The Municipal Advisor Regulatory Framework - Where We Are and Where to Next

by Clark Hill PLC
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On September 19, 2016, the Municipal Securities Rulemaking Board ("MSRB") advised Congress that it had "just concluded development of a core regulatory framework for municipal advisors."[1] This by no means signals a significant break from regulatory activities in this area given that, two weeks later, the MSRB announced regulatory priorities for its current fiscal year that include addressing municipal advisor advertising practices and activities of solicitor municipal advisors, developing a new qualification examination for municipal advisor principals, and establishing continuing education requirements for municipal advisors.[2] In the meantime, the Securities and Exchange Commission ("SEC") and Financial Industry Regulatory Authority ("FINRA") continue their initial rounds of compliance examinations of municipal advisors. In addition, municipal advisors must meet the October 31, 2016 deadline for making their initial filings of Form G-37 with the MSRB under its newly expanded pay-to-play rule.[3]

Municipal advisory firms should view the completion of the core framework and the need to make initial pay-to-play disclosure filings with the MSRB as an opportune time to assess where they stand with regard to this new regulatory structure. In particular, firms should review their policies, procedures and business practices to ensure that the compliance solutions they have put in place to address the rapidly evolving regulatory and marketplace landscape are fully up-to-date with the current status of rulemaking and are designed to effectively achieve compliance while being tailored to the firm's particular business needs.

This Alert provides general information about existing obligations and potential near-term developments relating to municipal advisors, while future Alerts will focus on specific aspects of municipal advisor regulatory and compliance requirements as new requirements emerge or as events may warrant from time to time.

SEC/FINRA EXAMINATION

If your firm has already been visited by SEC or FINRA examiners, you should focus sharply on any formal or informal feedback received from the examiners since the regulators will expect you to have fully addressed any concerns they raised by the time of your next examination and will be significantly less forgiving if matters have not been addressed to their satisfaction. Even if the examiners did not review or comment on some aspects of your municipal advisory business, compliance processes and procedures, or books and records, you should review all of these areas in light of any insight you can glean about expected approaches or disfavored practices from the examiners' questions, responses and feedback on the areas they in fact examined.

If your firm has not yet been examined by the SEC or FINRA, you should consider engaging in an end-to-end review of your business, processes and records before the examiners arrive. This review should focus on ensuring that your processes and records are fully consistent with your business activities and cover the current breadth of MSRB rulemaking, addressing each material aspect of those rules. You should also ensure that your processes and records fully acknowledge and support the fiduciary duty of municipal advisors to their municipal entity clients under Section 15B(c)(1) of the Securities Exchange Act of 1934 ("Exchange Act"), which is a duty that exists separate and apart from, but is also reflected in, SEC and MSRB rules.[4]

KEY REGULATORY MATTERS TO CONSIDER

In reviewing their business, processes and records, municipal advisory firms should consider the following, among others:

What is the full scope of the firm's municipal advisory activities?

  • Consider whether any of the firm's activities that it does not treat as municipal advisory activities might be viewed by examiners as falling within the definition of such activities
  • This can be a particularly difficult inquiry if the firm's primary line of business is in an entirely different role - such as broker-dealer, investment adviser, bank, accounting firm, law firm, engineering firm, corporate advisory firm, not-for-profit organization, or any other type of business; firms must understand the limits of the various exemptions and exceptions that the SEC has recognized in its definitional rule[5]

Which personnel are engaging in municipal advisory activities?

  • The firm must supervise personnel engaging in municipal advisory activities, who must become qualified as municipal advisor representatives through the new Series 50 qualification examination[6]
  • Because the definition of municipal advisor is a hair trigger that can be sprung by a single instance of advice, even without an intent to provide the advice, without an agreement to serve as a municipal advisor, and without compensation, the risk that personnel not designated as municipal advisor representatives may accidently become subject to the municipal advisor regulatory regime can be a constant presence

What registrations are required with the regulators?

  • Firms must register the firm with both the SEC[7] and MSRB,[8] must update their SEC and MSRB registrations annually and when changes occur, and must register municipal advisory personnel with the SEC

What books and records are required?

  • Firms must make, maintain and preserve extensive books and records as set forth under SEC and MSRB rules[9]
  • While SEC and MSRB recordkeeping rules set out a number of explicit requirements, other rules may effectively create implicit obligations to maintain additional records beyond those required by the recordkeeping rules

What supervisory and compliance requirements must a firm meet?

  • Firms must have, and enforce, supervisory systems over their municipal advisory activities that include written supervisory procedures, written compliance processes, designated supervisory principals, a designated chief compliance officer and annual chief executive officer certifications concerning written supervisory procedures and compliance processes[10]

What documentation and disclosures are required when engaging in municipal advisory activities?

  • Firms must document in writing their engagements with their municipal advisory clients, including, at a minimum, information about the scope of the engagement, compensation, termination provisions, and disclosures of material conflicts of interests and reportable legal or disciplinary events[11]
  • Disclosures of material conflicts of interests and reportable legal or disciplinary events must be provided to municipal advisory clients prior to or at the time firms first provide advice

What are some specific practices that a firm must ensure comply with the federal securities laws?

  • Firms must act consistent with their duty of care[12] and must act fairly[13] to all of their clients
    • This may entail, among other things, knowing the essential facts about the client, ensuring recommendations are suitable, engaging in due diligence, not receiving excessive compensation, not submitting inaccurate invoices, not making materially false or misleading representations, not engaging in, or disclosing, certain fee-splitting arrangements, and not making certain prohibited payments for third-party business solicitations
  • Firms must act consistent with their federal statutory fiduciary duty to their municipal entity clients, which includes, but is not limited to, a duty of loyalty in addition to a duty of care[14]
    • In addition to the requirements of the duty of care, the duty of loyalty adds (among other things) requirements to act in the municipal entity client's best interest and not to engage in most principal transactions with a municipal entity client in the same matter, or directly related to the matter, for which the firm serves as municipal advisor
  • Firms must adhere to certain limitations on the giving of gifts[15]
  • Firms must adhere to certain restrictions and public disclosure requirements concerning political contributions and related prohibitions on municipal advisory business[16]

[1] Letter dated September 19, 2016 from Nathaniel Singer, MSRB Chair, to The Honorable Richard Shelby, Chairman, and The Honorable Sherrod Brown, Ranking Member, Senate Committee on Banking, Housing & Urban Affairs, and The Honorable Jeb Hensarling, Chairman, and The Honorable Maxine Waters, Ranking Member, House Committee on Financial Services.

[2] MSRB Press Release, "MSRB Seats New Board and Announces Priorities for New Fiscal Year," October 3, 2016.

[3] MSRB Rule G-37. See Clark Hill PLC Client Alert, "The Federal Securities Pay-to-Play Regulatory Framework is Complete - A Primer for Financial Services Firms," September 29, 2016.

[4] Exchange Act Section 15B(c)(1) and MSRB Rule G-42. Municipal advisors should be aware that, while the federal statutory fiduciary duty applies only for municipal entity clients and not for private sector obligated persons, state law fiduciary duties may apply in the case of such private sector obligated person clients.

[5] SEC Rule 240.15Ba1-1.

[6] MSRB Rule G-3. As noted above, the MSRB stated it will consider this fiscal year creating a qualification examination for municipal securities principals under Rule G-3. In addition, the MSRB has published a notice for comment on potential continuing education requirements for municipal advisory personnel. See MSRB Notice 2016-24 (September 30, 2016).

[7] SEC Rule 240.15Ba1-2.

[8] MSRB Rule A-12. Registration with the MSRB entails initial and annual registration fees, and the MSRB also levies a fee on firms based on the number of personnel engaged in municipal advisory activities.

[9] SEC Rule 240.15Ba1-8 and MSRB Rules G-8 and G-9.

[10] MSRB Rule G-44.

[11] MSRB Rule G-42. The Securities Industry and Financial Markets Association ("SIFMA") has prepared model documentation for municipal advisors under Rule G-42, available at www.sifma.org/services/standard-forms-and-documentation/municipal-securities-markets. While the SIFMA model documents are designed specifically for broker-dealers acting as municipal advisors, they may be instructive for other types of municipal advisors as well.

[12] MSRB Rule G-42. The duty of care is owed to both municipal entity clients and private sector obligated persons. Rule G-42 does not cover the activities of solicitor municipal advisors, which the MSRB stated it will consider during the current fiscal year, as noted above.

[13] MSRB Rule G-17.

[14] Exchange Act Section 15B(c)(1) and MSRB Rule G-42.

[15] MSRB Rule G-20.

[16] MSRB Rule G-37. As noted above, the MSRB stated it will consider regulating municipal advisor advertising practices, likely through an amendment to MSRB Rule G-21, during the current fiscal year.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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