion and has not previously registered, then that person must register under the temporary registration rule and then register under the final rules under the above phase-in schedule.  If a person enters the municipal advisory business after October 1, 2014, then the advisor must apply and register under the permanent registration regime.  In any case, an advisor must register before engaging in municipal advisory activities.

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Draft Rule May Force Some Banks to Exit Municipal Advisory Business

On January 9, 2014, the Municipal Securities Rulemaking Board (the “MSRB”) published draft MSRB Rule G-42, which sets forth standards of conduct and duties of municipal advisors when engaging in municipal advisory activities other than the undertaking of solicitations.  As written, section (f) of the draft rule appears likely to force some banks who, directly or through an affiliate, are registered as a municipal advisor to exit the municipal advisor business.  The rule does not allow municipal advisors to both give “advice” to their municipal clients and to conduct other business with those clients.  Forced to choose between being a pure fiduciary /advice municipal advisor and engaging in other business with municipal entities, including more lucrative services as a depository bank, investment advisor, lender or swap provider, some banks will have no practical alternative but to exit the pure fiduciary business entirely.  Forcing banks to unbundle their services appears likely to drive up overall costs, since banks will be artificially removed as competitors from the marketplace and a separate entity acting as municipal advisor (and their counsel) will now be added to municipal bond transactions in addition to the municipal entity’s (and bond issuer’s) standard platoon of legal advisors.  It seems that both banks and their municipal entity customers (such as bond issuers) should lobby against this seemingly counterproductive rule.

The genesis of Rule G-42 the grant of rulemaking authority to the MSRB under the Securities Exchange Act, as amended by Dodd-Frank.  Section 15B(b)(2) of the Exchange Act requires the MSRB to promulgate rules for several types of entities, including municipal advisors.  Under that statute, the MSRB is required to promulgate rules designed to prevent practices inconsistent with a municipal entity’s fiduciary duty to its clients.  Dodd-Frank did not expressly require that municipal advisors be limited to a pure fiduciary role but that is essentially how the MSRB has chosen to draft section (f) of Rule G-42.

The MSRB’s theory in restricting municipal advisors to a purely fiduciary role is that client consent to a dual role, even after receiving complete disclosure, cannot be valid given the “high potential for self-dealing in such situations.”  In its regulatory notice accompanying proposed Rule G-42, the MSRB did not address the market reality that, just like real estate appraisers or bond rating agencies that do not “get along,” any municipal advisor acting in a purely fiduciary role will quickly find itself without clients if it gains a reputation for torpedoing bond deals negotiated by the real parties in interest.  In short, a pure advice / fiduciary municipal advisor will be strongly incentivized to bless the business deal negotiated by the business people and their lawyers.

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Banks Still Have to Worry about Being Regulated as “Municipal Advisors”

Why should banks worry about new municipal advisor regulations? This question is of particular importance to community banks that do not engage in underwriting or brokering municipal securities and therefore believe (logically), that they could not possibly be a “municipal advisor.”  But, many community banks hold significant deposits of municipal entities, extend credit to municipalities or enter into interest rate swaps with municipal entities and discuss all of those products and services extensively with the municipal entities.  As discussed below, such business dealings may, in some cases, bring the bank within the scope of the new municipal advisor registration regime.  Under that regime, municipal advisors are subject to extensive and demanding fiduciary duties to the municipalities they advise as well as anti-fraud standards.

No banking exemption.  Neither Dodd-Frank nor the Security Exchange Commission’s release adopting the new temporary rule includes any exemption for the activities of banks related to municipal deposits, loans to municipalities or interest rate swaps with municipalities.  Industry comments on this rule, such as those from The Financial Services Roundtable and the Independent Community Bankers of America, have clearly expressed to the Securities Exchange Commission (SEC) the need to exempt banks from municipal advisor status.  Without such an exemption, several of the definitions are broad enough to include a range of traditional banking services and products, such as interest rate swaps, cash management, deposit and lending activities and trust and custody services.  There are compelling arguments for such an exemption, including the fact that Section 975 of Dodd-Frank appears aimed at unregulated institutions and the longstanding regulatory tradition of allowing bank regulators exclusive authority to regulate and examine traditional banking activities.  But for now, no such exemption exists.

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