Broker-dealers are urging the Securities and Exchange Commission to abandon or narrow its proposal to allow municipal advisors to work on private placement deals without having to be registered as dealers.
Stakeholders commented on the SEC’s proposed exemptive order Monday, which would allow for municipal advisors to be involved in some private placement activities without registering as a broker-dealer. Broker-dealers say the proposal is at odds with the SEC’s past regulatory direction and if pushed through — even with limitations — would negatively impact the municipal market.
“Consequently, SIFMA strongly asserts that if it is approved, whether in its current form or if tweaked around the edges, the proposed exemptive order would be harmful to the market as a whole with ramifications for all investors, including retail investors,” wrote Leslie Norwood, a managing director, associate general counsel and head of municipals at the Securities Industry and Finacial Markets Association.
SIFMA does not want the SEC to move forward with the order.
The order has the potential to not only change the landscape of the private placement business, but could result in changes to current Municipal Securities Rulemaking Board rules.
MSRB Rule G-14, on reports of sales or purchases, G-32 on disclosures in connection with primary offerings and G-23 on activities of financial advisors and more would need to be reviewed, said Norwood.
“The fact that so many MSRB rules need to be amended highlights the dramatic change that the SEC has proposed here,” Norwood said.
Dealers have argued strenuously that broker-dealers have legal and regulatory obligations to protect investors, while MAs have a fiduciary duty of loyalty only to their municipal issuer clients and have no obligations to look out for investors.
“When a broker-dealer is involved in a transaction such as this, there are protections such as due diligence obligations that a broker-dealer engages in on behalf of the investor,” Norwood told The Bond Buyer. “This exemption would eliminate that requirement essentially because the municipal advisor would not be registered as a broker-dealer and they would have no obligation to the investors.”
However, MAs say MSRB rules that are already in place provide that investor protection.
The controversy originally stems from whether or not municipal advisors are becoming de facto placement agents in some private placement deals, essentially selling the bonds to investors on behalf of their municipal clients. Regulators have said they consider placement agent activity to be the realm of broker-dealers.
If the SEC does take next steps on its order, SIFMA suggested limitations to the order to protect those investors.
SIFMA wants the proposal to be amended to offer an exemption only on offerings of $1 million or less, and not allow MAs to break up larger issuances to meet the $1 million limit. When structuring a deal, an MA may have a conflict of interest with their fiduciary duty to issuers, Norwood said.
SIFMA also wants the SEC to narrow its definition of a "qualified provider," an entity eligible to purchase bonds in a deal utilizing the exemption.
Qualified providers should be limited to a bank, any entity directly or indirectly controlled by the bank or under common control with the bank other than a broker-dealer, or certain municipal entities such as a state revolving fund or a bond bank, SIFMA told the SEC.
Currently, the order defines a qualified provider as a bank, savings and loan association, insurance company or registered investment company; an investment advisor registered with the SEC or with a state or any other institution with total assets of at least $50 million.
As written, Norwood said, qualified providers could include investment advisors, which could then allocate the issue to retail investors. Norwood said that move would be inappropriate without disclosure documents and protections that broker-dealers bring to the transaction.
Rebecca Olsen, director of the SEC’s Office of Municipal Securities, has said the relief would not apply to deals sold to retail investors.
As a whole the limitations would protect issuers, investors, the regulatory scheme, transparency and public interest, Norwood wrote.
Disclosures should also be similar to those that the dealer has to provide in the MSRB’s Rule G-17 on fair dealing, Norwood said.
Bond Dealers of America strongly opposes the order. BDA told the SEC that if it moves forward with its proposal, the relief should be very narrow, have less impact on muni market structure and be less punitive to regional dealers who currently serve Main Street issuers and investors.
BDA wants “banks” as defined in the Securities Exchange Act of 1934, to be the only investors MAs solicit, wrote BDA CEO Mike Nicholas.
BDA is also concerned about how the order would change municipal market structure to the detriment of issuers, tax payers and retail investors, Nicholas said.
Nicholas told The Bond Buyer the proposed order would provide MAs a "perverse incentive" to recommend private placements over public offerings because it would be more profitable.
“This exemptive order would basically incentivize non-dealer municipal advisors to recommend only private placements and not public offerings of securities, raising issues of best execution, best price and to the obvious detriment of retail investors.”
Nicholas said this could lead to less availability to retail investors to retail if more issuance is done through private placement than public offerings.
"There’s an easy solution to non-dealer MAs wanting to privately place securities — register as a broker dealer and become obligated to the decades of SEC rules and regulations in place to protect investors," Nicholas said.
Nicholas said the SEC did not say how the relief would benefit the market.
"This proposed exemptive relief is very simply benefiting a specific business model and disrupting municipal market structure all without the case made by the SEC as to how this benefits, in any way, the public interest or individual investors," Nicholas said.
The proposed order will allow MAs to fulfill their statutory obligations to municipal entities and obligated persons, the National Association of Municipal Advisors wrote in its letter. The group emphasized that the order as proposed would not allow MAs to act as placement agents, but rather create regulatory clarity.
MAs have been reluctant to provide advice to their issuer clients in direct purchase transactions because they were concerned the activity could be perceived as broker activity, NAMA wrote.
NAMA believes the exemptive relief establishes the framework to allow MAs to provide municipal advisory services and represent and protect the best interest of issuers, as well as maintain important investor protection.
MSRB Rule G-17 on fair dealing would stay intact to protect investors in a private placement deal, Susan Gaffney, NAMA executive director, told The Bond Buyer.
“The fair dealing requirements still apply and it would really be no different than the situation where it exists today and the requirements that broker dealers have,” Gaffney said.
Under Rule G-17 a registered dealer or muni advisory firm has to deal fairly with all persons, Gaffney said.
“Fair dealing and Rule G-17 is a universal application of a rule both to municipal advisors, underwriters and in this case placement agents,” Gaffney said.
NAMA did not propose modifying the activities in the SEC’s proposal or changing the definition of a qualified provider.
PFM, a large non-dealer municipal advisory firm, supports the SEC’s exemptive order, saying that it clarifies uncertainty with certain private placement activities.
“PFM fully supports the commission’s proposal to clarify the uncertainty faced by registered municipal advisors as to whether the conduct of their municipal advisory activities would subject them to broker-dealer registration,” PFM wrote. “This uncertainty can result in a chilling effect on a registered municipal advisor’s ability to fulfill its fiduciary duty and provide the full range of municipal advisory services that Congress intended in adopting a new regime for the registration and regulation of municipal advisors under the Dodd-Frank Wall Street Reform and Consumer Protection Act.”
PFM also wants the SEC to adopt the qualified provider definition as proposed and said it supports the SEC’s narrow scope of the exemption to investors with “a certain level of investor sophistication.”
PFM wants the SEC to eliminate the single qualified provider condition. The proposal currently requires that the solicitation is in connection only with a potential direct placement of an entire issuance of municipal securities with a single qualified provider.
However, PFM said two or more providers can be involved in meeting the financing needs of an issuer client.
“This is often the case in smaller jurisdictions where a local bank may not be able to prudently purchase the entire financing but desires to support the municipal issuer as an investor/lender,” PFM wrote. “Even in larger jurisdictions, a provider may prefer having other providers involved in the financing for risk apportionment and other considerations.”
Also, an issuer may want to finance a particular project in multiple stages and possibly issuing muni securities for each stage with different providers, PFM wrote.
The Government Finance Officers Association overall supports the SEC’s proposal, and said it allows issuers to have the choice of representation and consultation in a private placement transaction.
Issuers have said they are looking for more options with private placement deals, and feel protected. Some issuers have said MAs should still register as broker-dealers if they want to engage in private placements of securities.
GFOA wants further definition of a single investor and entire issuance in the proposal.
“There may be instances where an issuer, especially from a larger jurisdiction, may want to place their debt — or enter into bank loans — with different maturities or with multiple parties but under the same issuance or transaction,” GFOA wrote. “Therefore, clarity about whether entire issuance means all bonds of a single traunch sold on the same date, or if it can include multiple traunches in the same transaction, would be helpful.”
Also, GFOA would want to know if multiple banks would be allowed under the SEC’s single investor definition.
“What we most appreciate about this particular proposal is that it does not preclude an issuer from choosing an MA or a placement agent or both on a transaction,” said Emily Brock, director of GFOA’s federal liaison center. “This exemptive order opens up a scope of choice for issuers when it comes to private placements and bank loans.”
