Securities and Exchange Commission Approves Amendments to MSRB Rule G-23 Relating to the Activities of Financial Advisors

On May 27, 2011, the Securities and Exchange Commission (“Commission” or “SEC”) approved the Municipal Securities Rulemaking Board’s (“MSRB”) proposed rule change[1] to Rule G-23 concerning activities of financial advisors.[2]  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 set forth below.

In general, Rule G-23 has been amended to prohibit a broker, dealer, or municipal securities dealer (“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;[3] (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 also 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.

May 31, 2011

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TEXT OF AMENDMENT TO RULE G-23[4]

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 a new issue or issues the issuance of municipal securities, including advice with respect to the structure, timing, terms and other similar matters concerning such issue or issues issue. for a fee or other compensation or in expectation of such compensation for the rendering of such services. Notwithstanding the foregoing 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 a new issue the issuance of municipal securities.

(c)        Basis of Compensation 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), Nno broker, dealer, or municipal securities dealer that has a financial advisory relationship with respect to a new issue 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. ,unless if such issue is to be sold by the issuer on a negotiated basis,

                        (A) the financial advisory relationship with respect to such issue has been terminated in writing and at or after such termination the issuer has expressly consented in writing to such acquisition or participation, as principal or agent, in the purchase of the securities on a negotiated basis;

                        (B) the broker, dealer, or municipal securities dealer has expressly disclosed in writing to the issuer at or before such termination that there may be a conflict of interest in changing from the capacity of financial advisor to purchaser of or placement agent for the securities with respect to which the financial advisory relationship exists and the issuer has expressly acknowledged in writing to the broker, dealer, or municipal securities dealer receipt of such disclosure; and

                        (C) the broker, dealer, or municipal securities dealer has expressly disclosed in writing to the issuer at or before such termination the source and anticipated amount of all remuneration to the broker, dealer, or municipal securities dealer with respect to such issue in addition to the compensation referred to in section (c) of this rule, and the issuer has expressly acknowledged in writing to the broker, dealer, or municipal securities dealer receipt of such disclosure; or

            (ii)        if such issue is to be sold by the issuer at competitive bid, the issuer has expressly consented in writing prior to the bid to such acquisition or participation.   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 and requirements 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 who has a financial advisory relationship with respect to a new issue the issuance 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 a new issue 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. ,unless the broker, dealer, or municipal securities dealer has expressly disclosed in writing to the issuer:

            (i) that there may be a conflict of interest in acting as both financial advisor and remarketing agent for the securities with respect to which the financial advisory relationship exists; and

            (ii) the source and basis of the remuneration the broker, dealer or municipal securities dealer could earn as remarketing agent on such issue.

            This written disclosure to the issuer may be included either in a separate writing provided to the issuer prior to the execution of the remarketing agreement or in the remarketing agreement. The issuer must expressly acknowledge in writing to the broker, dealer, or municipal securities dealer receipt of such disclosure and consent to the financial advisor acting in both capacities and to the source and basis of the remuneration.

(f)        Disclosure to Issuer of Corporate Affiliation. If the financial advisor for the issue is not a broker, dealer or municipal securities dealer, and the broker, dealer or municipal securities dealer that acquires the issue or arranges for such acquisition pursuant to section (d) of this rule is controlling, controlled by, or under common control with such financial advisor, the broker, dealer or municipal securities dealer must disclose this affiliation in writing to the issuer prior to the acquisition and the issuer has expressly acknowledged in writing to the broker, dealer, or municipal securities dealer receipts of such disclosure.

(g)        Each broker, dealer, and municipal securities dealer subject to the provisions of sections (d), (e) or (f) of this rule shall maintain a copy of the written disclosures, acknowledgments and consents required by these sections in a separate file and in accordance with the provisions of rule G-9.

(h)        Disclosure to Customers. If a broker, dealer, or municipal securities dealer acquires new issue municipal securities or participates in a syndicate or other account that acquires new issue municipal securities in accordance with section (d) of this rule, such broker, dealer, or municipal securities dealer shall disclose the existence of the financial advisory relationship in writing to each customer who purchases such securities from such broker, dealer, or municipal securities dealer, at or before the completion of the transaction with the customer.

(i)         (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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TEXT OF INTERPRETIVE NOTICE

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.

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