What Banks and Trust Companies Need to Know About the SEC’s New Municipal Advisor Rules

by Goodwin

On September 20, 2013, the SEC adopted final rules regulating municipal advisors.  This Client Alert discusses how the final rules will apply to banks and trust companies (referred to collectively in this Alert as banks).  For a more detailed discussion of the Municipal Advisor Rules and a link to the adopting release, see the October 8, 2013 Goodwin Procter Financial Services Alert.

As previously reported, the rules implement provisions in the Dodd-Frank Act amending Section 15B of the Securities Exchange Act of 1934 (“Exchange Act”) to require registration of “municipal advisors,” a new class of regulated persons that, among other things, 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.

The municipal advisor provisions of Section 15B, including the registration requirements, became effective on October 1, 2010.  Since that date, municipal advisors have been required to register under temporary interim rule 15Ba2-6T, using Form MA-T. In separate rulemaking, the SEC amended rule 15Ba2-6T to provide that it will expire on December 31, 2014.

Section 15B provides exceptions from the definition of “municipal advisor” for some categories of persons, such as investment advisers and broker-dealers serving as underwriters, but does not include an exception for banks.  This raised a concern that banks could be required to register as municipal advisors for providing traditional banking and fiduciary services to municipal entities or obligated persons, and many banks have temporarily registered as municipal advisors.  The Municipal Advisor Rules as adopted contain an exemption for some activities of banks, and also permit banks that are required to register as municipal advisors to register a separately identifiable department or division.

Banks may undertake a variety of activities related to municipal entities (as defined in Section 15B(e)(8) of the Exchange Act) and must therefore pay special attention to the municipal advisor rules to ensure compliance.  For example, banks may take deposits from and issue letters of credit to municipal entities, manage collective funds, common trust funds or other investment accounts that include assets contributed by municipal entities, enter into repurchase agreements with municipal entities, advise municipal entities regarding derivatives contracts or guaranteed investment contracts (“GICs”) or enter into derivatives contracts or GICs on a principal basis with municipal entities.  Although not all of these activities require that the bank register as a municipal advisor, any bank that interacts with a municipal entity should review the final rules to ensure that its activities are in compliance.

The Municipal Advisor Rules are effective on January 13, 2014 but, as discussed below in the section on “Registration Process and Timing,” permanent registration filings will be required to be made by temporary registrants based on their temporary registration numbers in the months of July through October 2014 and by persons not previously registered beginning October 1, 2014.

Municipal Advisor Definition

The term “municipal advisor” is defined by Section 15B to mean a person, other than a municipal entity or employee of a municipal entity, that provides advice to or on behalf of a municipal entity or obligated person (a person committed to support payment of the obligations on municipal securities sold in an offering) with respect to municipal financial products or the issuance of municipal securities, or undertakes a solicitation of a municipal entity or obligated person.

“Municipal financial products” mean municipal derivatives, GICs and investment strategies.  Investment strategies include plans or programs for the investment of proceeds of municipal securities other than municipal derivatives or GICs, and the recommendation of and brokerage of municipal escrow investments.  The term “municipal entity” is defined broadly in Section 15B(e)(8) and includes any state, political subdivision of a state, or municipal corporate instrumentality of a state, including state or municipal retirement plans and issuers of municipal securities.  As a result, persons that provide advice to, or solicit the purchase of certain services by, a state or municipal subdivision or instrumentality that does not issue securities may still be considered municipal advisors.

The “municipal advisor” definition is “broad,” in the words of the SEC and, absent an exclusion, would include many ordinary banking services provided to municipal entities and obligated persons.

Limited Bank Exemption

Rule 15Ba1-1(d)(3)(iii) provides an exemption from the definition of municipal advisor for any bank to the extent that it provides advice with respect to:

  • investments held in a deposit account, savings account, certificate of deposit, or other deposit instrument issued by a bank;
  • any extension of credit 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;
  • funds held in certain sweep accounts; or
  • any investment made by a bank acting as an indenture trustee or in a similar capacity. 

Other activities of banks providing advice to municipal entities or obligated persons are not exempt.  The adopting release[1] explicitly states that “the Commission is not exempting from registration [as a municipal advisor] banks that engage in municipal advisory activities, including without limitation banks that provide advice to municipal entities or obligated persons with respect to the issuance of municipal securities, or banks that provide advice with respect to municipal derivatives, unless the bank qualifies for another exclusion or exemption.”

Advice to a Municipal Entity

The statute does not define what constitutes “advice” to a municipal entity.  Rule 15Ba1-1(d) provides an “advice standard” that excludes “the provision of general information that does not involve a recommendation regarding municipal financial products or the issuance of municipal securities (including with respect to the structure, timing, terms and other similar matters concerning such financial products or issues).”

Accordingly, a person may provide such general information to a municipal entity or obligated person without registering as a municipal advisor. However, specific advice to a municipal entity or obligated person, for example, about the purchase of GICs, municipal derivatives or investment strategies other than bank deposit and savings accounts could cause a bank to be deemed a municipal advisor.

Investment Strategies

The limited bank exemptions the final rules do not cover investment advisory or management services.  A bank that manages, or provides investment advice with respect to, assets of a municipal entity would need to determine whether such assets constitute proceeds of municipal securities or municipal escrow investments, in evaluating whether the bank is a municipal advisor.

Moreover, the adopting release clarified that the term “investment strategies” includes not only the provision of advice to a separately managed account but also the management of pooled investment vehicles, as when acting as a trustee of collective investment or common trust funds, so that an advisor to a pooled investment vehicle is a municipal advisor if the vehicle contains proceeds of an issuance of municipal securities or municipal escrow investments, regardless of whether the vehicle also contains investments from persons that are not municipal entities.  Therefore, a bank that manages or advises a pooled investment vehicle (including a collective investment fund or common trust fund) would be required to register as a municipal advisor if the vehicle includes proceeds of municipal securities or municipal escrow investments.

In determining whether or not advised or managed assets include proceeds of municipal securities, a bank may rely on representations in writing made by a knowledgeable official of the municipal entity or obligated person whose funds are to be invested regarding the nature of such funds, provided the bank has a reasonable basis for such reliance.  Banks that are municipal advisors should register on the temporary registration form by January 13, 2014, the effective date of the final rules.

Obligated Persons

A bank may be a municipal advisor if it provides non-exempted advisory services to an obligated person.  An obligated person, as noted above, is a person—often, but not always, a bank—committed to support payment of the obligations on municipal securities sold in an offering.  Rule 15Ba1-1(k) excludes the following from the definition of obligated person:

  • a person who provides municipal bond insurance, letters of credit or other liquidity facilities;
  • a person whose financial information or operating data is not material to a municipal securities offering, without reference to any municipal bond insurance, letter of credit, liquidity facility or other credit enhancement (for consistency with Rule 15c2-12 disclosure obligations for municipal securities); or
  • the federal government.

The adopting release provides guidance about when a person becomes an obligated person, stating that a bank or other person that advises a client about conduit financing or other financing options would not be providing municipal advisory services to an “obligated person” until the client has begun the process of applying to, or negotiating with, a municipal entity to issue conduit bonds on behalf of the client.  Similarly, the SEC has clarified that a person is not an obligated person with respect to unrelated matters.

Banks should have processes to determine whether persons to whom they provide financial advice or services other than exempted services are obligated persons with respect to the subject matter of the advisory services.

Registration of Separately Identifiable Departments or Divisions

Rule 15Ba1-1(d)(4) provides that if a bank engages in municipal advisory activities exclusively through a “separately identifiable department or division” (“SID”) that meets certain requirements, the SID will be deemed to be the municipal advisor rather than the bank as a whole.  A SID is that unit of the bank that conducts all of the municipal advisory activities of the bank, provided that the following requirements are met:

  • Supervision. The unit is 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.
  • Separate Records. All of the records relating to the bank’s municipal advisory activities are separately maintained in, or extractable from, the unit’s own facilities or the facilities of the bank, and such records are so maintained or otherwise accessible as to permit independent examination thereof and enforcement of applicable provisions of the Exchange Act, the SEC rules and regulations under the Act and the rules of the Municipal Securities Rulemaking Board (“MSRB”) relating to municipal advisors.

Registration Process and Timing

Municipal advisors must submit registration applications on newly adopted Form MA through EDGAR.  The SEC has staggered the timing during the four-month period in which municipal advisors must register, with registration of advisors previously registered on temporary Form MA-T required during the months of July, August, September or October 2014, depending on the temporary registration number that a municipal advisor received when it registered pursuant to Rule 15Ba2-6T.

Firms that begin municipal advisory activities before October 1, 2014 must register on temporary Form MA-T and then on new Form MA during the applicable period as described above.  Firms that begin municipal advisory activities on or after October 1, 2014 and do not have a temporary registration number as of October 1, 2014 must register with the SEC on Form MA prior to engaging in municipal advisory activities.  Registered municipal advisors must also become members of the MSRB.

Banks that registered on temporary Form MA-T but determine that they are exempt under the new rules or are otherwise no longer required to be registered may withdraw by filing a Form MA-T indicating withdrawal.  If a person that is registered on temporary Form MA-T does not withdraw and does not register on Form MA by the end of the filing period applicable to it, the person’s temporary registration will expire 45 days after the end of the applicable filing period. 

*     *     *

The new rules are complex and will give rise to many interpretive questions.

[1] SEC Release No. 34-70462.

IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this informational piece (including any attachments) is not intended or written to be used, and may not be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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