The Securities and Exchange Commission (SEC) has finally issued its long-awaited set of final, permanent rules governing the registration and regulation of “municipal advisors,” as required by Section 975 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).1 Among other things, the final rules clarify the meaning of certain terms (including the statutory definition of “municipal advisor”), provide certain rule-based exemptions from the municipal advisor definition, and impose certain recordkeeping and filing requirements upon municipal advisors. The new rules and rule amendments will become effective 60 days after publication in the Federal Register, and municipal advisors must comply with the new rules within the applicable compliance periods specified in the release (based upon the municipal advisor's temporary registration number).
The new rule provisions may be relatively short in length, but they are by no means simple and straightforward. Quite the contrary, the SEC’s 777 page adopting release2 reveals numerous complex interpretations regarding the application of the rules in different contexts, many of which are less than intuitive. In short, while the final registration regime is more narrow and focused than what the SEC had previously proposed, the process of determining whether the final regime applies to a particular entity remains complicated and highly facts and circumstances specific.
This alert highlights key elements of the final rules, including certain potential issues and traps for the unwary as they endeavor to navigate these unchartered waters.
Staggered Compliance Date for New Rules; Extension of Temporary Registration Regime Through December 31, 2014
The SEC’s permanent registration system for municipal advisors will be available to accept registration applications (via EDGAR) beginning on July 1, 2014. In order to provide for an orderly transition to the permanent registration regime, the SEC is providing a staggered phase-in period for registration under, and compliance with, the new rules, with the first set of municipal advisors required to be in compliance beginning on July 1, 2014.
Concurrent with adopting the final rules, the SEC also has extended its temporary registration rule for municipal advisors, Rule 15Ba2-6T under the Securities Exchange Act of 1934 (Exchange Act), which will remain in effect through December 31, 2014. Any persons presently acting as municipal advisors (or seeking to act as municipal advisors prior to the time the SEC approves their application for registration under the permanent registration regime, in accordance with the below schedule) must be registered with the SEC pursuant to Rule 15Ba2-6T.
I. Regulatory Background and Prior Rulemaking
Effective October 1, 2010, Section 975 of the Dodd-Frank Act amended Section 15B of the Exchange Act to make it, among other things, unlawful for municipal advisors 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, for compensation, the solicitation of a municipal entity or obligated person, unless the municipal advisor is registered with the SEC.
The SEC previously adopted an interim final temporary rule, Rule 15Ba2-6T, providing a means for municipal advisors to register with the SEC on or before the October 1, 2010 effective date.3 The Municipal Securities Rulemaking Board (MSRB) also adopted a method for municipal advisors to register with the MSRB. In December 2010, the SEC proposed a permanent registration regime for “municipal advisors”4 that was met with substantial criticism from virtually all sides. Since that time, the SEC has been working on a final version of the rules, culminating in the final rules and Adopting Release discussed herein.
II. The Final Rules and Rule Amendments
According to the SEC and its staff, the final rules are intended to set forth clear, workable requirements and guidance for municipal advisors and other market participants by (i) taking a substantially more narrow and tailored approach to identifying who falls within the statutory definition of “municipal advisor,” and (ii) providing several additional rule-based exemptions from that definition. The new rules do take a more restrained approach to identifying who is acting as (and must be registered as) a municipal advisor. Whether the rules and the Adopting Release provide “clear” and “workable” guidance to market participants seeking to apply the rules to their business practices remains an open question.
The All Important Question: Who is Acting as a “Municipal Advisor”?
A clear understanding of when and whether a particular person is deemed to be acting as a municipal advisor is critical to understanding and complying with the regulatory scheme. This is because, in addition to registering with the SEC and the MSRB, municipal advisors owe a fiduciary duty to their municipal advisory clients (meaning they must put the clients’ interests above those of their own) and must comply with applicable SEC and MSRB rules governing their municipal advisory activities.
The Statutory Definition of a “Municipal Advisor.” Section 15B(e)(4) of the Exchange Act defines a “municipal advisor” generally as any person (other than a municipal entity or an employee of a municipal entity) that: (i) 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 (ii) undertakes a solicitation of a municipal entity. The statute also provides a few limited carve-outs or exclusions from this broad definition that are further discussed below.
New Rule 15Ba1-1. New Rule 15Ba1-1 attempts to address a variety of issues that have arisen with regard to the scope and construction of the Exchange Act’s “municipal advisor” definition by (i) defining various terms used in the definition, (ii) clarifying the application of the various exclusions from the definition, and (iii)providing several additional rule-based exemptions from the definition in response to various commenters’ concerns.
Key Definitions. In addition to the new definitions discussed and described elsewhere in this update, Rule 15Ba1-1 includes the following definitional items of note:
- Municipal advisor. Rule 15Ba1-1 repeats the Exchange Act definition of “municipal advisor,” subject to certain additional clarifications and exemptions as set forth in Rule 15Ba1-1(d)(2)-(3). The exclusions and exemptions are discussed below.
Advice. A key element in the “municipal advisor” definition is the term “advice.” In this regard, the rule clarifies that, for purposes of the general municipal advisor definition, “advice” does not include the provision of general information that does not involve a recommendation with respect to municipal financial products or the issuance of municipal securities. The Adopting Release emphasizes that the determination of whether a person is providing “advice” is inherently facts and circumstances intensive, but offers a few examples of “general information” intended to be eligible for the exclusion:
- information of a factual nature without subjective assumptions, opinions or views;
- information that is not particularized to a specific municipal entity or type of municipal entity; and
- information that is widely disseminated for use by the public, clients, or market participants other than municipal entities and obligated persons.
General information in the nature of certain educational materials may also be excluded, depending upon the circumstances. The provision of information that involves a “recommendation” is not covered by the exclusion, and the Adopting Release notes that whether a “recommendation” has taken place is itself dependent upon the facts and circumstances. In this regard, the Adopting Release makes several references to the interpretations of the Financial Industry Regulatory Authority (FINRA) and suggests that a “recommendation” will likely be deemed to exist if the communication may be perceived as a “call to action” (or “inaction”) regarding a security or investment strategy.
- Municipal financial products. While the SEC employs the statutory definition of this term, it has adopted its own definition of “guaranteed investment contracts” and “municipal derivatives,” which are components of the “municipal financial products” definition. For purposes of the rules adopted under Section 15B, the SEC limits the definition of “guaranteed investment contract” (GIC) to the subset of GICs that relate to investments of proceeds of municipal securities or municipal escrow funds. In addition, the new rules define a “municipal derivative” as any swap or security-based swap to which a municipal entity or an obligated person (if acting in its obligated person capacity) is a counterparty. While the SEC has chosen not to narrow the definition of “investment strategies,” it has adopted a new exemption from the municipal advisor definition for persons who provide advice with respect to certain investment strategies. The investment strategies exemption is discussed below.
- Municipal entity. The SEC’s definition echoes the Exchange Act definition but also makes clear that a municipal entity includes a municipal corporate instrumentality of a political subdivision of a state. In the Adopting Release, the SEC emphasizes its position that the definition is not limited to issuers of municipal securities and, in fact, that public employee retirement systems and benefit plans, as well as public pension plans, fall within the definition.
- Obligated person. The SEC’s definition excludes certain persons otherwise captured by the Exchange Act definition. For purposes of the rules adopted under Section 15B, an “obligated person” does not include (i) a person who provides municipal bond insurance, letters of credit, or other liquidity facilities, (ii) a person whose financial information or operating data is not material to a securities offering, without reference to any municipal bond insurance, letter of credit, liquidity facility or other credit enhancement, or (iii) the federal government.
Exclusions and Exemptions from the Municipal Advisor Definition. New Rule 15Ba1-1(d)(2) is intended to refine and clarify the various statutory exceptions to the “municipal advisor” definition. In addition, new Rule 15Ba1-1(d)(3) provides various rule-based exemptions from the SEC’s “municipal advisor” definition. The Adopting Release emphasizes that these exclusions and exemptions are intended to focus upon the nature of – and justification for – the activity rather than simply on the status of the entity engaging in the activity. At the same time, the final rules endeavor to coordinate the application of certain exemptions to the application of other regulatory regimes, with a view to avoiding unnecessary, duplicative regulation.
Activity-Based Exclusions and Exemptions from the Municipal Advisor Definition
- Responses to requests for proposals (RFPs) or requests for qualifications (RFQs). Rule 15Ba1-1(d)(3)(iv) exempts persons responding to these requests from the municipal advisor definition, provided that such persons are not compensated for advice given as part of the RFP or RFQ process. Of course, a person selected to perform the proposed services could be performing municipal advisor activity requiring registration. Moreover, someone who assists with the preparation of an RFP or RFQ on behalf of a municipal entity or obligated person, or assists in the selection of a broker-dealer, investment adviser, or financial advisor as part of the RFP process, could be engaged in municipal advisory activity requiring registration.
Participation by an independent registered municipal advisor. Rule 15Ba1-1(d)(3)(vi) exempts from the municipal advisor definition a person engaging in what would otherwise be deemed to be municipal advisory services, where the municipal entity or obligated person is represented by an independent registered municipal advisor with respect to the same aspects of a municipal financial product or an issuance of municipal securities, provided certain additional requirements are met:
- The “independent municipal advisor” must be registered pursuant to Section 15B of the Exchange Act and must be providing advice on the “same aspects” of the municipal financial product or issuance of municipal securities.5
- The person relying upon this exemption must receive from the municipal entity or obligated person a written representation that it is represented by, and will rely on the advice of, an independent registered municipal advisor. The recipient must also have a reasonable basis for relying on the representation.
- In connection with a municipal entity, the person relying upon this exemption must disclose that, by obtaining such representation from the municipal entity, such person is not a municipal advisor and is not subject to the fiduciary duty set forth in Section 15B(c)(1) of the Exchange Act with respect to the municipal financial product or issuance of municipal securities. In connection with an obligated person, the written disclosure must inform the obligated person that such person is not a municipal advisor with respect to the municipal financial product or issuance of municipal securities. A copy of the disclosure to the municipal entity or obligated person must be provided to the independent registered municipal advisor.
- The recipient of the disclosure must have sufficient time to allow it to assess the material incentives and conflicts of interest that such person may have in connection with the municipal advisory activities.
While this exemption will provide relief from registration in a number of situations, persons seeking to rely upon it will need to carefully consider whether they are providing advice on the “same aspects” of the municipal financial product or issuance of municipal securities as the independent advisor. For example, if an independent registered municipal advisor employs a subcontractor for a particular part of a project, the subcontractor will need to consider whether it is advising on the same aspects of the transaction and whether it can meet the representation and disclosure requirements discussed above.
Persons that provide advice on certain investment strategies. Contrary to what was implied at the SEC’s open meeting, the final rules do not narrow the definition of “investment strategies” (a key term used in the “municipal financial products” definition). Rather, both the SEC’s definition of the term, and the surrounding discussion in the Adopting Release, merely echo the statutory definition and emphasize the SEC’s continued belief that the term “includes,” but is not limited to, “plans or programs for the investment of proceeds of municipal securities that are not municipal derivatives or guaranteed investment contracts, and the recommendation of and brokerage of municipal escrow investments.” Nevertheless, the SEC, in a rather convoluted fashion, has provided an exemption from the municipal advisor definition in connection with advice on certain investment strategies, based upon the monies involved. In particular, Rule 15Ba1-1(d)(3)(vii) exempts from the municipal advisor definition “[a] person that provides advice with respect to investment strategies that are not plans or programs for the investment of the proceeds of municipal securities or the recommendation of and brokerage of municipal escrow investments.” Thus, the SEC seeks to tailor the protection afforded to municipal entities to activities relating to the investment of the proceeds of municipal securities and related municipal escrow investments.
This leaves the question of when funds are no longer considered the proceeds of municipal securities. The SEC answers this question by defining “proceeds of municipal securities” to mean (i) monies derived by a municipal entity from the sale of municipal securities, (ii) investment income derived from the investment or reinvestment of such monies, and (iii) any monies of a municipal entity or obligated person held in funds under legal documents for the municipal securities that are reasonably expected to be used as security or a source of payment for the payment of the debt service on the municipal securities (including reserves, sinking funds, and pledged funds created for such purpose, as well as the investment income derived from the investment or reinvestment of monies in such funds). Monies derived from offerings of Section 529 plan (municipal fund) securities are specifically excluded from the definition. Once the funds are “spent” to carry out the authorized purpose of the issuance of municipal securities, and the applicable legal documents or other agreements are no longer in effect, such funds will no longer constitute proceeds of municipal securities.
The rule allows a person seeking to avoid municipal advisor status to rely upon a written representation regarding the nature of the funds that is made by a knowledgeable official of the municipal entity or obligated person whose funds are being invested, so long as the person has a reasonable basis for such reliance.
Of note, the mere fact that proceeds are commingled with other funds generally does not cause such monies to lose their character as proceeds. The SEC does, however, recognize that Federal tax arbitrage rules provide that amounts of proceeds constituting investment earnings (excluding those of municipal escrow investments) on certain tax-exempt municipal securities may be deposited in a commingled fund with substantial tax or other revenues from government operations of the municipal issuer and the amounts are reasonably expected to be spent for governmental purposes within six months from the date of commingling. In that case, the SEC considers the proceeds spent at the time of the commingling.
In connection with the municipal escrow investment prong of this exemption, the SEC defines municipal escrow investments as proceeds of municipal securities and other funds of a municipal entity that are deposited in an escrow account to pay the principal of, premium (if any) and interest on, one or more issues of municipal securities. For purposes of determining whether funds to be invested or reinvested may constitute “municipal escrow investments,” the rule allow a person to rely upon a written representation regarding the nature of the funds that is made by a knowledgeable official of the municipal entity or obligated person whose funds are being invested, so long as the person has a reasonable basis for such reliance.
The SEC notes that a person who merely provides brokerage of municipal escrow investments would not be a municipal advisor if such person does not provide advice with respect to such investments.
With regard to pooled investment vehicles, the SEC is now taking the position that a pooled investment vehicle is an investment strategy, and an advisor to such a pool is a municipal advisor, when the pooled investment vehicle contains proceeds of an issuance of municipal securities, regardless of whether all of the funds invested in the vehicle are funds of municipal entities. Advisors to these funds may, however, be able to take advantage of other exclusions or exemptions, particularly the exclusion for registered investment advisers discussed below.
Certain solicitations. Section 15B(e)(9) of the Exchange Act provides that the term “solicitation of a municipal entity or obligated person” means “a direct or indirect communication with a municipal entity or obligated person6 made by a person, for direct or indirect compensation, on behalf of a broker, dealer, municipal securities dealer, or [registered] investment adviser . . . . that does not control, is not controlled by, or is not under common control with the person undertaking such solicitation 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 for or 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.”
In other words, and more simplistically, a broker, dealer, municipal securities dealer, municipal advisor, or investment adviser soliciting on its own behalf – or an affiliate of one of these entities soliciting for such entity – would not, by virtue of such solicitation, meet the definition of a municipal advisor and therefore would not be required to register as a municipal advisor in order to engage in such activity. Rule 15Ba1-1(n) accordingly clarifies that “solicitation of a municipal entity or obligated person” does not include advertising by a broker, dealer, municipal securities dealer, municipal advisor, or investment adviser. It further provides that the term solicitation does not include solicitations of an obligated person if the obligated person is not acting in such capacity.
To meet the solicitation prong of the municipal advisor definition, the solicitor must perform such services for “direct or indirect compensation” on behalf of an unaffiliated entity. Accordingly, a solicitation made without compensation would not require registration although it should be noted that the SEC staff has broadly interpreted “direct or indirect compensation” in other contexts (e.g., any form of economic benefit).
With regard to a placement agent for a pooled investment vehicle, the SEC clarifies in the Adopting Release (albeit with somewhat convoluted reasoning) that a placement agent for a pooled investment vehicle (such as a hedge fund or mutual fund) that solicits a municipal entity for investment in the fund is not soliciting to “obtain or retain an engagement” by a municipal entity or obligated person and thus is not acting as a municipal advisor by virtue of such solicitation. By contrast, a placement agent that undertakes a solicitation of a municipal entity for the purpose of obtaining an engagement by the municipal entity of an unaffiliated investment adviser to provide investment advisory services would be acting as a municipal advisor and therefore required to register as such.
Entity-Based Exclusions and Exemptions from the Municipal Advisor Definition
- Attorneys. Rule 15Ba1-1(d)(ii)(iv) excludes an attorney from the definition of municipal advisor to the extent that the attorney is offering legal advice or providing services that are of a traditional legal nature with respect to the issuance of municipal securities or municipal financial products to a client of such attorney that is a municipal entity, obligated person, or other participant in the transaction. The SEC acknowledges that legal advice in the municipal finance area inherently involves a financial advice component and that such advice would not trigger the municipal advisor definition and registration requirements. At the same time, an attorney who represents himself or herself as a financial advisor or financial expert regarding municipal financial products or the issuance of municipal securities would be deemed a municipal advisor because such services are primarily financial, not legal, in nature.
- Accountants. Under Rule 15Ba1-1(3)(i), accountants are exempt from the municipal advisor definition to the extent that they provide audit or other attest7 services, prepare financial statements, or issue letters for underwriters for, or on behalf of, a municipal entity or obligated person. This would further include feasibility studies concerning the issuance of municipal securities or municipal financial products for which an accountant only provides audit or attest services. The exemption does not cover activities or services that non-accountants could perform, including tax services (including arbitrage rebate services) and advice relating to GAAP.
Banks. Rule 15Ba1-1(d)(3)(iii) provides an exemption from the municipal advisor definition for any bank (as defined in Section 3(a)(6) of the Exchange Act) to the extent it provides advice with respect to the following:
- Any investments that are held in a deposit account, savings account, certificate of deposit, or other deposit instrument issued by a bank;
- Any extension of credit by a bank to a municipal entity or obligated person, including the issuance of a letter of credit, the making of a direct loan, or the purchase of a municipal security by the bank for its own account;
- Any funds held in a sweep account that meets the requirements of Section 3(a)(4)(B)(v) of the Exchange Act; or
- Any investment made by a bank acting in the capacity of an indenture trustee or similar capacity.
Of course, banks may also be able to rely upon another exemption from the municipal advisor definition. For example, in light of the investment strategies exemption, a bank providing advice on custody accounts, certain trust services, and similar services would not be deemed to be acting as a municipal advisor unless such accounts contain proceeds of municipal securities or municipal escrow investments.
To the extent that a bank provides products or services that require municipal advisor registration, the bank may do so through a “separately identified department or division” (“SID”) and the SID, rather than the bank as a whole, will be deemed the municipal advisor under Rule 15Ba1-1(d)(4). To qualify as a SID under this rule, the SID must (i) be under the direct supervision of an officer or officers designated by the board of directors of the bank as responsible for the day-to-day conduct of the bank’s municipal advisory activities, including the supervision of all bank employees engaged in the performance of such activities and (ii) separately maintain all of the records relating to the bank’s municipal advisory activities in, or extractable from, such unit’s own facilities or the facilities of the bank, and such records must be maintained in a manner that permits independent examination and enforcement of the requirements under the Exchange Act and MSRB rules relating to municipal advisors.
- Engineers. Pursuant to Rule 15Ba1-1(d)(2)(5), an engineer will not be considered a municipal advisor to the extent that the engineer is providing engineering advice. The SEC recognizes in the Adopting Release that this exclusion might cover feasibility studies, cash flow analyses, information on project scheduling and anticipated funding requirements, and certain projections (e.g., projections of output capacity or project market demand) -- as long as these activities do not constitute advice regarding municipal financial products or the issuance of municipal securities. Accordingly, an engineer solely providing projections of revenues should not need to register as a municipal advisor, but an engineer providing revenue projections to support the structure of an issuance of municipal securities probably would need to register (unless another exclusion or exemption is available).
- Public officials and employees. After much criticism of its approach to public officials and employees in the December 2010 proposals, the SEC has provided a broad exemption from the municipal advisor definition in Rule 15Ba1-1(d)(3)(ii) for all members of a municipal entity’s governing body, its advisory boards and its committees, as well as persons serving in a similar official capacity with respect to a municipal entity to the extent they are acting within the scope of their official capacity, regardless of whether such members or officials are employees of the municipal entity. The SEC recognizes that municipal employees as well as designees of public officials who engage in deliberative and decision-making functions with respect to municipal financial products or the issuance of municipal securities represent the municipal entity that is the intended recipient of the protections of the municipal advisor registration regime. The SEC notes that board members and other officials (appointed or elected as well as their duly appointed designees) may be subject to state and local law, including fiduciary duties and ethics laws, that negate the need for them to be treated, registered and regulated as municipal advisors. The public official and employees exemption also extends to board members, officers, and employees of obligated persons. The SEC explains in the Adopting Release that the exemption is appropriate because such persons, when acting in the scope of their duty to the obligated person, are accountable to the obligated person. Moreover, it finds that such persons are the intended beneficiaries of the municipal advisor registration requirement. Furthermore, the SEC acknowledges that employees or governing body members who solicit conduit issuers to issue bonds on behalf of the obligated person are not acting as advisors but, instead, are acting as principals seeking an issuance of municipal securities by a municipal entity on behalf of the obligated person “pursuant to an arm’s-length loan (or similar) agreement under which the obligated person will be required to pay debt service and other costs” upon issuance.
- Registered commodity trading advisors. Under Rule 15Ba1-1(d)(2)(iii), the municipal advisor definition excludes any commodity trading advisor registered under the Commodity Exchange Act of 1936 (Commodity Exchange Act), or person associated with a registered commodity trading advisor, to the extent that such registered commodity trading advisor or associated person is providing advice that is related to swaps (as defined in Section 1a(47) of the Commodity Exchange Act and Section 3(a)(69) of the Exchange Act and any rules and regulations thereunder). Thus, to the extent that a registered commodity trading advisor engages in municipal advisory activity unrelated to advice on swaps, that advisor will be a municipal advisor and will need to register as such (unless another exemption is available). The SEC notes that it is not exempting from the municipal advisor definition persons that have received no-action letters from the Commodity Futures Trading Commission (CFTC) or are otherwise exempt from registration as commodity trading advisors.
Registered investment advisers. Investment advisers registered under the Investment Advisers Act of 1940 (Advisers Act), as well as their associated persons, are excluded from the definition of municipal advisor under Rule 15Ba1-1(d)(2)(ii) so long as such advisers and associated persons are providing “investment advice” in such capacity. For purposes of the exemption, “investment advice” does not include advice concerning whether and how to issue municipal securities, advice concerning the structure, timing, and terms of an issuance of municipal securities and other similar matters, advice concerning municipal derivatives, or a solicitation of a municipal entity or obligated person. While a registered investment adviser therefore may not rely upon the exemption to provide advice with respect to these latter items, it may rely upon the exemption to the extent it is providing advice concerning the investment of proceeds of municipal securities. The Adopting Release further clarifies that, if the advice is provided pursuant to an advisory agreement that extends to investments in both securities and non-security financial instruments, such advice would be “investment advice” and would not require municipal advisor registration. As advisers often provide ancillary or additional advice with respect to non-securities investments, investment advisers should consider whether they have advisory agreements that are broad enough to capture such services.
The exclusion does not extend to affiliates of registered investment advisers that are not themselves registered investment advisers. Any such affiliates that provide services to municipal entities and obligated persons must therefore consider whether they may qualify for another exclusion or exemption or whether they need to register as a municipal advisor.
- Swap dealers. Rule 15Ba1-1(d)(3)(v) provides an exemption from the municipal advisor definition for swap dealers, but not security-based swap dealers, so long as certain conditions are satisfied. More specifically, a registered swap dealer (as defined in Section 1a(49) of the Commodity Exchange Act and the rules and regulations thereunder) and its associated persons are exempt from the municipal advisor definition when recommending a municipal derivative, or trading strategy that involves a municipal derivative, so long as the registered swap dealer or associated person is not “acting as an advisor” to the municipal entity or obligated person with respect to the municipal derivative or trading strategy pursuant to Section 4s(h)(4) of the Commodity Exchange Act and the rules and regulations thereunder. To determine whether the dealer is acting as an advisor, the municipal entity or obligated person involved in the transaction will be treated as a “special entity” under Section 4s(h)(2) of the Commodity Exchange Act and the rules and regulations thereunder (regardless of whether it is otherwise a “special entity”).8 Although the SEC has determined not to extend the exemption to security-based swap dealers, the SEC notes in the Adopting Release that security-based swap dealers may be able to qualify for one of the other exemptions. The SEC also notes that a security-based swap dealer may apply for no-action or exemptive relief, if appropriate.
Underwriters. Under Rule 15Ba1-1(d)(2)(i), the term municipal advisor excludes a broker, dealer, or municipal securities dealer serving as an underwriter of a particular issuance of municipal securities to the extent such person or entity engages in activities that are within the scope of an underwriting of municipal securities. The Adopting Release emphasizes that there must be a relationship to a particular, specified transaction and that advice concerning related transactions would only be covered by the underwriting exclusion if it corresponds to the underwriting for which the underwriter is engaged (e.g., advising on the timing of a related transaction for which one is not engaged to the extent it would impact the particular underwriting for which one is engaged would be covered by the exclusion). The SEC also clarified in the Adopting Release that a registered broker-dealer does not need to fall within the strict definition of an underwriter under Section 2(a)(11) of the Securities Act of 1933 (Securities Act) to qualify for the underwriter exclusion, and a broker-dealer may rely upon the exclusion when acting as agent or placement agent.
In an effort to clarify the scope of the underwriting exclusion, the Adopting Release provides non-exclusive examples of activities that would be covered by the exclusion, while noting that such activities must be integral to the purchase and distribution of a particular issuance of municipal securities for which the broker, dealer, or municipal securities dealer has been engaged to serve as underwriter. Some of the examples provided include (i) preparations for and assistance with investor “road shows” and investor discussions related to the issuance being underwritten, (ii) advice regarding retail order periods and institutional marketing if the municipal entity has determined to engage in a negotiated sale, and (iii) assistance in the preparation of the preliminary and final official statements for the municipal securities and assistance with the closing of the issuance of municipal securities. The SEC also provided a list of activities that would fall outside of the underwriter exclusion, which include (i) advice on investment strategies, (ii) advice on municipal derivatives (including derivative valuation services), and (iii) advice on what method of sale (competitive or negotiated) a municipal entity should use for an issuance of municipal securities. While these examples are helpful, much ambiguity remains as to what constitutes underwriting activity and persons seeking to rely upon this exclusion will need to carefully consider the activities at issue.
In connection with sales of securities to municipal entities and obligated persons (unrelated to an underwriting), the Adopting Release states that a broker-dealer will be engaged in municipal advisory activity if the monies used to purchase the security are proceeds of municipal securities and if the broker-dealer recommends or otherwise offers advice about which securities to purchase or sell.
Registration Mechanics and Filing Requirements; Treatment of Natural Persons Associated with Municipal Advisor Entities
New Rule 15Ba1-2 prescribes the process for registering with the SEC as a municipal advisor, including the submission of detailed information regarding (i) the firm’s municipal advisory business (on Form MA) and (ii) the natural persons engaged in municipal advisory activities on behalf of the firm (on Form MA-1). In a notable departure from the December 2010 proposals, new Rule 15Ba1-3 exempts natural persons associated with a registered municipal advisor from themselves registering as municipal advisors, so long as they are performing municipal advisory activities solely on behalf of the registered municipal advisor with which they are associated. Pursuant to new Rule 15Bc4-1, the SEC does, however, retain the authority to censure such natural persons for misconduct. Natural persons who are required to register as municipal advisors (e.g., in the case of a sole proprietorship) must submit information about both their business and themselves on Forms MA and MA-1, respectively. New Rule 15Ba1-5 requires Forms MA and MA-1 to be amended periodically to keep the information current for so long as the registration remains effective. The process for withdrawing from registration as a municipal advisor is prescribed by Rule 15Ba1-4, which calls for the filing of Form MA-W. Finally, new Rule 15Ba1-7 governs the “successor registration” provisions for municipal advisors, which are similar to those currently in place for broker-dealers. The Directors of the Office of Municipal Securities and the Office of Compliance Inspections and Examinations have been delegated the authority to issue orders granting or cancelling the registration of municipal advisors.
Pursuant to new Rule 15Ba1-6, non-resident municipal advisors (i.e., those resident outside the United States) applying for registration pursuant to Section 15B of the Exchange Act are required to (i) file with the SEC (on Form MA-NR) an irrevocable consent to service of process in the United States and a power of attorney appointing an agent in the United States for such purpose, and (ii) provide an opinion of counsel (on Form MA) regarding the municipal advisor’s ability, as a matter of law, to provide the SEC with access to the firm’s books and records and to submit to inspection and examination by the SEC. Likewise, any municipal advisors that have a non-resident general partner or managing agent, or that have non-resident natural person associated persons conducting municipal advisory activities on their behalf, must file with the SEC (on Form MA-NR) an irrevocable consent to service of process in the United States for such person(s), as well as a power of attorney appointing an agent in the United States for such purpose. The consents and powers of attorney must be kept current and updated for as long as the municipal advisor’s registration is in effect.
Books and Records Requirements for Municipal Advisors
New Rule 15Ba1-8 imposes recordkeeping requirements on municipal advisors. Most of the required records must be preserved for a minimum of five years, the first two in an easily accessible place. Certain types of records (e.g., partnership documents, articles of incorporation, minute books and stock certificate books) are required to be preserved until at least three years after termination of the business or withdrawal from registration as a municipal advisor. While the municipal advisor records required to be made and preserved bear some similarity to those applicable to registered broker-dealers, they are not nearly as detailed and complex. Of particular note, the rule expressly permits records to be preserved electronically but, unlike Exchange Act Rule 17a-4 (applicable to registered broker-dealers), it does not impose a “write once read many” (WORM) requirement, nor does it impose a “third-party downloader” requirement. In addition, records made and preserved in accordance with Exchange Act Rules 17a-3 and 17a-4, MSRB rules and/or Advisers Act Rule 204-2 and that are substantially similar to records required to be maintained and preserved under new Rule 15Ba1-8 shall be deemed to satisfy the requirements of new Rule 15Ba1-8.
Non-resident municipal advisors are required to maintain and preserve their required books and records at a location within the United States, and to provide written notice to the SEC as to the address at which such records are located, unless the non-resident municipal advisor (i) files with the SEC a written undertaking to furnish the SEC, upon demand, true, complete and current copies of all required books and records, and (ii) in fact furnishes such records to the SEC, at the non-resident municipal advisor’s own expense, within 14 calendar days of the SEC’s written demand therefor.
Examination of Municipal Advisors that are also Registered Broker-Dealers
Although not set forth in any new rule or rule amendment, the SEC emphasizes in the Adopting Release that it is designating FINRA to examine its member firms’ municipal advisor activities for compliance with applicable requirements, subject to the SEC’s oversight. The Adopting Release expresses the SEC’s belief that FINRA already has the necessary statutory authority to perform such examinations. Although certain of the statutory provisions that authorize FINRA to examine its members’ compliance with the Exchange Act provisions and rules, as well as MSRB rules, also afford FINRA the authority to enforce compliance with such provisions and rules, the Adopting Release is silent as to FINRA’s use of any such enforcement authority. The SEC's designation of FINRA in this regard is notable because competitive issues and regulatory arbitrage may develop in a regime where one set of municipal advisors are subject to an additional regulator’s examination, and even potentially enforcement, authority over their municipal advisory activities. FINRA members who presently are, or who are considering, registering as municipal advisors should take these considerations into account and may even wish to consider moving their municipal advisory activities into a separate legal entity that is not a FINRA member.
No Self-Certification Requirements. Unlike the December 2010 proposals, the final rules do not include any “self-certification” requirements for municipal advisors (e.g., certifications as to compliance with regulatory obligations and standards of training). Although she voted in favor of adopting the final rules, Commissioner Stein expressed disappointment that the final rules failed to include any self-certification requirements (noting that such requirements have proven to be quite effective in other contexts and that, in fact, only a single commenter (out of 1000) advocated in favor of removing the self-certification requirements). Perhaps Commissioner Stein’s vocal disappointment in this regard is an indirect “call to action” for the MSRB to adopt rules imposing such requirements.
MSRB Municipal Advisor Rulemaking Initiatives Can Now Resume. The MSRB had suspended its prior rulemaking initiatives with respect to municipal advisors pending the SEC’s adoption of final rules and, in particular, clarification as to the scope of the municipal advisor definition. With the SEC’s adoption of final rules, the MSRB is likely to promptly resume its efforts, including proposals relating to a municipal advisor’s fiduciary duty and managing conflicts of interest. As such, the full panoply of regulatory requirements to which municipal advisors are and will be subject remains very much in a state of flux.