Signed into law by President Obama on July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act, or the Act) is the most sweeping change to financial regulation in the United States since the Great Depression. The Dodd-Frank Act affects almost every aspect of the financial services industry, including the municipal securities sector. In particular, the Act establishes new requirements and duties for municipal advisors, alters the composition and authority of the Municipal Securities Rulemaking Board (MSRB) and creates the Securities and Exchange Commission (SEC) Office of Municipal Securities. The Act also mandates the completion of several studies that could result in further changes to the regulatory framework governing municipal securities.
New Standards and Duties Imposed on Municipal Advisors
The Dodd-Frank Act creates a fiduciary relationship between municipal advisors and the municipal entities they represent. In order to enforce this duty, the Act requires municipal advisors to register with the SEC. On September 1, 2010 the SEC adopted interim final temporary Rule 15Ba2-6T requiring the registration of municipal advisors, and related Form MA-T as a means for municipal advisors to register. Municipal advisors must register by October 1, 2010. The Act defines a municipal advisor as a person who “provides advice to or on behalf of a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities, including advice with respect to the structure, timing, terms, and other similar matters concerning such financial products or issues; or undertakes a solicitation of a municipal entity.” The Act specifically states that financial advisors, guaranteed investment contract brokers, third-party marketers, placement agents, solicitors, finders and swap advisors qualify as municipal advisors.
Not all professionals who provide financial advice to municipalities qualify as municipal advisors under the Act. The definition does not include the following individuals: 1) brokers, dealers, or municipal securities dealers serving as underwriters; 2) investment advisors registered under the Investment Advisers Act of 1940 or persons associated with investment advisers who provide investment advice; 3) commodity trading advisors registered under the Commodity Exchange Act or persons associated with such commodity trading advisors who provide advice related to swaps; 4) attorneys offering traditional legal services; and 5) engineers providing engineering advice.
Pepper Point: Until the MSRB elaborates and expands upon the definition of a municipal advisor there will likely be a significant amount of confusion as to who qualifies as such. In general, consultants providing advice to municipalities about the issuance of securities or general investments should assume that they qualify as municipal advisors under the Act and consequently owe a fiduciary duty to the municipality. Consultants providing advice on other types of transactions, such as union negotiations or vendor contracts, likely will not qualify as municipal advisors.
Pepper Point: After the MSRB promulgates detailed regulations about who will qualify as a municipal advisor it will submit the proposed rules to the SEC. At that time a public comment period will ensue. It would be wise for any interested parties, especially those who may be subject to registration as municipal advisors, to provide comments.
Pepper Point: Professionals providing advice to municipalities should craft their engagement letters carefully so that the scope of services provided does not trigger fiduciary duties. However, if fiduciary duties arise, the municipal advisor should appropriately price its services to cover additional costs such as insurance for the fiduciary risk resulting from the engagement. Professionals seeking to respond to a request for proposal issued by a municipality should carefully craft their response to address the issue of potential assumption of a fiduciary duty and appropriately price the proposal to include this risk.
Changes to the Municipal Securities Rulemaking Board
The MSRB was established by Congress in 1975 and has traditionally functioned as a rule-making body without enforcement power. The Dodd-Frank Act substantially expands the powers of the MSRB by authorizing it to assist the SEC and the Financial Industry Regulatory Authority (FINRA) in examinations and enforcement actions. Moreover, the Act allows the MSRB to retain a portion of penalties collected in enforcement actions.
The composition of the MSRB board will also change going forward. The Act requires that the board consist of at least 15 members, at least eight of which are unrelated to any municipal securities broker-dealer or municipal advisor. The independent portion of the board must include at least one representative of institutional or retail investors in municipal securities, at least one representative of municipal entities, and at least one member of the public with knowledge of or experience in the municipal securities industry. Before the passage of the Act the board contained only five independent members. The other 10 members were industry representatives from securities firms and municipal bond dealers.
Creation of the SEC Office of Municipal Securities
Currently, the SEC has only a small staff devoted to full-time policy oversight of the municipal securities markets. The Dodd-Frank Act expands the SEC’s municipal securities oversight and creates a separate Office of Municipal Disclosure, whose director will report directly to the chairman of the SEC. This office will administer rules related to municipal securities brokers and dealers, municipal securities advisors, municipal securities investors, and municipal securities issuers. It will also be responsible for coordinating with the MSRB in rule-making and enforcement actions.
Pepper Point: Because the Dodd-Frank Act grants both the MSRB and the Office of Municipal Disclosure enforcement powers, future regulations will need to address the division of power between these two agencies.
Municipal Securities Studies
The Dodd-Frank Act directs the Government Accountability Office (GAO) to conduct several studies to help Congress better understand the complexities of municipal securities markets. The GAO will conduct a study within the next two years on disclosures made by municipal issuers. Specifically, the study will address whether the Tower Amendment, a provision in the Securities Exchange Act of 1934 that prohibits the SEC from requiring a municipal issuer to make any filing prior to the sale of municipal securities, should be repealed. The study will also compare the frequency and quality of municipal disclosures and corporate disclosures.
The Act requires the GAO to complete an additional study on municipal securities markets within the next 18 months. This study will focus on mechanisms for trading, quality of trade executions, market transparency, trade reporting, price discovery, settlement clearing, and credit enhancements. The GAO will make recommendations to improve the transparency, efficiency, fairness, and liquidity of trading in municipal securities markets, as well as potential uses of derivatives in these markets.
Pepper Point: By requesting these studies, Congress signaled that it intends to introduce significant reform to municipal securities markets in the future.
Other than the new standards and duties imposed on municipal advisors, the Dodd-Frank Act will likely have minimal initial effects on the municipal securities industry. Nevertheless, these municipal securities provisions lay the groundwork for increased regulation and enforcement in the future by the MSRB, the SEC, and Congress.