MSRB NOTICE 2011-65 (November 18, 2011)

REMINDER OF UPCOMING EFFECTIVE DATE OF REVISED MSRB RULE G-23 CONCERNING THE ACTIVITIES OF FINANCIAL ADVISORS

The Municipal Securities Rulemaking Board (MSRB) reminds brokers, dealers, municipal securities dealers (“dealers”) and municipal advisors of amendments to MSRB Rule G-23, on activities of financial advisors, which are effective on November 27, 2011.  As previously announced,[1] the Securities and Exchange Commission (“Commission” or “SEC”) on May 27, 2011 approved the MSRB’s proposed rule change[2] to Rule G-23 concerning activities of financial advisors.[3]  The proposed rule change consists of: (i) amendments to Rule G-23 (on activities of financial advisors) and (ii) an interpretive notice concerning Rule G-23, as described below.

In general, Rule G-23 has been amended to prohibit a dealer that serves as financial advisor to an issuer for a particular issue sold on either a negotiated or competitive bid basis from switching roles and underwriting the same issue.  The amendments to Rule G-23 will, subject to the exceptions described below, (i) prohibit a dealer financial advisor with respect to the issuance of municipal securities from acquiring all or any portion of such issue directly or indirectly, from the issuer as principal, or acting as agent for the issuer in arranging the placement of such issue, either alone or as a participant in a syndicate or other similar account formed for that purpose; (ii) apply the same prohibition to any dealer controlling, controlled by, or under common control with the dealer financial advisor; and (iii) prohibit a dealer financial advisor from acting as the remarketing agent for such issue.

The amendments to Rule G-23 will not prohibit: (i) a dealer financial advisor from placing an issuer’s entire issue with another governmental entity, such as a bond bank, as part of a plan of financing by such entity for or on behalf of the dealer financial advisor’s issuer client;[4] (ii) a dealer financial advisor from serving as successor remarketing agent to an issuer for the same issue with respect to which it provided financial advisory services if the financial advisory relationship with the issuer has been terminated for at least one (1) year; or (iii) a dealer financial advisor from purchasing such securities from an underwriter, either for its own trading account or for the account of its customers, except to the extent that such purchase is made to contravene the purpose and intent of the rule.

The amendments to the rule will change references in Rule G-23 from “a new issue or issues of municipal securities” to “the issuance of municipal securities” to conform the language of the rule to the language used in Section 15B of the Securities Exchange Act of 1934, as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act (as amended, the “Act”); however, those changes will not change the meaning or operation of Rule G-23.  Further, the amendments will remove the requirement that financial advisory services be provided for compensation under Rule G-23(b), thereby conforming the rule to the provisions of Section 15B(e)(4) of the Act, which does not require that financial advisors receive compensation in order to be considered “municipal advisors.” A minor change  to Rule G-23(b) will also parallel the language of the interpretive notice (as discussed below) that a dealer acting as an underwriter and not as a financial advisor will not trigger the ban.

The interpretive notice provides that Rule G-23 is solely a conflicts-of-interest rule and does not establish normative standards for dealer conduct.  The notice does not address whether the provision of any of the advice permitted by Rule G-23 would cause the dealer to be considered a “municipal advisor” that is subject to a fiduciary duty under Section 15B(c)(1) of the Act.  It also reiterates what the rule has always provided, that a financial advisory relationship may exist without a writing.

The interpretive notice also provides that, for purposes of Rule G-23, an underwriter may provide advice concerning the structure, timing, terms, and other similar matters concerning an issue of municipal securities that it is underwriting if: (i) it clearly identifies itself in writing as an underwriter and not as a financial advisor from the earliest stages of its relationship with the issuer with respect to that issue (e.g., in a response to a request for proposals or in promotional materials provided to an issuer); (ii) the writing makes clear that the primary role of an underwriter is to purchase securities in an arm’s-length commercial transaction between the issuer and the underwriter and that the underwriter has financial and other interests that differ from those of the issuer; and (iii) the dealer does not engage in a course of conduct that is inconsistent with an arm’s-length relationship with the issuer in connection with such issue of municipal securities.

The interpretive notice further provides that, in addition to engaging in underwriting activities, a dealer that states that it is acting as an underwriter with respect to the issuance of municipal securities may also provide advice on the investment of the proceeds of the issue, municipal derivatives integrally related to the issue, or other similar matters concerning the issue, without being subject to a ban under Rule G-23(d). 

The rule change is effective for new issues for which the Time of Formal Award (as defined in Rule G-34(a)(ii)(C)(1)(a)) occurs after November 27, 2011.

November 18, 2011

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Revised Rule G-23.  Activities of Financial Advisors

(a)        Purpose.  The purpose and intent of this rule is to establish ethical standards and disclosure requirements for brokers, dealers, and municipal securities dealers who act as financial advisors to issuers with respect to the issuance of municipal securities.

(b)        Financial Advisory Relationship.  For purposes of this rule, a financial advisory relationship shall be deemed to exist when a broker, dealer, or municipal securities dealer renders or enters into an agreement to render financial advisory or consultant services to or on behalf of an issuer with respect to the issuance of municipal securities, including advice with respect to the structure, timing, terms and other similar matters concerning such issue.  For purposes of this rule, a financial advisory relationship shall not be deemed to exist when, in the course of acting as an underwriter and not as a financial advisor, a broker, dealer or municipal securities dealer renders advice to an issuer, including advice with respect to the structure, timing, terms and other similar matters concerning the issuance of municipal securities.

(c)        Agreement with Respect to Financial Advisory Relationship.  Each financial advisory relationship shall be evidenced by a writing entered into prior to, upon or promptly after the inception of the financial advisory relationship (or promptly after the creation or selection of the issuer if the issuer does not exist or has not been determined at the time the relationship commences). Such writing shall set forth the basis of compensation, if any, for the financial advisory services to be rendered, including provisions relating to the deposit of funds with or the utilization of fiduciary or agency services offered by such broker, dealer, or municipal securities dealer or by a person controlling, controlled by, or under common control with such broker, dealer, or municipal securities dealer in connection with the rendering of such financial advisory services and shall be delivered to the issuer.

(d)        Prohibition on Engaging in Underwriting Activities.

            (i)         Subject to provisions of subsections (d)(ii) and (iii), no broker, dealer, or municipal securities dealer that has a financial advisory relationship with respect to the issuance of municipal securities shall acquire as principal either alone or as a participant in a syndicate or other similar account formed for the purpose of purchasing, directly or indirectly, from the issuer all or any portion of such issue, or act as agent for the issuer in arranging the placement of such issue.

            (ii)        Notwithstanding subsection (d)(i), a broker, dealer, or municipal securities dealer that has a financial advisory relationship with respect to the issuance of municipal securities shall not be prohibited from acting as agent for the issuer in arranging the placement of the entire issue with any state, local or federal governmental entity as part of a plan of financing by such entity for or on behalf of the issuer, but only if such broker, dealer or municipal securities dealer does not receive compensation from any person other than with respect to financial advisory services related to such placement and does not receive compensation from any person for underwriting any contemporaneous financing transaction directly or indirectly related to such issue undertaken by the state, local, or federal governmental entity with which such issue was placed.

            (iii)       The limitations set forth in this section (d) shall also apply to any broker, dealer, or municipal securities dealer controlling, controlled by, or under common control with the broker, dealer, or municipal securities dealer having a financial advisory relationship with respect to the issuance of municipal securities.  The use of the term "indirectly" in this section (d) shall not preclude a broker, dealer, or municipal securities dealer that has a financial advisory relationship with respect to the issuance of municipal securities from purchasing such securities from an underwriter, either for its own trading account or for the account of customers, except to the extent that such purchase is made to contravene the purpose and intent of this rule.

(e)        Remarketing Activities.  No broker, dealer, or municipal securities dealer that has a financial advisory relationship with an issuer with respect to the issuance of municipal securities shall act as the remarketing agent for such issue; provided, however, that this section shall not prohibit such broker, dealer, or municipal securities dealer from thereafter serving as successor remarketing agent for such issue if the financial advisory relationship in connection with such issue has been terminated for a period of at least one (1) year prior to such broker, dealer, or municipal securities dealer being selected to serve as successor remarketing agent.

(f)        Applicability of State or Local Law.  Nothing contained in this rule shall be deemed to supersede any more restrictive provision of state or local law applicable to the activities of financial advisors.

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Guidance on the Prohibition on Underwriting Issues of Municipal Securities for Which a Financial Advisory Relationship Exists Under Rule G-23

MSRB Rule G-23 establishes certain basic requirements applicable to a broker, dealer, or municipal securities dealer (“dealer”) acting as a financial advisor with respect to the issuance of municipal securities.  MSRB Rule G-23(d) provides that a dealer that has a financial advisory relationship with respect to the issuance of municipal securities is precluded from acquiring all or any portion of such issue, directly or indirectly, from the issuer as principal, either alone or as a participant in a syndicate or other similar account formed for that purpose.  A dealer is also precluded from arranging the placement of an issue with respect to which it has a financial advisory relationship.  This notice refers to both of these activities as “underwritings” and provides interpretive guidance on when a dealer may be precluded by Rule G-23(d) from underwriting an issue of municipal securities due to having served as financial advisor with respect to that issue.  Rule G-23 is solely a conflicts rule.  Accordingly, this notice does not address whether provision of the advice permitted by Rule G-23 would cause the dealer to be considered a “municipal advisor” under the Exchange Act and the rules promulgated thereunder.

Rule G-23(b) provides, among other things, that a financial advisory relationship shall be deemed to exist for purposes of Rule G-23 when a dealer renders or enters into an agreement to provide financial advisory or consultant services to or on behalf of an issuer with respect to the issuance of municipal securities, including advice with respect to the structure, timing, terms, and other similar matters concerning such issue or issues.  Rule G-23(b) also provides, however, that a financial advisory relationship shall not be deemed to exist when, in the course of acting as an underwriter and not as a financial advisor, a dealer provides advice to an issuer, including advice with respect to the structure, timing, terms, and other similar matters concerning the issuance of municipal securities.

Although Rule G-23(c) requires a financial advisory relationship to be evidenced by a writing, a financial advisory relationship will be deemed to exist whenever a dealer renders the types of advice provided for in Rule G-23(b), regardless of the existence of a written agreement.  However, a dealer that clearly identifies itself in writing as an underwriter and not as a financial advisor from the earliest stages of its relationship with the issuer with respect to that issue (e.g., in a response to a request for proposals or in promotional materials provided to an issuer) will be considered to be “acting as an underwriter” under Rule G-23(b) with respect to that issue.  The writing must make clear that the primary role of an underwriter is to purchase, or arrange for the placement of, securities in an arm’s-length commercial transaction between the issuer and the underwriter and that the underwriter has financial and other interests that differ from those of the issuer.  The dealer must not engage in a course of conduct that is inconsistent with an arm’s-length relationship with the issuer in connection with such issue of municipal securities or the dealer will be deemed to be a financial advisor with respect to that issue and precluded from underwriting that issue by Rule G-23(d).  Thus, a dealer providing advice to an issuer with respect to the issuance of municipal securities (including the structure, timing, and terms of the issue and other similar matters, when integrally related to the issue being underwritten) will not be viewed as a financial advisor for purposes of Rule G-23, if such advice is rendered in its capacity as underwriter for such issue.  In addition to engaging in underwriting activities, it shall not be a violation of Rule G-23(d) for a dealer that states that it is acting as an underwriter with respect to the issuance of municipal securities to provide advice with respect to the investment of the proceeds of the issue, municipal derivatives integrally related to the issue, or other similar matters concerning the issue.


[1] See MSRB Notice 2011-29 (May 31, 2011).

[2] The proposed rule change was originally filed with the SEC on February 9, 2011 (See File No. SR-MSRB-2011-03 (February 9, 2011)).  An amendment to the proposed rule change was filed on May 26, 2011 (See Amendment No. 1 to SR-MSRB-2011-03 (May 26, 2011) (“Amendment”)).  The text of the proposed rule change as amended may be found in MSRB Notice 2011-29 (May 31, 2011).

[3] See Securities Exchange Act Release No. 34-64564 May 27, 2011 (File No. SR-MSRB-2011-03).

[4] The exception will only apply if the dealer financial advisor does not receive compensation for the placement of such issue and the dealer financial advisor is not compensated as an underwriter in connection with any related transaction undertaken by the governmental entity with which such issue is placed.