The Municipal Securities Rule Making Board, or MSRB, is requesting comments on a draft rule and two interpretive notices applicable to municipal advisors.
The interpretive notices are based upon the statutory definition of municipal advisor set forth in the Dodd-Frank Act without regard to any interpretation of that term proposed by the SEC in its proposed permanent registration rule for municipal advisors (SEC Release No. 34-63576 (December 20, 2010). If the SEC’s permanent registration rule is adopted in its current form, the MSRB may request comment on revisions to the draft interpretive notice.
Fiduciary Duty of Municipal Advisors
The Dodd-Frank Wall Street Reform and Consumer Protection Act amended Section 15B(c)(1) of the Securities Exchange Act of 1934 to provide that municipal advisors have a fiduciary duty to their municipal entity clients. Section 15B(b)(2)(L)(i) of the Exchange Act directs the MSRB to establish rules with respect to municipal advisors that “prescribe means reasonably designed to prevent acts, practices, and courses of business as are not consistent with a municipal advisor’s fiduciary duty to its clients.”
The MSRB requests comment on draft Rule G-36 and a related draft interpretive notice.
Draft Rule G-36 (on fiduciary duty of municipal advisors) provides:
In the conduct of its municipal activities on behalf of municipal entities, a municipal advisor shall be subject to a fiduciary duty, which shall include a duty of loyalty and a duty of care.
The interpretive notice provides that the Rule G-36 duty of loyalty requires the municipal advisor to deal honestly and in good faith with the municipal entity and to act in the municipal entity’s best interests without regard to financial or other interests of the municipal advisor. It requires a municipal advisor to make clear, written disclosure of all material conflicts of interest, such as those that might impair its ability to satisfy the duty of loyalty, and to receive the written, informed consent of officials of the municipal entity with the authority to bind the municipal entity by contract with the municipal advisor. Such disclosure must be made before the municipal advisor may provide municipal advisory services to the municipal entity or, in the case of conflicts arising after the municipal advisory relationship has commenced, before the municipal advisor may continue to provide such services.
The notice provides that the Rule G-36 duty of care requires that a municipal advisor act competently and provide advice to the municipal entity after inquiry into reasonably feasible alternatives to the financings or products proposed (unless the engagement is of a limited nature).
The MSRB amended Rule G-17, effective December 22, 2010, to make the rule applicable to municipal advisors. Amended Rule G-17 provides:
In 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 draft interpretive notice notes Rule G-17 precludes a municipal advisor from engaging in any deceptive, dishonest, or unfair practice with any person, including a municipal entity or an obligated person. The rule contains an anti-fraud prohibition similar to the standard set forth in Rule 10b-5 adopted by the SEC under the Exchange Act. Thus, a municipal advisor must not misrepresent the facts, risks, or other material information about municipal advisory activities undertaken with a municipal entity or obligated person. However, Rule G-17 does not merely prohibit deceptive conduct on the part of the municipal advisor. It also establishes a general duty of a municipal advisor to deal fairly with all persons (including but not limited to municipal entities and obligated persons), even in the absence of fraud.
According to the draft interpretive notice, a municipal advisor’s duties to its obligated person client under Rule G-17 will vary depending upon whether the municipal advisor has recommended a municipal securities transaction or municipal financial product to its client, or whether it has been asked to review such a transaction or product recommended by another person. If a municipal advisor has recommended such a transaction or product to its client, the advisor must have concluded, in its professional judgment, that the transaction or product is appropriate for the client, given its financial circumstances, objectives, and market conditions, and must advise the client of material risks and characteristics of the structure or product. The municipal advisor must also advise the client of any incentives for the municipal advisor to recommend the transaction or product and any other associated conflicts of interest.
If a municipal advisor has been engaged by its obligated person client to review a municipal securities transaction or municipal financial product recommended by another party (e.g., an underwriter), Rule G-17 requires the municipal advisor to evaluate and advise the client of the material risks and characteristics of the transaction or product and its appropriateness for the client, based on the client’s financial circumstances, objectives, and market conditions. The municipal advisor is not required to have considered then reasonably feasible alternatives unless otherwise requested to do so by the client. Furthermore, the municipal advisor need not advise its client as to the appropriateness of the transaction or product if it has expressly disclaimed that obligation in its engagement letter or other writing with the client.
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