WASHINGTON — The Bond Dealers of America is urging the Securities and Exchange Commission to crack down on non-dealer municipal advisors who are acting as unlicensed broker-dealers by assisting municipalities in placing their debt with banks and other institutional investors.
BDA chief executive officer Mike Nicholas made the plea to commission members in an Oct. 17 letter. He said that mid-market and regional dealers are reporting that non-dealer MAs are crossing the line and violating federal securities laws and Municipal Securities Rulemaking Board rules when they provide placement services for the state and local issuers who have retained them as MAs.
The letter comes as the SEC is embarking on a two- year program to examine non-dealer muni advisor practices, and as the MSRB works to complete rulemaking regulating MAs.
At issue are alternative funding mechanisms whereby issuers choose to raise capital by selling their municipal securities to a bank or a select number of investors instead of making the bonds available to the public. MAs owe their state and local government clients a fiduciary duty and by law become MAs automatically when they provide bond-related advice to issuers. But the MSRB warned in 2011 that MAs that introduce potential investors to issuers or negotiate with potential investors in exchange for transaction-based compensation may be subject to federal securities laws and MSRB rules that apply to dealers.
"The rapid growth of 'direct placement, direct loan or private placement' transactions to banks and other investors has been well documented," Nicholas wrote. "Now that the SEC is enforcing its own, and the MSRB's regulations in regards to non-broker dealer municipal advisors we believe that this practice should be an important area of focus for the commission's municipal advisor enforcement priorities."
The letter acknowledges there is no "bright line" separating muni advisory services from placement agent services in some instances, and that there can be a complex analysis involved in determining if a transaction is a loan or a private placement of municipal securities. But Nicholas added that there have been instances where BDA members have reported behavior that violates the letter and the spirit of the SEC's MA registration rule and the MSRB's Rule G-23, which generally prohibits dealer financial advisors from switching to underwriter or placement agent for the same issue of municipal securities.
For years the SEC had allowed firms to perform some placement activities without registering as broker dealers, but reversed that decision in 2000 on the basis that evolving technology had changed the landscape and made it possible for a wider array of people to play roles in securities-related services. MAs are allowed to advise on private placements, but not to solicit investors and get paid on a transaction-based basis. The MSRB warned that advisors that act as placement agents are required to register as broker-dealers, even if they are already registered as MAs. That would make them subject to various dealer regulations, such as transaction reporting and political contribution rules that are not yet finalized for MAs.
Nicholas wrote that BDA members have been told by banks that they have been purchasing bonds from non-dealer MA firms, or have lost out on requests for placement agents because the non-dealer MAs had "more placement experience."
"There have also been instances reported, where non-broker dealer municipal advisors have represented to issuers, that they could provide direct placement services to an issuer at a lower cost than a broker-dealer placement agent because they were not regulated in this activity like broker -dealers," Nicholas told the SEC.
BDA is asking the regulators to take these situations into account in rulemaking and to take action to prevent it. Dealer groups have been aggressive in pushing for additional regulation of non-dealer MAs.
"We would like to see the MSRB take these violations into consideration when drafting the final rules governing municipal advisor activities and communicate to the market again your concerns about non-dealer advisors conducting placement agent activities," Nicholas wrote. "We would also like to see the SEC emphasize a review of direct placement transactions and the role played by a municipal advisor as the SEC is conducting its field audits of non-dealer municipal advisors."
SEC muni office staff have said they have no current plans to issue further guidance on MA requirements, but may decide to if it becomes necessary.
