WASHINGTON – The Securities and Exchange Commission has approved the Municipal Securities Rulemaking Board's core conduct rule for municipal advisors, despite its controversial ban on principal transactions.
Rule G-42 will take effect in June 2016.
"Congress charged the MSRB with developing regulations to protect state and local governments from the risks – and potentially costly consequences – of relying on financial advice from unaccountable and unqualified individuals," said the board's executive director Lynnette Kelly. "The MSRB rule approved by the SEC details standards of conduct that municipal advisors owe to their clients."
"The final version of this rule reflects the valuable input received from the industry and the public throughout the federal rulemaking process," Kelly said. "The MSRB carefully considers the diversity of municipal advisors and their clients as we work to implement a regulatory framework that supports municipal market integrity."
Kelly said the MSRB plans to soon publish a regulatory notice reviewing the new rule's requirements.
Under the rule's core standards of conduct, MAs owe a fiduciary "duty of loyalty" to their municipal issuer clients and are required "without limitation … to deal honestly and with the upmost good faith with a municipal entity and act in the client's best interests without regard to the financial or other interests of the municipal advisor."
The rule also contains a "duty of care" for all clients that requires MAs to: exercise due care in their work; be qualified to provide advisor services; make a "reasonable inquiry" into the facts relevant to a client's request before deciding whether to proceed; and undertake a "reasonable investigation" to determine their advice is not based on bad information.
The SEC's approval of the rule comes less than a month after two dealer groups – the Securities Industry and Financial Markets Association and Bond Dealers of America -- asked the commission with disapprove the rule. The Government Finance Officers Association also told the SEC it doesn't support the rule and asked for clarifications.
The groups were upset about the rule's ban on a municipal advisor acting as a principal in a transaction with a muni issuer client that is directly related to a transaction on which the MA is providing advice. They said it would make the rule overly burdensome and anti-competitive.
MSRB filed an amendment with the SEC in November that provided a limited exception to the ban.
MAs can only use the exception if they are registered broker-dealers under the Securities and Exchange Act of 1934 and if the accounts they want to use are brokerage accounts subject to the Exchange Act, as well as the rules of their member-self-regulatory organizations. MAs also can only use the exception if they use their investment discretion on a temporary or limited basis, at their clients' discretion.
Under the rule, if an MA uses the exception for one principal transaction with a municipal client, it can then use the exception for future principal transactions with the same municipal client that are directly related to the first transaction.
MA principal transactions under the exception would be limited to sales to, or purchases from, a municipal client of U.S. Treasury securities, agency debt securities, or corporate debt securities.
If an MA complies with these requirements, it can then choose whether to use the exception on a transaction-by-transaction basis or through a process that is more complex, but gives the MA the flexibility to obtain oral consent.
If the MA chooses to apply the exception on a transaction-by-transaction basis, the MA must tell its municipal client in writing the capacity in which it is acting and get the client's informed written consent for the transaction, either before executing the transaction or after execution but before settlement.
If an MA opts not to apply the exception on a transaction-by-transaction basis, it must follow several steps. Neither the MA nor any of its affiliates can be the issuer or underwriter of a security that is the subject to the principal transaction. The MA must get an executed written, revocable consent from its municipal client that would prospectively authorize it to directly or indirectly act as principal for its own account in selling a security to, or purchasing a security from, the client. The written consent must have been obtained after the MA explains to the client in writing the circumstances under which the MA may engage in principal transactions, the nature and significance of conflicts with the client's interests and how the MA will address those conflicts.
An MA also must inform its client either orally or in writing of the capacity in which it may act and get the client's consent either orally or in writing before executing each subsequent principal transaction. The MA must also send a written confirmation to the client saying that it disclosed that is may be acting in a principal capacity, the client authorized the transaction, and the MA sold or bought the security for its own account.
In addition, MA would be required to send clients, at least annually, a list of all executed transactions in the client's account that relied on the exception, complete with the date and price. Each written disclosure would also have to include a statement about the client's ability to revoke its consent without penalty at any time by written notice.
But the groups, in particular the dealers, were still concerned that the ban, even with the exception, would be too burdensome.
In approving the final rule, the SEC said it felt the MSRB, through its responses to comments and amendments, had addressed the groups' concerns.
But Jessica Giroux, general counsel and managing director of federal regulatory affairs, said, "We appreciate the open dialogue we had with the SEC and MSRB during the G-42 rule making process. However, BDA believes regulators could have designed a more efficient conflicts of interest regime, without the onerous requirements associated with principal transaction, so that issuers could have retained reasonable access to valuable dealer-provided services while still being protected by robust conflict of interest processes."
