[Federal Register Volume 76, Number 240 (Wednesday, December 14, 2011)]
[Notices]
[Pages 77865-77877]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-32087]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-65918; File No. SR-MSRB-2011-09]
Self-Regulatory Organizations; Municipal Securities Rulemaking
Board; Order Instituting Proceedings to Determine Whether to Disapprove
Proposed Rule Change, as Modified by Amendment No. 2, Consisting of
Interpretive Notice Concerning the Application of MSRB Rule G-17 to
Underwriters of Municipal Securities
December 8, 2011.
I. Introduction
On August 22, 2011, the Municipal Securities Rulemaking Board
(``MSRB'' or ``Board'') filed with the Securities
[[Page 77866]]
and Exchange Commission (``Commission''), pursuant to Section 19(b)(1)
of the Securities Exchange Act of 1934 (``Exchange Act'' or ``Act'')
\1\ and Rule 19b-4 thereunder,\2\ a proposal consisting of an
interpretive notice concerning the application of MSRB Rule G-17
(Conduct of Municipal Securities and Municipal Advisory Activities) to
underwriters of municipal securities (``Notice''). The proposed rule
change was published for comment in the Federal Register on September
9, 2011.\3\ The Commission received five comment letters on the
proposed rule change.\4\ On October 11, 2011, the MSRB extended the
time period for Commission action to December 7, 2011. On November 3,
2011, the MSRB filed Amendment No. 1 to the proposed rule change. On
November 10, 2011, the MSRB withdrew Amendment No. 1, responded to
comments,\5\ and filed Amendment No. 2 to the proposed rule change. The
proposed rule change, as modified by Amendment No. 2, was published in
the Federal Register on November 21, 2011.\6\ The Commission received
eight comment letters on the proposed rule change, as modified by
Amendment No. 2, and a response from the MSRB.\7\ On December 6, 2011,
the MSRB extended the time period for Commission action to December 8,
2011.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 65263 (September 6,
2011), 76 FR 55989.
\4\ See Letters from Joy A. Howard, Principal, WM Financial
Strategies, dated September 30, 2011 (``WM Letter''); Mike Nicholas,
Chief Executive Officer, Bond Dealers of America, dated September
30, 2010 (``BDA Letter''); Colette J. Irwin-Knott, CIPFA, President,
National Association of Independent Public Finance Advisors, dated
September 30, 2011 (``NAIPFA Letter''); Leslie M. Norwood, Managing
Director and Associate General Counsel, Securities Industry and
Financial Markets Association, dated September 30, 2011 (``SIFMA
Letter''); and Susan Gaffney, Director, Federal Liaison Center,
Government Finance Officers Association, dated October 3, 2011
(``GFOA Letter'').
\5\ See Letter from Margaret C. Henry, General Counsel, Market
Regulation, MSRB, to Elizabeth M. Murphy, Secretary, Commission,
dated November 10, 2011 (``Response Letter I'').
\6\ See Securities Exchange Act Release No. 65749 (November 15,
2011), 76 FR 72013.
\7\ See Letters from Colette J. Irwin-Knott, CIPFA, President,
National Association of Independent Public Finance Advisors, dated
November 30, 2011 (``NAIPFA Letter II''); E. John White, Chief
Executive Officer, Public Financial Management, Inc., dated November
30, 2011 (``PFM Letter''); Leslie M. Norwood, Managing Director and
Associate General Counsel, Securities Industry and Financial Markets
Association, dated November 30, 2011 (``SIFMA Letter II''); Joy A.
Howard, Principal, WM Financial Strategies, dated November 30, 2011
(``WM Letter II''); Michael Nicholas, CEO, Bond Dealers of America,
dated December 1, 2011 (``BDA Letter II''); Susan Gaffney, Director,
Federal Liaison Center, Government Finance Officers Association,
dated December 1, 2011 (``GFOA Letter II''); Robert Doty, AGFS,
dated December 1, 2011 (``AGFS Letter''); and Peter C. Orr, CFA,
President, Intuitive Analytics LLC, dated December 7, 2011 (``IA
Letter''). See Letter from Margaret C. Henry, General Counsel,
Market Regulation, MSRB, to Elizabeth M. Murphy, Secretary,
Commission, dated December 7, 2011 (``Response Letter II'').
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This order institutes proceedings under Section 19(b)(2)(B) of the
Act to determine whether to disapprove the proposed rule change.
II. Description of the Proposal
MSRB proposes to adopt an interpretive notice with respect to MSRB
Rule G-17, which states that ``[i]n the conduct of its municipal
securities or municipal advisory activities, each broker, dealer,
municipal securities dealer, and municipal advisor shall deal fairly
with all persons and shall not engage in any deceptive, dishonest, or
unfair practice.''
The scope of the Notice would apply to underwriters and their duty
to municipal entity \8\ issuers of municipal securities in negotiated
underwritings (except as set forth otherwise), but would not apply to
selling group members or when a dealer is serving as an advisor to a
municipal entity. The Notice includes the following sections: (1) Basic
Fair Dealing Principle; (2) Role of the Underwriter/Conflicts of
Interest; (3) Representations to Issuers; (4) Required Disclosures to
Issuers; (5) Underwriter Duties in Connection with Issuer Disclosure
Documents; (5) Underwriter Compensation and New Issue Pricing; (6)
Conflicts of Interest; (7) Retail Order Periods; and (8) Dealer
Payments to Issuer Personnel.
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\8\ The Notice defines the term ``municipal entity'' as that
term is defined by Section 15B(e)(8) of the Exchange Act: ``any
State, political subdivision of a State, or municipal corporate
instrumentality of a State, including--(A) any agency, authority, or
instrumentality of the State, political subdivision, or municipal
corporate instrumentality; (B) any plan, program, or pool of assets
sponsored or established by the State, political subdivision, or
municipal corporate instrumentality or any agency, authority, or
instrumentality thereof; and (C) any other issuer of municipal
securities.'' See proposed Notice endnote 1.
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A. Basic Fair Dealing Principle
The Notice would specify that an underwriter must not misrepresent
or omit the facts, risks, potential benefits, or other material
information about municipal securities activities undertaken with a
municipal entity issuer. The Notice would also state that MSRB Rule G-
17 establishes a general duty of a dealer to deal fairly with all
persons (including, but not limited to, issuers of municipal
securities), even in the absence of fraud.
B. Role of the Underwriter/Conflicts of Interest
Under the Notice, MSRB Rule G-17's duty to deal fairly with all
persons would require the underwriter to make certain disclosures to
the issuer of municipal securities to clarify the underwriter's role in
an issuance of municipal securities and the actual or potential
material conflicts of interest with respect to such issuance.
1. Disclosures Concerning the Underwriter's Role
The Notice would require an underwriter to disclose the following
information to an issuer: (A) MSRB Rule G-17 requires an underwriter to
deal fairly at all times with both municipal issuers and investors; (B)
the underwriter's primary role is to purchase securities with a view to
distribution in an arm's-length commercial transaction with the issuer
and it has financial and other interests that differ from those of the
issuer; (C) unlike a municipal advisor, the underwriter does not have a
fiduciary duty to the issuer under the federal securities laws and is
not required by federal law to act in the best interest of the issuer
without regard to the underwriter's own financial or other interests;
(D) the underwriter has a duty to purchase securities from the issuer
at a fair and reasonable price, but must balance that duty with its
duty to sell municipal securities to investors at prices that are fair
and reasonable; and (E) the underwriter will review the official
statement for the issuer's securities in accordance with, and as part
of, its responsibilities to investors under the federal securities
laws, as applied to the facts and circumstances of the transaction.
Moreover, the Notice would state that the underwriter must not
recommend that the issuer not retain a municipal advisor.
2. Disclosure Concerning the Underwriter's Compensation
The Notice would require an underwriter to disclose to an issuer
whether its underwriting compensation will be contingent on the closing
of a transaction. The underwriter must also disclose that compensation
that is contingent on the closing of a transaction or the size of a
transaction presents a conflict of interest, because it may cause the
underwriter to recommend a transaction that it is unnecessary or to
recommend that the size of the transaction be larger than is necessary.
[[Page 77867]]
3. Other Conflicts Disclosures
The Notice would require an underwriter to disclose other potential
or actual material conflicts of interest, including, but not limited
to, the following: (A) Any payments described below in Section II
(G)(1) ``Conflicts of Interest--Payments to or from Third Parties'';
(B) any arrangements described below in Section II (G)(2) ``Conflicts
of Interest--Profit-Sharing with Investors''; (C) the credit default
swap disclosures described below in Section II (G)(3) ``Conflicts of
Interest--Credit Default Swaps''; and (D) any incentives for the
underwriter to recommend a complex municipal securities financing and
other associated conflicts of interest described below in Section II
(D) ``Required Disclosures to Issuers''.
The Notice would permit disclosures concerning the role of the
underwriter and the underwriter's compensation to be made by a
syndicate manager on behalf of other syndicate members. The Notice
would require other conflicts disclosures to be made by the particular
underwriters subject to such conflicts.
4. Timing and Manner of Disclosures
The Notice would require that all of the disclosures be made in
writing to an official of the issuer that the underwriter reasonably
believes has the authority to bind the issuer by contract with the
underwriter and that, to the knowledge of the underwriter, is not a
party to a disclosed conflict. The Notice would specify that the
disclosures must be made in a manner designed to make clear to such
official the subject matter of the disclosures and their implications
for the issuer.
The Notice would specify when the disclosures must be made. First,
disclosure concerning the arm's-length nature of the underwriter-issuer
relationship must be made in the earliest stages of the underwriter's
relationship with the issuer, for example, in a response to a request
for proposals or in promotional materials provided to an issuer. Other
disclosures concerning the role of the underwriter and the
underwriter's compensation generally must be made when the underwriter
is engaged to perform underwriting services, for example, in an
engagement letter, not solely in a bond purchase agreement. Moreover,
conflicts disclosures must be made at the same time, except with regard
to conflicts discovered or arising after the underwriter has been
engaged. For example, a conflict may not be present until an
underwriter has recommended a particular financing. In that case, the
disclosure must be provided in sufficient time before the execution of
a contract with the underwriter to allow the official to evaluate the
recommendation, as described below in Section II (D) ``Required
Disclosures to Issuers''.
5. Acknowledgement of Disclosures
The Notice would require an underwriter to attempt to receive
written acknowledgement (other than by automatic email receipt) by the
official of the issuer of receipt of the foregoing disclosures. If the
official of the issuer agrees to proceed with the underwriting
engagement after receipt of the disclosures but will not provide
written acknowledgement of receipt, the underwriter may proceed with
the engagement after documenting with specificity why it was unable to
obtain such written acknowledgement.
C. Representations to Issuers
The Notice would require all representations made by underwriters
to issuers of municipal securities in connection with municipal
securities undertakings, whether written or oral, to be truthful and
accurate and not misrepresent or omit material facts. Underwriters must
have a reasonable basis for the representations and other material
information contained in documents they prepare and must refrain from
including representations or other information they know or should know
is inaccurate or misleading. For example, in connection with a
certificate signed by the underwriter that will be relied upon by the
issuer or other relevant parties to an underwriting, for example, an
issue price certificate, the dealer must have a reasonable basis for
the representations and other material information contained therein.
In addition, an underwriter's response to an issuer's request for
proposals or qualifications must fairly and accurately describe the
underwriter's capacity, resources, and knowledge to perform the
proposed underwriting as of the time the proposal is submitted and must
not contain any representations or other material information about
such capacity, resources, or knowledge that the underwriter knows or
should know to be inaccurate or misleading. Matters not within the
personal knowledge of those preparing the response, for example,
pending litigation, must be confirmed by those with knowledge of the
subject matter. An underwriter must not represent that it has the
requisite knowledge or expertise with respect to a particular financing
if the personnel that it intends to work on the financing do not have
the requisite knowledge or expertise.
D. Required Disclosures to Issuers
The Notice would require that disclosures be tailored to the
personnel of the issuer if knowledge or experience is lacking with a
particular type of structure. While many municipal securities are
issued using financing structures that are routine and well understood
by the typical municipal market professional, including most issuer
personnel that have the lead responsibilities in connection with the
issuance of municipal securities, the underwriter must provide
disclosures on the material aspects of structures when the underwriter
reasonably believes issuer personnel lacks knowledge or experience with
such structures that it recommends.
In cases where the issuer personnel responsible for the issuance of
municipal securities would not be well positioned to fully understand
or assess the implications of a financing in its totality, because the
financing is structured in an unique, atypical, or otherwise complex
manner, the underwriter in a negotiated offering that recommends such
complex financing has an obligation to make more particularized
disclosures than otherwise required in a routine financing.\9\ Examples
of complex financings include variable rate demand obligations and
financings involving derivatives such as swaps. The underwriter must
disclose the material financial characteristics of the complex
financing, as well as the material financial risks of the financing
that are known to the underwriter and reasonably foreseeable at the
time of the disclosure.\10\ The underwriter must also
[[Page 77868]]
disclose any incentives to recommend the financing and other associated
conflicts of interest.\11\ These disclosures must be made in a fair and
balanced manner based on principles of fair dealing and good faith.
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\9\ The Notice would state that if a complex municipal
securities financing consists of an otherwise routine financing
structure that incorporates a unique, atypical or complex element
and the issuer personnel have knowledge or experience with respect
to the routine elements of the financing, the disclosure of material
risks and characteristics may be limited to those relating to such
specific element and any material impact such element may have on
other features that would normally be viewed as routine. See
proposed Notice endnote 6.
\10\ The Notice would provide an example that an underwriter
that recommends variable rate demand obligations should inform the
issuer of the risk of interest rate fluctuations and material risks
of any associated credit or liquidity facilities (for example, the
risk that the issuer might not be able to replace the facility upon
its expiration and might be required to repay the facility provider
over a short period of time). As an additional example, if the
underwriter recommends that the issuer swap the floating rate
interest payments on the variable rate demand obligations to fixed
rate payments under a swap, the underwriter must disclose the
material financial risks (including market, credit, operational, and
liquidity risks) and material financial characteristics of the
recommended swap (for example, the material economic terms of the
swap, the material terms relating to the operation of the swap, and
the material rights and obligations of the parties during the term
of the swap), as well as the material financial risks associated
with the variable rate demand obligation.
Such disclosure should be sufficient to allow the issuer to
assess the magnitude of its potential exposure as a result of the
complex municipal securities financing. The underwriter must also
inform the issuer that there may be accounting, legal, and other
risks associated with the swap and that the issuer should consult
with other professionals concerning such risks. If the underwriter's
affiliated swap dealer is proposed to be the executing swap dealer,
the underwriter may satisfy its disclosure obligation with respect
to the swap if such disclosure has been provided to the issuer by
the affiliated swap dealer or the issuer's swap or other financial
advisor that is independent of the underwriter and the swap dealer,
as long as the underwriter has a reasonable basis for belief in the
truthfulness and completeness of such disclosure. If the issuer
decides to enter into a swap with another dealer, the underwriter is
not required to make disclosures with regard to that swap. Dealers
that recommend swaps or security-based swaps to municipal entities
may also be subject to rules of the Commodity Futures Trading
Commission or those of the Commission. See proposed Notice endnote
7.
\11\ The Notice would provide an example that a conflict of
interest may exist when the underwriter is also the provider of a
swap used by an issuer to hedge a municipal securities offering or
when the underwriter receives compensation from a swap provider for
recommending the swap provider to the issuer. See proposed Notice
endnote 8.
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The Notice would dictate that the level of required disclosure may
vary according to the issuer's knowledge or experience with the
proposed financing structure or similar structures, capability of
evaluating the risks of the recommended financing, and financial
ability to bear the risks of the recommended financing, in each case
based on the reasonable belief of the underwriter.\12\ In all events,
the underwriter must disclose any incentives for the underwriter to
recommend the complex municipal securities financing and other
associated conflicts of interest.
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\12\ The Notice would state that even a financing in which the
interest rate is benchmarked to an index that is commonly used in
the municipal marketplace, such as LIBOR or SIFMA, may be complex to
an issuer that does not understand the components of that index or
its possible interaction with other indexes. See proposed Notice
endnote 9.
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The Notice would require that this disclosure be made in writing to
an official of the issuer whom the underwriter reasonably believes has
the authority to bind the issuer by contract with the underwriter in
(A) sufficient time before the execution of a contract with the
underwriter to allow the official to evaluate the recommendation and
(B) a manner designed to make clear to such official the subject matter
of such disclosures and their implications for the issuer. The complex
financing disclosures must address the specific elements of the
financing and cannot be general in nature. Finally, the Notice would
require the underwriter to make additional efforts reasonably designed
to inform the official of the issuer if the underwriter does not
reasonably believe that the official is capable of independently
evaluating the disclosures.
E. Underwriter Duties in Connection With Issuer Disclosure Documents
The Notice would note that underwriters often play an important
role in assisting issuers in the preparation of disclosure documents,
such as preliminary official statements and official statements.\13\
These documents are critical to the municipal securities transaction,
in that investors rely on the representations contained in the
documents in making their investment decisions. Investment
professionals, such as municipal securities analysts and ratings
services, rely on the representations in forming an opinion regarding
the credit.
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\13\ The Notice would state that underwriters that assist
issuers in preparing official statements must remain cognizant of
the underwriters' duties under federal securities laws. With respect
to primary offerings of municipal securities, the SEC has noted,
``By participating in an offering, an underwriter makes an implied
recommendation about the securities.'' See Securities Exchange Act
Release No. 34-26100 (September 22, 1988), 53 FR 37778 (September
28, 1998) (proposing Exchange Act Rule 15c2-12) at text following
note 70. The SEC has stated that ``this recommendation itself
implies that the underwriter has a reasonable basis for belief in
the truthfulness and completeness of the key representations made in
any disclosure documents used in the offerings.'' Furthermore,
pursuant to SEC Rule 15c2-12(b)(5), an underwriter may not purchase
or sell municipal securities in most primary offerings unless the
underwriter has reasonably determined that the issuer or an
obligated person has entered into a written undertaking to provide
certain types of secondary market disclosure and has a reasonable
basis for relying on the accuracy of the issuer's ongoing disclosure
representations. Securities Exchange Act Release No. 34-34961
(November 17, 1994), 59 FR 59590 (November 10, 1994) (adopting
continuing disclosure provisions of Exchange Act Rule 15c2-12) at
text following note 52. See proposed Notice endnote 10.
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The Notice would provide that a dealer's duty to have a reasonable
basis for the representations it makes, and other material information
it provides, to an issuer and to ensure that such representations and
information are accurate and not misleading extends to representations
and information provided by the underwriter in connection with the
preparation by the issuer of its disclosure documents, for example,
cash flows.
F. Underwriter Compensation and New Issue Pricing
1. Excessive Compensation
The Notice states that an underwriter's compensation for a new
issue (including both direct compensation paid by the issuer and other
separate payments, values, or credits received by the underwriter from
the issuer or any other party in connection with the underwriting), in
certain cases and depending upon the specific facts and circumstances
of the offering, may be so disproportionate to the nature of the
underwriting and related services performed as to constitute an unfair
practice with regard to the issuer that it is a violation of MSRB Rule
G-17. The Notice would look at factors such as the credit quality of
the issue, the size of the issue, market conditions, the length of time
spent structuring the issue, and whether the underwriter is paying the
fee of the underwriter's counsel or any other relevant costs related to
the financing.
2. Fair Pricing
The Notice states that the duty of fair dealing under MSRB Rule G-
17 includes an implied representation that the price an underwriter
pays to an issuer is fair and reasonable, taking into consideration all
relevant factors, including the best judgment of the underwriter as to
the fair market value of the issue at the time it is priced.\14\ In
general, a dealer purchasing bonds in a competitive underwriting for
which the issuer may reject any and all bids will be deemed to have
satisfied its duty of fairness to the issuer with respect to the
purchase price of the issue as long as the dealer's bid is a bona fide
bid as defined in MSRB Rule G-13 \15\ that is based on the dealer's
best judgment of
[[Page 77869]]
the fair market value of the securities that are the subject of the
bid.
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\14\ The Notice would state that the MSRB has previously
observed that whether an underwriter has dealt fairly with an issuer
for purposes of MSRB Rule G-17 is dependent upon all of the facts
and circumstances of an underwriting and is not dependent solely on
the price of the issue. The Notice refers to MSRB Notice 2009-54 and
Rule G-17 Interpretive Letter--Purchase of new issue from issuer,
MSRB interpretation of December 1, 1997. See proposed Notice endnote
11.
\15\ The Notice would refer to MSRB Rule G-13(b)(iii), which
provides: ``For purposes of subparagraph (i), a quotation shall be
deemed to represent a ``bona fide bid for, or offer of, municipal
securities'' if the broker, dealer or municipal securities dealer
making the quotation is prepared to purchase or sell the security
which is the subject of the quotation at the price stated in the
quotation and under such conditions, if any, as are specified at the
time the quotation is made.'' See proposed Notice endnote 12.
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In a negotiated underwriting, the underwriter has a duty under MSRB
Rule G-17 to negotiate in good faith with the issuer. This duty would
include the obligation of the dealer to ensure the accuracy of
representations made during the course of such negotiations, including
representations regarding the price negotiated and the nature of
investor demand for the securities, for example, the status of the
order period and the order book. If, for example, the dealer represents
to the issuer that it is providing the ``best'' market price available
on the new issue, or that it will exert its best efforts to obtain the
``most favorable'' pricing, the dealer may violate MSRB Rule G-17 if
its actions are inconsistent with such representations.\16\
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\16\ The Notice would refer to Rule G-17 Interpretive Letter--
Purchase of new issue from issuer, MSRB interpretation of December
1, 1997. See proposed Notice endnote 13.
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G. Conflicts of Interest
1. Payments To or From Third Parties
The Notice would state that in certain cases, compensation received
by the underwriter from third parties, such as the providers of
derivatives and investments (including affiliates of the underwriters),
may color the underwriter's judgment and cause it to recommend
products, structures, and pricing levels to an issuer when it would not
have done so absent such payments. The MSRB would view the failure of
an underwriter to disclose to the issuer the existence of payments,
values, or credits received by the underwriter in connection with its
underwriting of the new issue from parties other than the issuer, and
payments made by the underwriter in connection with such new issue to
parties other than the issuer (in either case including payments,
values, or credits that relate directly or indirectly to collateral
transactions integrally related to the issue being underwritten), to be
a violation of the underwriter's obligation to the issuer under MSRB
Rule G-17.
For example, the MSRB would consider it to be a violation of MSRB
Rule G-17 for an underwriter to compensate an undisclosed third party
in order to secure municipal securities business. Similarly, the MSRB
would consider it to be a violation of MSRB Rule G-17 for an
underwriter to receive undisclosed compensation from a third party in
exchange for recommending that third party's services or products to an
issuer, including business related to municipal securities derivative
transactions. The Notice does not require that the amount of such third
party payments be disclosed.
In addition, the underwriter must disclose to the issuer whether
the underwriter has entered into any third-party arrangements for the
marketing of the issuer's securities.
2. Profit-Sharing With Investors
The Notice would state that arrangements between the underwriter
and an investor purchasing new issue securities from the underwriter
(including purchases that are contingent upon the delivery by the
issuer to the underwriter of the securities) according to which profits
realized from the resale by such investor of the securities are
directly or indirectly split or otherwise shared with the underwriter
would, depending on the facts and circumstances (including, in
particular, if such resale occurs reasonably close in time to the
original sale by the underwriter to the investor), constitute a
violation of the underwriter's fair dealing obligation under MSRB Rule
G-17. Such arrangements could also constitute a violation of MSRB Rule
G-25(c), which precludes a dealer from sharing, directly or indirectly,
in the profits or losses of a transaction in municipal securities with
or for a customer.\17\
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\17\ MSRB Rule D-9 defines the term ``customer'' as: ``Except as
otherwise specifically provided by rule of the Board, the term
``Customer'' shall mean any person other than a broker, dealer, or
municipal securities dealer acting in its capacity as such or an
issuer in transactions involving the sale by the issuer of a new
issue of its securities.''
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3. Credit Default Swaps
The issuance or purchase by a dealer of credit default swaps for
which the reference is the issuer for which the dealer is serving as
underwriter, or an obligation of that issuer, may pose a conflict of
interest, because trading in such municipal credit default swaps has
the potential to affect the pricing of the underlying reference
obligations, as well as the pricing of other obligations brought to
market by that issuer. The Notice would require a dealer to disclose
the fact that it engages in such activities to the issuers for which
the dealer serves as underwriter.
The Notice would not require disclosures for activities with regard
to credit default swaps based on baskets or indexes of municipal
issuers that include the issuer or its obligations, unless the issuer
or its obligations represents more than 2% of the total notional amount
of the credit default swap or the underwriter otherwise caused the
issuer or its obligations to be included in the basket or index.
H. Retail Order Periods
The Notice would require an underwriter that has agreed to
underwrite a transaction with a retail order period to honor such
agreement.\18\ The Notice would require a dealer that wishes to
allocate securities in a manner that is inconsistent with an issuer's
requirements to obtain the issuer's consent.
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\18\ The Notice refers to MSRB Interpretation on Priority of
Orders for Securities in a Primary Offering under Rule G-17, MSRB
interpretation of October 12, 2010, reprinted in the MSRB Rule Book.
The Notice would remind underwriters of previous MSRB guidance on
the pricing of securities sold to retail investors and refer to
Guidance on Disclosure and Other Sales Practice Obligations to
Individual and Other Retail Investors in Municipal Securities, MSRB
Notice 2009-42 (July 14, 2009). See proposed Notice endnote 15.
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The Notice would require an underwriter that has agreed to
underwrite a transaction with a retail order period to take reasonable
measures to ensure that retail clients are bona fide. An underwriter
that knowingly accepts an order that has been framed as a retail order
when it is not, for example, a number of small orders placed by an
institutional investor that would otherwise not qualify as a retail
customer, would violate MSRB Rule G-17 if its actions are inconsistent
with the issuer's expectations regarding retail orders. Moreover, a
dealer that places an order that is framed as a qualifying retail order
but in fact represents an order that does not meet the qualification
requirements to be treated as a retail order, for example, an order by
a retail dealer without ``going away'' orders \19\ from retail
customers when such orders are not within the issuer's definition of
``retail,'' would violate its MSRB Rule G-17 duty of fair dealing.
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\19\ The Notice would state that a ``going away'' order is an
order for new issue securities for which a customer is already
conditionally committed and cites Securities Exchange Act Release
No. 62715 (August 13, 2010), 75 FR 51128 (August 18, 2010) (File No.
SR-MSRB-2009-17). See proposed Notice endnote 16.
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The Notice specifies that the MSRB will continue to review
activities relating to retail order periods to ensure that they are
conducted in a fair and orderly manner consistent with the intent of
the issuer and the MSRB's investor protection mandate.
I. Dealer Payments to Issuer Personnel
The Notice would state that dealers are reminded of the application
of MSRB Rule G-20 on gifts, gratuities, and non-cash compensation, and
MSRB Rule G-17, in connection with certain
[[Page 77870]]
payments made to, and expenses reimbursed for, issuer personnel during
the municipal bond issuance process.\20\ The Notice would further state
that the rules are designed to avoid conflicts of interest and to
promote fair practices in the municipal securities market.
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\20\ The Notice would cite to MSRB Rule G-20 Interpretation--
Dealer Payments in Connection With the Municipal Securities Issuance
Process, MSRB interpretation of January 29, 2007, reprinted in the
MSRB Rule Book. See proposed Notice endnote 17.
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The Notice would alert dealers to consider carefully whether
payments they make in regard to expenses of issuer personnel in the
course of the bond issuance process, including in particular, but not
limited to, payments for which dealers seek reimbursement from bond
proceeds or issuers, comport with the requirements of MSRB Rule G-20.
For example, the Notice provides that a dealer acting as a financial
advisor or underwriter may violate MSRB Rule G-20 by paying for
excessive or lavish travel, meal, lodging and entertainment expenses in
connection with an offering such as may be incurred for rating agency
trips, bond closing dinners, and other functions, that inure to the
personal benefit of issuer personnel and that exceed the limits or
otherwise violate the requirements of the rule.\21\
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\21\ The Notice cites to In the Matter of RBC Capital Markets
Corporation, SEC Rel. No. 34-59439 (Feb. 24, 2009) (settlement in
connection with broker-dealer alleged to have violated MSRB Rules G-
20 and G-17 for payment of lavish travel and entertainment expenses
of city officials and their families associated with rating agency
trips, which expenditures were subsequently reimbursed from bond
proceeds as costs of issuance); In the Matter of Merchant Capital,
L.L.C., SEC Rel. No. 34-60043 (June 4, 2009) (settlement in
connection with broker-dealer alleged to have violated MSRB rules
for payment of travel and entertainment expenses of family and
friends of senior officials of issuer and reimbursement of the
expenses from issuers and from proceeds of bond offerings). See
proposed Notice endnote 18.
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III. Comment Letters and the MSRB's Responses
As noted earlier, the Commission received five comments \22\ on the
proposed rule change as originally proposed and eight comments \23\ on
the proposed rule change, as modified by Amendment No. 2.\24\ The MSRB
filed two letters responding to the comments.\25\ A summary of the
comments and the MSRB's responses are set forth below.
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\22\ See supra note 4.
\23\ See supra note 7.
\24\ One commenter stated that the amended Notice is a
significant improvement over the original Notice. See PFM Letter.
Another commenter stated that it supports the changes made in the
Notice, as modified by Amendment No. 2, such as the limits on
negotiated offerings, disclosures based on reasonable beliefs, and
nondisclosure of third-party payment amounts. See GFOA Letter II.
\25\ See supra notes 5 and 7.
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A. Basic Fair Dealing Principle
Commenters generally supported the principle of fair dealing in
MSRB Rule G-17,\26\ but some commenters believed that the principle of
fair dealing should not be interpreted to impose a fiduciary duty on
underwriters to issuers,\27\ while other commenters believed that
underwriters have such a duty if they engage in certain activities.\28\
In Response Letter I, the MSRB responded that the Notice does not
impose a fiduciary duty on underwriters and that the duties imposed by
the Notice on underwriters are no different in many cases from the
duties already imposed on them by MSRB rules with respect to customers.
Further, the MSRB stated that an underwriter is not required to act in
the best interest of an issuer without regard to the underwriter's own
financial and other interests and is not required to consider all
reasonably feasible alternatives to the proposed financings. Rather,
the MSRB stated that one purpose of the Notice is to eliminate issuer
confusion about the role of the underwriter.
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\26\ See SIFMA Letter I.
\27\ See SIFMA Letter I; NAIPFA Letter I; BDA Letter I. Both
NAIPFA Letter I and BDA Letter I noted that the imposition of a
fiduciary duty would confuse municipal issuers on the role of
underwriters. One commenter disagreed with the imposition of a
fiduciary duty and noted that municipal issuers often do not
understand the disclosures that they are provided and municipal
issuers do not benefit from complex disclosures from firms that are
not acting in a fiduciary capacity. See WM Letter I (stating its
belief that the proposal will not improve transparency in the
municipal market).
\28\ See, e.g., PFM Letter. The commenter stated that advice
given by brokers in their promotion of themselves to become
underwriters makes them municipal advisors.
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B. Role of the Underwriter/Conflicts of Interest
1. Disclosures Concerning the Underwriter's Role
Some commenters suggested additional disclosures with respect to
the role of underwriters.\29\ For example, commenters suggested that
the MSRB require an underwriter to state: (1) That the underwriter does
not have a fiduciary duty to the issuer and is a counterparty at arm's
length; \30\ (2) that the issuer may choose to engage a financial
advisor to represent its interests; \31\ (3) that the underwriter is
not acting as an advisor; \32\ (4) that the underwriter has conflicts
with issuers because the underwriter represents the interests of
investors and other parties; \33\ (5) that the underwriter seeks to
maximize profitability; \34\ and (6) that the underwriter has no
continuing obligation to the issuer after the transaction.\35\
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\29\ One commenter stated that it supports the proposal but
believes that additional changes would be required to protect
infrequent and/or small and unsophisticated issuers. See NAIPFA
Letter I.
\30\ See GFOA Letter I and NAIPFA Letter I. One commenter stated
its belief that a simple disclosure from an underwriter to the
issuer that the underwriter is not acting as financial advisor and
that the issuer should consult with a financial advisor would be
sufficient. See WM Letter I.
\31\ See GFOA Letter I and NAIPFA Letter I (requesting a
disclosure that an underwriter is no replacement for a municipal
advisor and stating that when an issuer engages a municipal advisor,
the underwriter disclosures should not overlap with areas covered by
the role of municipal advisor). Other commenters stated their belief
that in a negotiated sale, when the issuer of municipal securities
engages a registered municipal advisor, disclosures should be
reduced. See NAIPFA Letter II; SIFMA Letter II; and WM Letter II
(stating that the exemption from some of the disclosures required by
the rule for underwriters engaged in a competitive sale should be
extended to all transactions in which a financial advisor has been
retained). In Response Letter II, the MSRB noted its disagreement
because it believes that more disclosure would empower, rather than
confuse, issuers.
\32\ See NAIPFA Letter I.
\33\ See NAIPFA Letter I. One commenter objected to the required
disclosure that an underwriter must balance a fair and reasonable
price for issuers with a fair and reasonable price for investors.
See BDA Letter II. The commenter stated its belief that there exists
a reasonable price for both issuers and investors, and recommended
that the disclosure be modified to reflect that statement. In
Response Letter II, the MSRB stated its belief that it is
appropriate to characterize the underwriter's duties of fair pricing
as a balance between the interests of the issuer and investors.
\34\ See NAIPFA Letter I.
\35\ See NAIPFA Letter I.
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In Response Letter I, the MSRB noted that the Notice, as modified
by Amendment No. 2, incorporates many of the recommendations suggested
by the commenters, such as requiring underwriters to provide issuers
with disclosure that underwriters do not have a fiduciary duty to
issuers. In addition, the MSRB noted that the Notice, as modified by
Amendment No. 2, requires disclosure regarding the underwriter's role
compared to a municipal advisor,\36\ and prohibits an underwriter from
recommending that the issuer not retain a municipal advisor.\37\ The
MSRB also
[[Page 77871]]
stated that it does not believe that it is necessary for underwriters
to disclose that they seek to maximize profitability and have no
continuing obligation to the issuer after the transaction.
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\36\ One commenter stated that the requirement for an
underwriter to compare its obligations with others, such as a
municipal advisor, should be eliminated. See BDA Letter II. In
Response Letter II, the MSRB noted that it has determined to take
the approach suggested by another commenter (GFOA) and, therefore,
has not changed this provision of the proposal but will monitor
disclosure practices under the proposal and will engage in a
dialogue with industry participants and the Commission to determine
whether sufficient improvements have occurred in the flow of
disclosures to decision-making personnel of issuers or whether
additional steps should be taken.
\37\ One commenter agreed with the MSRB that an underwriter
should not recommend that an issuer not retain a municipal advisor.
See BDA Letter II. However, the commenter stated that it is
concerned that municipal advisors are not subject to professional
standards, continuing education, licensing or other requirements, or
a prohibition against making political contributions.
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One commenter suggested that the MSRB require underwriters to
disclose pending litigation that may affect the underwriter's municipal
securities business, departure of experts that the issuer relied upon,
and transactional risk including a comparison of different forms of
financings.\38\ In Response Letter I, the MSRB disagreed that
underwriters should disclose different types of financings that may be
applicable to an issuer's particular situation because that is under
the domain of the municipal advisor, and noted that pending litigation
and expert departures do not rise to the level of conflicts, but could
be required by issuers as the issuers deem appropriate.
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\38\ See GFOA Letter I. See also GFOA Letter II.
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One commenter stated its belief that the Notice should require
underwriters to educate issuers to better understand underwriting
pricing and fees.\39\ In Response Letter I, the MSRB noted it is in the
process of developing education materials for issuers as suggested by
the commenter.
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\39\ See GFOA Letter I.
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Another commenter stated that underwriters should not be required
to provide generalized role and compensation disclosures or written
risk disclosures to large and frequent issuers unless requested by such
issuers.\40\ In Response Letter II, the MSRB noted its disagreement and
stated its belief that additional disclosure would empower, rather than
confuse, issuers and, therefore, no further modifications to these
provisions are warranted.
---------------------------------------------------------------------------
\40\ See SIFMA Letter II.
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2. Disclosure Concerning the Underwriter's Compensation
One commenter requested additional conflicts of interest
disclosures regarding underwriter compensation, such as how the
underwriter is compensated.\41\ In Response Letter I, the MSRB stated
that it believes that the Notice, as modified by Amendment No. 2, would
incorporate the commenter's recommendation, such as disclosure
regarding contingent fee compensation as a conflict of interest.
---------------------------------------------------------------------------
\41\ See GFOA Letter I.
---------------------------------------------------------------------------
Another commenter stated its belief that the underwriter should be
required to disclose to an issuer, and obtain its informed consent in
writing, that the form of the underwriter's compensation creates a
conflict of interest, because underwriter compensation is based
primarily on the size and type of issuance.\42\ The commenter later
stated that contingent fees should be disclosed.\43\ Another commenter
objected to the characterization of contingent fee arrangements as
resulting in a conflict of interest with issuers.\44\ The commenter
stated that such arrangements do not necessarily result in a conflict,
and recommended that disclosure should state that such disclosure
``may'' present a conflict or ``may have'' the potential for a
conflict.\45\
---------------------------------------------------------------------------
\42\ See NAIPFA Letter I.
\43\ See NAIPFA Letter II.
\44\ See BDA Letter II.
\45\ See id.
---------------------------------------------------------------------------
In Response Letter II, the MSRB stated that it believes that it has
accurately characterized compensation arrangements contingent on
closing or on the size of the transactions as creating a conflict of
interest--it may be that other factors on which an underwriter and the
issuer have a coincidence of interests may outweigh the conflicting
interests resulting from the contingent arrangement, but that does not
change the fact that such arrangement itself represents a conflict.
Further, given the transaction-based nature of the typical relationship
between underwriters and issuers, the MSRB stated that it believes that
the proposal's requirements regarding disclosure of compensation
conflicts, together with the other conflicts disclosures included in
the proposal, adequately address concerns that may arise in cases where
potential conflicts may arise under less typical compensation
scenarios.
One commenter stated that it would be more beneficial to issuers to
require underwriters to disclose the amount of compensation at the
outset and conclusion of the transaction.\46\ In Response Letter II,
the MSRB stated that the provisions relating to these disclosures are
appropriate given the transaction-based nature of the typical
relationship between underwriters and issuers. The MSRB stated its
belief that the proposal's requirements regarding disclosure of
compensation conflicts, together with the other conflicts disclosures
included in the proposal, adequately address concerns that may arise in
cases where potential conflicts may arise under less typical
compensation scenarios.
---------------------------------------------------------------------------
\46\ See NAIPFA Letter II.
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3. Other Conflicts Disclosures
One commenter requested additional conflicts of interest
disclosures such as the duty the underwriter has to investors.\47\ In
Response Letter I, the MSRB stated that it believes that the Notice, as
modified by Amendment No. 2, would incorporate the commenter's
recommendation, such as by requiring disclosure of an underwriter's
other actual or potential material conflicts of interest.
---------------------------------------------------------------------------
\47\ See GFOA Letter I.
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One commenter stated that when there is a syndicate of
underwriters, an underwriter whose participation level is below 10%
should be exempted from the disclosure requirements.\48\ Another
commenter stated that, with respect to underwriter syndicates,
underwriters who do not have a role in the development or
implementation of the financing structure or other aspects of the issue
should not be subject to the disclosures.\49\ In Response Letter II,
the MSRB declined to create any such exemption since not all conflicts
or other concerns that arise in the context of an underwriting are
necessarily proportionate to the size of participation of an
underwriter. The MSRB noted, however, that with respect to disclosures
about the material financial characteristics and risks of an
underwriting transaction recommended by underwriters, where such
recommendation is made by the syndicate manager on behalf of the
underwriting syndicate, the Notice does not prohibit syndicate members
from delegating to the syndicate manager (through, for example, the
agreement among underwriters) the task of delivering such disclosure in
a full and timely manner on behalf of the syndicate members, although
each syndicate member would remain responsible for providing
disclosures with respect to conflicts specific to such member.
---------------------------------------------------------------------------
\48\ See SIFMA Letter II.
\49\ See BDA Letter II.
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4. Timing and Manner of Disclosures
With respect to the disclosure process, one commenter stated its
belief that underwriters should be subject to a process similar to the
proposed municipal advisors' more rigorous process under the municipal
advisor portion of proposed MSRB Rules G-17 and G-36.\50\ The commenter
stated its
[[Page 77872]]
belief that providing disclosures is inadequate; rather, underwriters
should be required to obtain informed consent from issuers. Moreover,
the commenter stated its belief that disclosures should be made to
officials of the municipal entity with the power to bind the
issuer.\51\ The commenter also stated that the Notice should be amended
to prohibit the giving of disclosures based on a reasonable belief
standard and instead require underwriters to have actual knowledge
whether an official has the power to bind the issuer by contract.
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\50\ See NAIPFA Letter I. The Commission notes that these
proposals were subsequently withdrawn by the MSRB. See Securities
Exchange Act Release Nos. 65397 (September 26, 2011), 76 FR 60955
(September 30, 2011) (withdrawing proposed MSRB Rule G-36 and
interpretive guidance concerning MSRB Rule G-36); and 65398
(September 26, 2011), 76 FR 60958 (September 30, 2011) (withdrawing
proposed interpretive notice concerning MSRB Rule G-17).
\51\ See NAIPFA Letter I and NAIPFA Letter II.
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In Response Letter I, the MSRB stated that it believes that it is
not necessary for underwriters to obtain consent from the issuer's
governing body when the issuer finance officials have been delegated
the ability to contract with the underwriter. The MSRB stated that it
is not necessary for a contract to have been executed in order for an
underwriter to have a reasonable belief that an issuer official has the
requisite power to bind the issuer.
Another commenter stated its belief that disclosure should be made
to an official that the underwriter reasonably believes ``has or will
have'' the requisite authority, instead of the standard that the
underwriter believes ``has'' the authority to bind the issuer by
contract.\52\ The commenter stated that due to the nature of these
transactions, at the time of disclosures, there may not be an official
with such authority as the authority may not be granted until later. In
Response Letter II, the MSRB noted that an official, such as a finance
director, who is expected to receive the delegation of authority from
the governing body to bind the issuer could reasonably be viewed as an
acceptable recipient of disclosures for purposes of the proposal so
long as such expectation remains reasonable.
---------------------------------------------------------------------------
\52\ See BDA Letter II.
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Another commenter stated that the Notice should state that the
disclosure must be made in a response to a request for proposals or in
promotional materials provided to an issuer, rather than the proposed
``at the earliest stages'' standard, because the commenter believes
that the proposed standard is vague and ambiguous.\53\ Another
commenter requested clarification regarding the meaning of ``execution
of a contract'' with respect to the timing of the required risk
disclosures.\54\ The commenter stated that execution of the purchase
agreement should be the appropriate measurement. In Response Letter II,
the MSRB clarified that, other than the disclosure with regard to the
arm's-length nature of the relationship, the remaining disclosures
regarding the underwriter's role, underwriter's compensation and other
conflicts of interest all must be provided when the underwriter is
engaged to perform underwriting services (such as in an engagement
letter), not solely in the bond purchase agreement.
---------------------------------------------------------------------------
\53\ See id.
\54\ See SIFMA Letter II. The same commenter also requested
clarification in situations where the financing terms are determined
in a short period of time, such as within a 24-hour window, and how
underwriters would satisfy the disclosure requirements. In Response
Letter II, the MSRB stated that the timeframe set out in the
proposal, which matches the timeframe for this same disclosure under
guidance provided in connection with recent amendments to MSRB Rule
G-23, on activities of financial advisors, is appropriate and should
not be changed.
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One commenter suggested that the underwriter make its disclosures
to the issuer, in plain English, to ensure that the issuer understands
such disclosures.\55\ In Response Letter II, the MSRB stated that it
agrees that reasonable efforts must be made to make the disclosures
understandable, that disclosures must be made in a fair and balanced
manner and, if the underwriter does not reasonably believe that the
official to whom the disclosures are addressed is capable of
independently evaluating the disclosures, the underwriter must make
additional efforts reasonably designed to inform the issuer or its
employees or agent.
---------------------------------------------------------------------------
\55\ See GFOA Letter II.
---------------------------------------------------------------------------
One commenter stated that it remains concerned that to provide
disclosure to an official of the issuer that the underwriter reasonably
believes has authority to bind the issuer would not provide the issuer
with sufficient knowledge of any existing conflicts.\56\ The commenter
recommended that underwriters make disclosure to the issuer's governing
body and require underwriters to have actual knowledge, instead of a
reasonable belief knowledge standard, as to whether the official being
presented with disclosures has the power to bind the issuer by
contract. In Response Letter II, the MSRB responded that underwriters
must document the failure to receive acknowledgement, as well as what
actions were taken to attempt to obtain the acknowledgement, in order
for the underwriter to fulfill its obligation to document why it was
unable to obtain the acknowledgement.
---------------------------------------------------------------------------
\56\ See NAIPFA Letter II.
---------------------------------------------------------------------------
5. Acknowledgement of Disclosures
One commenter stated its belief that the provision of the Notice
requiring issuer written acknowledgement of disclosures would be
helpful, but in situations where written acknowledgement is not
received from the issuer, the commenter urged the MSRB to require
underwriters to put forth some level of effort to obtain the written
acknowledgement of the issuer.\57\ Another commenter stated that it
believes that an underwriter should not be required to document why an
official of the issuer does not acknowledge in writing that disclosures
were received.\58\ Instead, the commenter recommended that the Notice
require the underwriter to document that disclosures were made and
whether acknowledgement was received.
---------------------------------------------------------------------------
\57\ See NAIPFA Letter I.
\58\ See BDA Letter II.
---------------------------------------------------------------------------
In Response Letter II, the MSRB clarified that if an issuer does
not provide the underwriter with a written acknowledgement of receipt
of disclosures, the failure to receive such acknowledgement must be
documented, as well as what actions were taken to attempt to obtain the
acknowledgement, in order for the underwriter to fulfill its obligation
to document why it was unable to obtain the acknowledgement.
C. Representations to Issuers
Under the Notice, an underwriter would be required to have a
reasonable basis for providing representations and material information
in a certificate that will be relied upon by the municipal entity
issuer or other relevant parties to an underwriting. One commenter
stated that one example of such a certificate used by the MSRB in the
Notice is already regulated by tax laws and does not need additional
regulation by the MSRB.\59\ In Response Letter I, the MSRB stated that
it does not believe the disclosure requirement imposes an additional
regulatory burden on underwriters.
---------------------------------------------------------------------------
\59\ See SIFMA Letter I.
---------------------------------------------------------------------------
D. Required Disclosures to Issuers
One commenter stated that the disclosure requirements, especially
for routine transactions, should only be imposed when the underwriter
has reason to believe that the issuer does not have the knowledge or
experience available to understand the transaction.\60\ Moreover, the
commenter
[[Page 77873]]
stated that the proposal should be clarified as to when the underwriter
is required to provide disclosures on the material aspects of the
financing structures. The commenter also noted that ``issuer personnel
responsible for the issuance of municipal securities'' and ``an
official of the issuer whom the underwriter reasonably believes has the
authority to bind the issuer by contract with the underwriter'' are not
the same.\61\ Thus, the commenter stated its belief that clarification
should be provided that these regulatory requirements are imposed on
the underwriter only if the underwriter has reason to believe that
issuer personnel do not have the requisite knowledge or experience,
regardless of whether the particular official that the underwriter
reasonably believes to have the legal authority to contractually bind
the issuer can be reasonably thought to have the requisite knowledge
and experience. Another commenter stated that the Notice should be
amended to take into consideration the needs of unsophisticated
municipal issuers, and underwriters should be required to assess the
knowledge and understanding of municipal issuers on a case-by-case
basis.\62\ In Response Letter I, the MSRB stated that it does not
consider it unreasonable to require that an underwriter evaluate the
level of knowledge and sophistication of the issuer, particularly
considering that under the Notice, as amended by Amendment No. 2, the
underwriter need only have a reasonable basis for its evaluation.
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\60\ See BDA Letter I. One commenter suggested factors to
determine routine financings when disclosures would not be
necessary. See NAIPFA Letter I. In Response Letter I, the MSRB
stated that while the factors are helpful, they do not address the
particular issuer personnel's experience and knowledge, which are
more relevant to the Notice. The MSRB stated that it would take the
comment under advisement. Another commenter stated that in a routine
financing, the Notice should require an underwriter to disclose, in
writing, information regarding the transaction, should the issuer
make such a request. See GFOA Letter II. The commenter stated that
additional information on routine financings would be helpful. In
Response Letter II, the MSRB stated its belief that the provisions
relating to this disclosure are appropriate for the reasons
described in Response Letter I and, therefore, no further
modification is warranted.
\61\ Another commenter noted that to require an underwriter to
determine who should be considered ``issuer personnel'' is an issue
worth more consideration and discussion. See GFOA Letter II. In
Response Letter II, the MSRB noted that it would monitor disclosure
practices and would engage in a dialogue with industry participants
and the Commission to determine whether sufficient improvements have
occurred in the flow of disclosures to decision-making personnel of
issuers or whether additional steps should be taken.
\62\ See NAIPFA Letter I and NAIPFA Letter II. The commenter
reiterated that the proposal requires additional changes in order to
protect over 50,000 infrequent and/or small, unsophisticated issuers
of municipal bonds. See NAIPFA Letter II. Another commenter stated
that there are many unsophisticated issuers who will benefit from
the disclosures. See AGFS Letter. The commenter stated that issuers
should rely upon advice from advisors who owe the issuers a
fiduciary duty, instead of underwriters who may be in an adversarial
position.
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One commenter stated its belief that the written risk disclosures
imposed on underwriters related to the financings (including complex
financings) are too broad and vague and do not take into account the
role of the issuer's municipal advisor, if any.\63\ Other commenters
stated that the underwriter should not have disclosure requirements
when the issuer has engaged a financial advisor.\64\ Another commenter
stated that the underwriter should not be required to evaluate issuer
personnel when the issuer has retained a municipal advisor.\65\ In
Response Letter I, the MSRB stated that underwriters are in the best
position to understand the material terms and risks associated with
recommended financings, and the burden should not be solely on
municipal advisors to ascertain such terms and risks.
---------------------------------------------------------------------------
\63\ See SIFMA Letter I.
\64\ See BDA Letter I and WM Letter I.
\65\ See SIFMA Letter I.
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One commenter noted that if written risk disclosures are to be
required, then additional guidance and clarity is needed on the
following: (1) References to ``atypical or complex'' financings; \66\
(2) references to ``all material risks and characteristics of the
complex municipal securities financing''; \67\ (3) which issuer
personnel must have the requisite level of knowledge and
sophistication; \68\ (4) if the issuer does not have a financial
advisor or internal personnel acting in a similar role, then the
issuer's finance staff's knowledge and experience should be assessed by
underwriters; and (5) only material risks that are known to the
underwriter and reasonably foreseeable at the time of the disclosure
should be required.\69\
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\66\ The commenter stated that these additional written
disclosures may require detailed review by counsel, which would be
costly. The commenter urged the Commission to carefully consider the
costs relative to the potential benefits.
\67\ The commenter stated that this reference should be limited
to financial risks and characteristics since the underwriter should
not have to provide disclosures on legal issues.
\68\ The commenter stated that if the issuer has a financial
advisor or internal personnel serving the same role then no
underwriter written disclosures should be required. The commenter
further stated that underwriters may satisfy their disclosure
requirements by communicating the disclosures to the financial
advisor or issuer internal personnel.
\69\ See SIFMA Letter I.
---------------------------------------------------------------------------
In Response Letter I, the MSRB stated that it does not consider it
appropriate to provide a more precise definition of ``complex municipal
securities financing'' since the Notice already provides examples of
complex financings, such as those involving variable rate demand
obligations and swaps. The MSRB stated that it does not consider it
appropriate to require an issuer to inform the underwriter that the
issuer lacks knowledge or experience with a financing. The MSRB stated
its belief that it is reasonable to require the underwriter to evaluate
the level of knowledge and sophistication of the issuer. The Notice, as
modified by Amendment No. 2, would only require the underwriter to have
a reasonable basis for its evaluation. Further, the MSRB stated that it
agrees with the commenter that disclosure on complex financings should
be limited to material financial risks that are known to the
underwriter and reasonably foreseeable. The MSRB stated that the
Notice, as modified by Amendment No. 2, shows such change. The Notice,
as modified by Amendment No. 2, would also require disclosures of the
characteristics of a financing that are limited to the material
financial characteristics and would provide examples in the case of
swaps.
One commenter disagreed with the MSRB that the level of disclosure
should vary based on the issuer's financial ability to bear the risks
of the recommended financing.\70\ The commenter stated its belief that
a municipal entity with taxing power, who would be able to bear more
risks of a financing, should not be ineligible for advice that is
competent and unimpaired by the broker's own interests simply because
the government can tax the citizens to restore any loss. In Response
Letter II, the MSRB conceded that the financial ability to bear the
risks of a recommended financing would not normally be a sufficient
basis, by itself, for determining the level of disclosure to provide.
The MSRB noted, however, the proposal states three distinct factors
that should be considered together in coming to this determination.
---------------------------------------------------------------------------
\70\ See PFM Letter.
---------------------------------------------------------------------------
Other commenters noted that disclosure regarding derivatives is
premature since there are pending rulemakings with the Commodity
Futures Trading Commission (``CFTC'') and the Commission that will
apply to dealers recommending swaps or security-based swaps to
municipal entities.\71\ One commenter urged the MSRB to work together
with SEC and CFTC to ensure that one set of
[[Page 77874]]
definitions and rules apply to the municipal securities market.\72\
---------------------------------------------------------------------------
\71\ See SIFMA Letter I; BDA Letter I; GFOA, Letter I.
\72\ See GFOA Letter I.
---------------------------------------------------------------------------
In Response Letter I, the MSRB noted that it is aware of the
ongoing rulemaking by the Commission and CFTC and has taken care to
ensure that any requirements of the Notice are consistent with such
rulemaking. In Response Letter II, the MSRB disagreed with the
commenter that the proposal is premature for the reasons described in
Response Letter I.
E. Underwriter Duties in Connection With Issuer Disclosure Documents
Under the Notice, the underwriter must have a reasonable basis for
its representations and information provided to issuers in connection
with the preparation by the issuer of its disclosure documents. One
commenter stated its belief that the reasonable basis requirement is
unreasonably broad.\73\ The commenter stated that the Notice should be
revised to clarify that an underwriter may limit its responsibility for
information provided by disclosing to the issuer any limitations on the
scope of the underwriter's analysis and factual verification it
performed. The commenter further stated that such duty should extend
only to material information. In Response Letter I, the MSRB stated
that it disagrees with the commenter and believes that an underwriter
should have a reasonable basis for its own representations set forth in
the official statement, as well as a reasonable basis for the material
information it provides to the issuer in connection with the
preparation of the official statement.
---------------------------------------------------------------------------
\73\ See id.
---------------------------------------------------------------------------
One commenter also stated its belief that when an underwriter
intends to assist in the preparation of an official statement, that a
disclosure should be made to the issuer stating that the underwriter
can only be held liable where it can be shown that it did not act with
a reasonable belief that the information presented was truthful and
complete.\74\ In Response Letter I, the MSRB noted that the Notice
would provide that an underwriter must have ``a reasonable basis for
the representations it makes, and other material information it
provides, to an issuer and to ensure that such representations and
information are accurate and not misleading.''
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\74\ See NAIPFA Letter I.
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F. Underwriter Compensation and New Issue Pricing
1. Excessive Compensation
One commenter requested that, in the absence of disclosure and
informed consent, underwriters be prohibited from seeking
reimbursements from bond proceeds for expenditures made on behalf of
the issuer for any expenses incurred by the underwriter.\75\ In
Response Letter I, the MSRB noted that it disagrees with the commenter
and that MSRB Rule G-20 already precludes underwriters from seeking
reimbursement for lavish expenditures, especially from bond proceeds.
Further, in Response Letter I, the MSRB noted that state law would
govern whether such reimbursements are permissible.
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\75\ See id.
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2. Fair Pricing
With respect to the representation that the price an underwriter
pays in a negotiated sale be fair and reasonable, one commenter stated
its belief that such representation should be altered so that the price
the underwriter pays is ``not unreasonable.'' \76\ In Response Letter
I, the MSRB stated that the fair and reasonable pricing standard is no
different in many cases than the duties already imposed on underwriters
by MSRB rules with respect to underwriters' customers and that it
believes the approach in the Notice would require more robust
disclosures by underwriters to issuers. In the alternative, the
commenter recommended that the disclosure should be changed to state
that the pricing is not necessarily the best pricing.\77\ In Response
Letter II, the MSRB stated that it believes that the provisions
relating to these disclosures are appropriate for the reasons described
in Response Letter I and, therefore, no further modifications to these
provisions are warranted.
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\76\ See NAIPFA Letter I and NAIPFA Letter II.
\77\ See NAIPFA Letter II.
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One commenter urged the Commission to require underwriters to
expressly represent in writing to the issuer that the price paid for
the issuer's debt is fair, and specify the facts that support the
representation.\78\ In Response Letter II, the MSRB stated that its
view is that, even if an underwriter provides a fair price to an issuer
for its new issue offering, its fair practice duties under Rule G-17
are not thereby discharged because, among other things, the many
principles laid out in the proposal also must be addressed. Conversely,
an underwriter cannot justify under Rule G-17 an unfair price to an
issuer by balancing that unfair price with the fact that it may
otherwise have been fair to the issuer under the other fairness
principles enunciated in the proposal.
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\78\ See PFM Letter.
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G. Conflicts of Interest
1. Payments To or From Third Parties
One commenter stated that disclosures with respect to third-party
arrangements for the marketing of the issuer's securities should be
clarified as to the level of details.\79\ Further, the commenter stated
its belief that payments to and from affiliates of the underwriters are
not third-party payments since those payments would not cloud a party's
judgment when the parties are related to each other, unlike third
parties. In Response Letter I, the MSRB noted that the Notice, as
modified by Amendment No. 2, would require only the disclosure of
third-party marketing arrangements, not the particular terms. Moreover,
while the MSRB disagreed with the commenter that payments from
affiliates do not raise risks, the MSRB noted that the Notice, as
modified by Amendment No. 2, would not require the disclosure of the
amounts of such payments.
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\79\ See SIFMA Letter I. See also IA Letter. The commenter cited
examples where an underwriter would outsource certain routine tasks
related to the financing transactions, and sought clarification
whether the Notice would encompass such payments for services
rendered. The Commission received the IA Letter after the MSRB filed
Response Letter II, and thus, the MSRB has not specifically
responded to the commenter.
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Another commenter stated that the payment amount is an important
variable for the issuer to consider and would encourage its members to
further question the underwriter about any relevant third-party
relationships and payments, which provides better transparency for the
transaction.\80\ In Response Letter II, the MSRB stated its agreement
that such further inquiries can be made. In addition, the MSRB
clarified that the third-party payments to which the disclosure
requirement under the Notice would apply are those that give rise to
actual or potential conflicts of interest and typically would not apply
to third-party arrangements for products and services of the type that
are routinely entered into in the normal course of business, so long as
any specific routine arrangement does not give rise to an actual or
potential conflict of interest.
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\80\ See GFOA Letter II.
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2. Profit-Sharing With Investors
One commenter sought clarification that legitimate trading, such as
when an
[[Page 77875]]
underwriter sells a bond and later repurchases the bond from a
purchaser, is not included in the disclosure for profit sharing
arrangements.\81\ In Response Letter II, the MSRB stated its belief
that the language of the proposal appropriately reflects that the
disclosure applies in cases where there exists an arrangement to split
or share profits realized by an investor upon resale.
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\81\ See BDA Letter II.
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3. Credit Default Swaps
One commenter stated that it believes that underwriters should not
be required to disclose hedging and risk management strategies and
activities when the underwriter, in its role as a dealer, issues or
purchases credit default swaps that reference the obligations of the
municipal issuer.\82\ The commenter noted that should these disclosures
be required, a general disclosure to the issuers that the underwriters
may engage in such activities should be sufficient. The commenter
objected to any provisions that would require underwriters to provide
specific disclosures that may reveal identities of counterparties and
the underwriters' hedging and risk management strategies. In Response
Letter I, the MSRB stated that it does not believe that the disclosure
requirement would compromise counterparty relationships or deter the
use of credit default swaps for legitimate risk management purposes. In
addition, the MSRB noted that the Notice would only require that a
dealer that engages in the issuance or purchase of a credit default
swap for which the underlying reference is an issuer for which the
dealer is serving as underwriter, or an obligation of that issuer, must
disclose the fact that it does so to the issuer, not the terms of the
particular trades.\83\
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\82\ See SIFMA Letter I.
\83\ One commenter noted that the Notice provides that if a
dealer issues or purchases credit default swaps for which the
reference obligor is the issuer to which the dealer is serving as an
underwriter, the underwriter must disclose that fact to the issuer.
See SIFMA Letter II. The commenter requested clarification that, in
the case of a conduit issuer that issues bonds for multiple obligors
or on a specific project, whether disclosures need to be made to the
obligor(s) to satisfy the disclosure requirements. See SIFMA Letter
II. In Response Letter II, the MSRB stated that the proposal only
requires that credit default swap disclosures be made to the issuers
of the municipal securities and not to any conduit borrowers or
other obligors. However, the MSRB stated that it would take under
advisement the question of whether such disclosure should be
extended to any applicable obligors other than the issuer.
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H. Retail Order Periods
One commenter recommended that the Notice use a single standard of
requiring that the underwriter not knowingly accept orders that do not
meet the requirements of the retail order period.\84\ In Response
Letter II, the MSRB stated that it believes that the commenter has
misunderstood these provisions. The MSRB stated that the Notice
provides that an underwriter that knowingly accepts an order that has
been framed as a retail order when it is not, would violate MSRB Rule
G-17 if its actions are inconsistent with the issuer's expectations
regarding retail orders, but also provides that a dealer that places an
order that is framed as a qualifying retail order but in fact
represents an order that does not meet the qualification requirements
to be treated as a retail order, violates its duty of fair dealing. The
MSRB stated that these two provisions are entirely consistent and
appropriate, since in the first provision an underwriter is receiving
an order framed by a third party, whereas in the second provision, a
dealer (not limited to an underwriter) is itself placing and framing
the order. Therefore, the MSRB noted that it has not modified these
provisions.
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\84\ See BDA Letter II.
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I. Timing and Consistency
One commenter noted that underwriters that may also be municipal
advisors will not be able to properly evaluate the Notice until rules
with respect to municipal advisors have been approved and adopted by
the Commission and MSRB.\85\ The commenter noted that many underwriters
may be classified as municipal advisors under these yet-to-be-adopted
rules and questioned how the underwriters' obligations under the Notice
may relate to these rules. The commenter stated that many interested
parties are abstaining from commenting on the proposal due to this
uncertainty. The commenter stated its belief that, at a minimum, the
portion of the proposal addressing an underwriter's obligation to
provide written risk disclosures should be withdrawn and refiled at a
later time.
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\85\ See SIFMA Letter I and SIFMA Letter II.
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One commenter stated that a 90-day implementation period is too
short and requested a period no less than six months.\86\ In Response
Letter I, the MSRB stated that it believes that 90 days is an adequate
time period for underwriters to develop the required disclosures.
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\86\ See SIFMA Letter I.
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J. Miscellaneous Comments
Some commenters raised issues that are outside the scope of the
proposal. For example, commenters asked the MSRB to provide clarity on
the definition of ``flipping'' \87\ and the application of the
suitability standard to transactions proposed by an underwriter to an
issuer.\88\
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\87\ See GFOA Letter I; GFOA Letter II and NAIPFA Letter II.
\88\ See GFOA Letter I and GFOA Letter II.
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With respect to ``flipping,'' the MSRB stated in Response Letter II
that it would reach out to other regulators and the Commission in an
attempt to develop a shared understanding of what such ``flipping''
activities entail and potential concerns regarding the implications of
these activities. The MSRB noted that, to the extent these activities
could be characterized as arrangements between the underwriter and an
investor purchasing new issue securities from the underwriter according
to which profits realized from the resale by such investor of the
securities are directly or indirectly split or otherwise shared with
the underwriter, these activities may already be subject to the
proposal's disclosure obligation with respect to profit-sharing with
investors.
In Response Letter II, the MSRB noted that although the suitability
comment is outside the scope of the proposal, the MSRB will keep this
suggestion under advisement.
Another commenter urged further consideration of the costs of
disclosures and weighing the costs against the potential benefits.\89\
In Response Letter II, the MSRB noted its disagreement that it did not
weigh the costs and benefits, and that the proposal in fact recognizes
that many of the disclosures required under the proposal can be
tailored, and in some cases are not required at all, based on a number
of relevant factors set out in the proposal and described in greater
detail in Response Letter I. Most across-the-board disclosure
provisions in the proposal either require transaction-specific or
underwriter-specific disclosures of relevant conflicts of interest or
consist of standardized educational disclosures with respect to which,
underwriters most likely would realize greater cost-effectiveness and
reduced regulatory risk by making such disclosures globally rather than
on a case-by-case basis. The MSRB stated that providing more
information to issuers would empower and provide considerable benefits
to issuers. Further, the MSRB stated that it concedes that some
underwriters may bear up-front costs in creating basic frameworks for
the required disclosures for the various types of products they may
offer their issuer clients, but the on-going burden should thereafter
be considerably
[[Page 77876]]
reduced and the preparation of written disclosures would become an
inter-related component of the necessary documentation of the
transaction.
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\89\ See SIFMA Letter II.
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One commenter sought clarification that the proposal would not
apply to private placement agents.\90\ In Response Letter II, the MSRB
responded that while the Notice would not apply to private placement
agents, parties relying on this exception should be cautious in its
application because the term ``private placement'' is often used to
describe transactions that are not recognized as private placements for
purposes of MSRB rules and other applicable law.
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\90\ See SIFMA Letter II.
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IV. Proceedings To Determine Whether To Disapprove SR-MSRB-2011-09 and
Grounds for Disapproval Under Consideration
The Commission is instituting proceedings pursuant to Section
19(b)(2)(B) of the Act \91\ to determine whether the proposed rule
change should be disapproved. Institution of such proceedings appears
appropriate at this time in view of the legal and policy issues raised
by the proposal, as discussed below. Institution of disapproval
proceedings does not indicate that the Commission has reached any
conclusions with respect to any of the issues involved. Rather, as
described in greater detail below, the Commission seeks and encourages
interested persons to comment on the proposed rule change to inform the
Commission's analysis whether to approve or disapprove the proposed
rule change.
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\91\ 15 U.S.C. 78s(b)(2)(B).
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Pursuant to Section 19(b)(2)(B) of the Act, the Commission is
providing notice of the grounds for disapproval under consideration. In
particular, Section 15B(b)(2)(C) of the Act \92\ requires, among other
things, that the rules of the MSRB shall be designed to prevent
fraudulent and manipulative acts and practices, to promote just and
equitable principles of trade, to foster cooperation and coordination
with persons facilitating transactions in municipal securities and
municipal financial products, to remove impediments to and perfect the
mechanism of a free and open market in municipal securities and
municipal financial products, and, in general, to protect investors,
municipal entities, obligated persons, and the public interest.
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\92\ 15 U.S.C. 78o-4(b)(2)(C).
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The MSRB's proposal would interpret the application of MSRB Rule G-
17 applicable to dealers acting in the capacity of underwriters in
negotiated underwritings of municipal securities transactions (except
as specified in the Notice). The Notice would impose disclosures on
underwriters regarding, among other things, their role, compensation
arrangements, conflicts of interest, and representations made to
issuers of municipal securities. Commenters that represent issuers and
financial advisors generally support the proposal and urge additional
disclosures, while commenters that represent dealers and underwriters
believe the proposal should be disapproved or required disclosures be
modified to ease the requirements for dealers. Based on the comments,
the Commission believes that the proposal raises concerns, among other
things, as to whether the disclosures are appropriate and, if so,
whether the disclosures are sufficiently balanced to protect investors
and municipal entities by assisting issuers and their advisors in
evaluating underwriters and the transactions proposed by the
underwriters without being overly burdensome for underwriters.
The Commission believes these concerns raise questions as to
whether the MSRB's proposal is consistent with the requirements of
Section 15B(b)(2)(C) of the Act, including whether the disclosures
outlined in the notice would prevent fraudulent and manipulative acts
and practices, promote just and equitable principles of trade, foster
cooperation and coordination with persons facilitating transactions in
municipal securities and municipal financial products, remove
impediments to and perfect the mechanism of a free and open market in
municipal securities and municipal financial products, and, in general,
protect investors, municipal entities, obligated persons, and the
public interest. The Commission believes the issues raised by the
proposed rule change can benefit from additional consideration and
evaluation in light of the requirements of Section 15B(c)(2)(C) of the
Act.
V. Procedure: Request for Written Comments
The Commission requests that interested persons provide written
submissions of their views, data, and arguments with respect to the
concerns identified above, as well as any others they may have with the
proposal. In particular, the Commission invites the written views of
interested persons concerning whether the proposed rule change is
inconsistent with Section 15B(b)(2)(C) or any other provision of the
Act, or the rules and regulation thereunder. Although there do not
appear to be any issues relevant to approval or disapproval which would
be facilitated by an oral presentation of views, data, and arguments,
the Commission will consider, pursuant to Rule 19b-4, any request for
an opportunity to make an oral presentation.\93\
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\93\ Section 19(b)(2) of the Act, as amended by the Securities
Act Amendments of 1975, Pub. L. 94-29 (June 4, 1975), grants the
Commission flexibility to determine what type of proceeding--either
oral or notice and opportunity for written comments--is appropriate
for consideration of a particular proposal by a self-regulatory
organization. See Securities Act Amendments of 1975, Senate Comm. on
Banking, Housing & Urban Affairs, S. Rep. No. 75, 94th Cong., 1st
Sess. 30 (1975).
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Interested persons are invited to submit written data, views, and
arguments regarding whether the proposed rule change should be
disapproved by January 30, 2012. Any person who wishes to file a
rebuttal to any other person's submission must file that rebuttal by
February 13, 2012. Comments may be submitted by any of the following
methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-MSRB-2011-09 on the subject line.
Paper Comments
Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street NE.,
Washington, DC 20549-1090.
All submissions should refer to File Number SR-MSRB-2011-09. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for Web site viewing and
printing in the Commission's Public Reference Room, 100 F Street NE.,
Washington, DC 20549, on official business days between the hours of 10
a.m. and 3 p.m. Copies of such filing
[[Page 77877]]
also will be available for inspection and copying at the principal
office of the Exchange. All comments received will be posted without
change; the Commission does not edit personal identifying information
from submissions. You should submit only information that you wish to
make available publicly. All submissions should refer to File Number
SR-MSRB-2011-09 and should be submitted on or before January 30, 2012.
Rebuttal comments should be submitted by February 13, 2012.
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\94\
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\94\ 17 CFR 200.30-3(a)(57).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2011-32087 Filed 12-13-11; 8:45 am]
BILLING CODE 8011-01-P