On September 18, 2013, the Securities and Exchange Commission (“SEC”) voted to adopt its final rule establishing registration requirements for municipal advisors in accordance with the Dodd-Frank Act. This final rule went into effect on July 1, 2014. The new rule will greatly impact the ability of certain service providers, particularly broker-dealers and investment bankers, to interact with their issuer and conduit borrower clients.
The SEC final rule requires that people who provide “advice” to a municipal entity or “obligated person” with respect to investment strategies register with the SEC if such advice relates to (i) the issuance of municipal securities, (ii) the investment of proceeds of municipal securities, or (iii) municipal derivatives. Under the rule, the term obligated persons includes traditional conduit borrowers such as nonprofit healthcare providers and universities who are obligated to repay amounts borrowed through a municipal securities offering. Whether someone gives advice to a municipal entity or obligated person is based on “all of the relevant facts and circumstances,” including whether the advice: (i) involves a recommendation to a municipal entity, (ii) is particularized to the specific needs of a municipal entity, or (iii) relates to municipal financial products or the issuance of municipal securities.
Many investment bankers regularly work with their issuer and borrower clients to come up with appropriate and often innovative financial recommendations that best suit the clients’ needs with respect to a potential transaction or series of transactions. Under the new rule, this type of advice, even something as simple as recommending a refunding transaction, qualifies the investment banker as a municipal advisor, triggering registration requirements and a fiduciary duty. Further, under the new rules, as a municipal advisor, the banker would not be permitted to serve as the underwriter for any transaction where such advice was offered. As a result, many investment bankers will likely find it in their best interest not to provide this type of advice to issuers and conduit borrowers regarding a potential transaction, unless an exclusion or exemption from registration under the rule can be found.
Exemption from Registration if Engaged as an Underwriter
Brokers, dealers, and municipal securities dealers who work as underwriters are exempt from registration as a municipal advisor so long as their advice involves the structure, timing and terms of a municipal securities issuance. To qualify for this exemption, there must be an engagement of the dealer as an underwriter. The SEC has noted that this exemption begins when the underwriter is engaged and continues until the end of the underwriting period for that transaction. As a result of this exemption, the underwriter does not incur a fiduciary duty to the borrower. An engagement letter or letter of intent may be subject to certain conditions, such as formal approval of the selection of the underwriter by the borrower’s governing body or finalizing the structure of the issue of municipal securities. It may also state that the engagement is nonbinding and can be terminated by either party.
It is important to note, however, that the underwriter exemption does not apply to advice other than that relating to the structure, timing and terms of an issuance. The SEC has noted that underwriters may also assist in related matters such as rating presentations and strategies, investor road shows and the preparation of preliminary and final official statements. However, the underwriter exclusion does not apply to advice on the investment of proceeds of municipal securities, advice on municipal derivatives, or advice relating to the method of sale of municipal securities.
Exemption from Registration for a RFP
The rule provides an exemption for responses to a borrower’s request for proposals (“RFP”). This exemption allows borrowers to seek input from broker-dealers, investment banks and other market participants regarding a proposed issuance of municipal securities. The RFP must meet certain guidelines established by the SEC for this exemption to apply, including that the RFP clearly identifies the objective of the issuer or borrower, that it remains open for a reasonable specified period of time and that it be sent to a particular number of firms or publicly posted, among others. If these criteria are met, then those responding to the RFP may provide advice on a non-fiduciary basis without triggering registration as a municipal advisor under the rule.
Exemption from Registration due to Involvement of a Registered Municipal Advisor
If an issuer or borrower is already represented by an “Independent Registered Municipal Advisor” (“IRMA”), a dealer or investment banker may provide advice to the issuer or borrower so long as the following conditions are met:
- An IRMA is providing advice to the borrower with respect to the same issuance of municipal securities or matter;
- The IRMA representing the borrower was not associated with the person seeking to rely on the exemption within the past two years;
- The person seeking to rely on the exemption obtains a written statement of the borrower that the borrower is represented by an IRMA, and will rely on the advice of the IRMA and the person can reasonably rely on this statement; and
- The person seeking to rely on the exemption discloses to the borrower that it is not a municipal advisor and, in the case of municipal entities, is not subject to the fiduciary duty that applies to registered municipal advisors. The person also provides a copy of such disclosure to the IRMA at a time and in a manner that allows the borrower to assess the benefits and conflicts of interest the person may have.