MSRB Files Interpretive Notice Concerning the Application of MSRB Rule G-17 to Municipal Advisors Advising Obligated Persons or Soliciting Municipal Entities on Behalf of Others

On August 24, 2011, the Municipal Securities Rulemaking Board (“Board” or “MSRB”) filed with the Securities and Exchange Commission (“SEC”) a proposed rule change consisting of a proposed interpretive notice (the “Notice”) concerning the application of MSRB Rule G-17  to municipal advisors advising obligated persons or soliciting municipal entities on behalf of others.[1]  The MSRB requested that the proposed rule change be made effective on the date that rules defining the term “municipal advisor” under the Securities Exchange Act of 1934 (the “Exchange Act”) are first made effective by the SEC or such later date as the proposed rule change is approved by the SEC.

BACKGROUND

With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act,[2]  the MSRB was expressly directed by Congress to protect municipal entities and obligated persons.  Accordingly, the MSRB is proposing to provide interpretive guidance that addresses how Rule G-17 applies to municipal advisors when advising obligated person clients or when soliciting municipal entities on behalf of others.

SUMMARY OF PROPOSED RULE CHANGE

Duty to Obligated Persons; Fair Dealing.  The Notice would provide that the Rule G-17 duty of fair dealing requires that the municipal advisor determine if a recommended municipal securities transaction or municipal financial product is suitable for its obligated person client, and that it provide disclosure of the material risks and characteristics of the transaction or product, as well as any incentives the municipal advisor has received for recommending the transaction or product and any other associated conflicts of interest. Further, under the Notice, the Rule G-17 duty of fair dealing would require that the municipal advisor exercise due care when providing advice to the obligated person client, and not undertake an engagement if the municipal advisor does not have the necessary skills and resources to perform its duties in respect of the engagement.

The Notice also would provide that the municipal advisor must disclose all material conflicts of interest such as those that may color its judgment and impair its ability to render unbiased advice to its obligated person client, including those existing at the time the engagement is entered into, and those discovered or arising during the course of the engagement. The municipal advisor would be required to make these disclosures in writing and, in general, to obtain the informed consent thereto by an official of the obligated person having the authority to bind the obligated person by contract with the municipal advisor.  Conflicts that constituted an unfair, deceptive, or dishonest practice would preclude a municipal advisor from undertaking an engagement with an obligated person client and disclosure of such conflict would not be effective in permitting such engagement to be undertaken.

The Notice would provide that a municipal advisor is required to provide written disclosure of the amount of its direct compensation and indirect compensation (e.g., amounts paid to affiliates) from the engagement, and the scope of services to be provided.  The municipal advisor would also be required to provide written disclosure of the conflicts of interest associated with various forms of compensation, including the form of compensation applicable to its engagement, unless the obligated person client has required a particular form of compensation, in which case such disclosure would only need to address that particular form of compensation.

Deceptive, Dishonest or Unfair Practices.  The Notice would provide that all representations made by municipal advisors to their obligated person clients, whether written or oral, must be truthful and accurate, and municipal advisors must not omit material facts, and that matters not within the personal knowledge of those preparing the response (e.g., pending litigation) must be confirmed by those with knowledge of the subject matter.  A municipal advisor would not be permitted to represent that it has the requisite knowledge or expertise with respect to a particular type of transaction or product if the personnel that it intends to work on the engagement do not have the requisite knowledge or expertise.

The Notice would provide that in certain cases and depending upon the specific facts and circumstances of the engagement, a municipal advisor’s compensation, including payments from third parties, may be so disproportionate to the nature of the municipal advisory services to be an unfair practice in violation of Rule G-17.

The Notice would also provide that kickback arrangements, and certain fee-splitting arrangements, with underwriters or the providers of investments or services to obligated persons are unfair, dishonest, and deceptive practices that are prohibited by Rule G-17, as are payments by municipal advisors made for the purpose of obtaining or retaining municipal advisory business, other than reasonable fees paid to a municipal advisor regulated by the MSRB.

Solicitation of a Municipal Entity; Fair Dealing.  The Notice would provide that, while municipal advisors are not required to exercise a fiduciary duty when soliciting municipal entities on behalf of third parties (in such capacity, a “solicitor”), they are required to deal fairly with the municipal entities they solicit and not engage in conduct that is deceptive, dishonest, or unfair.

The Notice would provide that a solicitor must provide written disclosure of all material facts about the solicitation to the municipal entity being solicited, including, among other things, the amount and source of all compensation received by the solicitor, any payments (including in-kind) made by the solicitor to facilitate the solicitation regardless of characterization; and any relationships of the solicitor with any employees, board members, or affiliated persons of the municipal entity or its officials who may have influence over the selection of the solicitor’s client.

The Notice would provide that the solicitor, if engaged by its client to present information to the municipal entity about a product or service being offered by the client, is required to disclose all material risks and characteristics of the product or service, as well as any incentives received by the solicitor (other than compensation from its client) to recommend the product or service, and any other conflicts of interest regarding the product or service.

Deceptive, Dishonest or Unfair Practices.  The Notice would provide that kickbacks and fee-splitting arrangements with others, made or entered into by solicitors for the purpose of facilitating the solicitation are unfair, dishonest, and deceptive practices that violate Rule G-17.  The Notice would also provide that lavish gifts and gratuities (that exceed limits set forth in MSRB Rule G-20) made to officials of the municipal entity or affiliated parties may improperly influence the decision of the municipal entity to engage the solicitor’s client, and may therefore be a violation of Rule G-17.

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Questions about this notice should be directed to Peg Henry, General Counsel, Market Regulation, or Karen Du Brul, Associate General Counsel, at 703-797-6600.

August 24, 2011

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TEXT OF PROPOSED RULE CHANGE

INTERPRETIVE NOTICE CONCERNING THE APPLICATION OF MSRB RULE G-17 TO MUNICIPAL ADVISORS ADVISING OBLIGATED PERSONS OR SOLICITING MUNICIPAL ENTITIES ON BEHALF OF OTHERS

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”)[1] amended Section 15B of the Securities Exchange Act of 1934 (the “Exchange Act”) to provide for the regulation of municipal advisors[2]by the Municipal Securities Rulemaking Board (“MSRB”) and to direct the MSRB expressly to protect municipal entities and obligated persons.  Among other things, the MSRB was directed to adopt rules that are

designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and 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 . . . .[3]

Accordingly, the MSRB amended its Rule G-17 to provide: “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.”[4]  This notice provides guidance on a municipal advisor’s duties under Rule G-17 when providing municipal advisory services to an obligated person[5] and a municipal advisor’s duties to a municipal entity when undertaking a solicitation of a municipal entity on behalf of another person.[6]  The examples discussed in this notice are illustrative only, and are not meant to encompass all obligations of municipal advisors under Rule G-17.

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.  Thus, a municipal advisor must not misrepresent or omit 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.  Even so, unlike a municipal advisor’s duty to its municipal entity client, neither the Dodd-Frank Act, nor Rule G-17 requires a municipal advisor to exercise a fiduciary duty when advising an obligated person, unless that obligated person is itself a municipal entity.[7]

DUTY TO OBLIGATED PERSONS

FAIR DEALING

Suitability and Risk Disclosure.   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 reasonable grounds for believing that the transaction or product is suitable for the client, based on the client’s financial circumstances, objectives, tax status,[8] and any other material information known by the municipal advisor about the client and the transaction or product, after reasonable inquiry.

If a municipal advisor has recommended a transaction or product to its client, the advisor must advise the client of the material risks and characteristics of the structure or product. Such disclosure must be sufficient to allow the obligated person to assess the magnitude of its potential exposure as a result of the transaction 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 in the manner described herein under “Fair Dealing/Disclosure of Conflicts.”[9]  For example, a municipal advisor that recommends that an obligated person enter into a variable rate demand obligation financing must inform the obligated person of the risk of interest rate fluctuations and the material terms of any associated credit or liquidity facilities (e.g., the risk that the obligated person 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).  Similarly, a municipal advisor that recommends that an obligated person enter into a municipal derivative contract must disclose the material risks (including market, credit, operational, and liquidity risks) and characteristics of the derivative.

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 to further advise the client as to whether the advisor has reasonable grounds for believing that the transaction or product recommended by another party is suitable for the client, based on the client’s financial circumstances, objectives, tax status, and any other material information known by the municipal advisor about the client and the transaction or product.  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 suitability of a transaction or product recommended by another party if it has expressly disclaimed that obligation in its engagement letter or other writing with the client.

Due Care.  In all cases, the municipal advisor’s Rule G-17 duty to deal fairly requires it to exercise due care in the provision of advice to its obligated person client, which requires that the municipal advisor possess the necessary capacity, resources, and knowledge to render informed advice.  A municipal advisor must not undertake a swap advisory engagement or security-based swap advisory engagement unless it has sufficient knowledge to evaluate the transaction and its risks, as well as the pricing and the appropriateness of the transaction.[10]  The municipal advisor must also have a reasonable basis for any representations it makes in any certificate it signs that will be relied upon by other parties to the transaction.  A municipal advisor’s obligation to act with due care does not make the municipal advisor a guarantor of a successful financing or a guarantor that there are no facts material to its client’s decision-making process other than the ones known by the municipal advisor and disclosed to the client.

Disclosure of Conflicts.  The municipal advisor’s Rule G-17 duty to deal fairly with an obligated person client requires the municipal advisor to disclose material conflicts of interest, such as those that may color its judgment and impair its ability to render unbiased advice to its client.  Such conflicts of interest include those existing at the time the engagement is entered into, and those discovered or arising during the course of the engagement.  All disclosures of conflicts, including those discovered or arising during the course of the engagement, must be made in writing to an official of the obligated person that the municipal advisor reasonably believes has the authority to bind the obligated person by contract with the municipal advisor.  Such disclosures must be made in a manner sufficiently detailed to inform the obligated person of the nature and implications of the conflict.  The following are examples of the types of conflicts that must be disclosed by the municipal advisor, but this list is not intended to be exhaustive:

(i) payments by municipal advisors made for the purpose of obtaining or retaining municipal advisory business;

(ii) payments from third parties to the municipal advisor in relation to the municipal advisory engagement;

(iii) payments from third parties to enlist the municipal advisor’s recommendation of their services to the obligated person;

(iv) whether the municipal advisor or an affiliate of the municipal advisor is acting as a principal in matters concerning the municipal advisory engagement;

(v) the form of compensation for the municipal advisory engagement; and

(vi) other engagements or relationships that might impair the municipal advisor’s ability to provide unbiased advice to its obligated person client.

Failure to disclose conflicts of interest has resulted in various SEC enforcement actions and administrative proceedings for, among other things, violations of Rule G-17 by dealer financial advisors.[11]  If a conflict is so significant that it is described in this notice as an unfair, deceptive, or dishonest practice, such conflict would preclude a municipal advisor from undertaking an engagement with an obligated person client and disclosure of such conflict would not be effective in permitting such engagement to be undertaken.

Informed Consent.  In addition to its duty to disclose various conflicts, Rule G-17 also requires the municipal advisor to obtain informed consent from its obligated person client to each of the conflicts disclosed.  The municipal advisor must receive written consent to its conflicts by an official of the obligated person that the municipal advisor reasonably believes has the authority to bind the obligated person by contract with the municipal advisor before the municipal advisory engagement begins or, in the case of conflicts discovered or arising after the municipal advisory engagement has begun, before the municipal advisor may continue to provide such services.  For purposes of Rule G-17, an obligated person client will be deemed to have consented to conflicts that are clearly described in its engagement letter or other written contract with the municipal advisor, if the obligated person client expressly acknowledges the existence of such conflicts.  If the official of the obligated person client agrees to proceed with the municipal advisory engagement after receipt of the conflicts disclosure but will not provide written acknowledgement of such conflicts, the municipal advisor may proceed with the engagement after documenting with specificity why it was unable to obtain such written acknowledgement.

Disclosure of conflicts, coupled with written consent, will not satisfy the requirements of Rule G-17 in instances in which the municipal advisor has reason to believe that such consent is not informed.  In such cases, a municipal advisor must make additional efforts reasonably designed to inform the officials of the obligated person client of the nature and implications of the municipal advisor’s conflicts.  Additionally, disclosures to an official of the obligated person who is a party to the conflict of interest (such as recipients of payments from municipal advisors) will not satisfy the requirements of Rule G-17.

Forms of Compensation.  The manner in which municipal advisors are compensated varies according to the nature of the engagement and the requirements of the obligated person client, among other factors.  Pursuant to Rule G-17, a municipal advisor must provide written disclosure to its obligated person client of what the amount (in dollars and to the extent it can be quantified) of its direct compensation and indirect compensation (e.g., amounts paid to affiliates) from the engagement will be, or is projected to be, as well as the scope of services to be provided for that compensation.  Additionally, except as provided below, the municipal advisor must provide written disclosure to its client of the conflicts of interest associated with various forms of compensation, including the form of compensation applicable to its engagement.  One way in which a municipal advisor may satisfy its obligation to provide written disclosure of the conflicts with various forms of compensation is to provide its client with the document entitled “Disclosure of Conflicts of Interest With Various Forms of Compensation,” attached as Appendix A to this notice (the “Compensation Disclosure Document”).  The disclosures described in this paragraph must be provided as described above under “DUTY TO OBLIGATED PERSONS/FAIR DEALING/Disclosure of Conflicts.”  Provision by the municipal advisor to its client of the Compensation Disclosure Document will not satisfy the municipal advisor’s obligation to disclose conflicts of interest not addressed in the Compensation Disclosure Document, such as payments from third parties.  Notwithstanding the foregoing, if the obligated person client has required that a particular form of compensation be used, the compensation conflicts disclosure provided by the municipal advisor need only address that particular form of compensation.

DECEPTIVE, DISHONEST, OR UNFAIR PRACTICES

Misrepresentations.  Rule G-17 requires that all representations made by municipal advisors to their obligated person clients, whether written or oral, must be truthful and accurate, and municipal advisors must not omit material facts.  For example, a municipal advisor’s response to an obligated person’s request for proposals or qualifications must fairly and accurately describe the municipal advisor’s capacity, resources, and knowledge to perform the proposed municipal advisory engagement 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 municipal advisor knows or should know to be inaccurate or misleading.  Matters not within the personal knowledge of those preparing the response (e.g., pending litigation) must be confirmed by those with knowledge of the subject matter.  A municipal advisor may not represent that it has the requisite knowledge or expertise with respect to a particular type of transaction or product if the personnel that it intends to work on the engagement do not have the requisite knowledge or expertise.

Excessive Compensation.   The MSRB recognizes that what is considered reasonable compensation for a municipal advisor will vary according to the municipal advisor’s expertise, the complexity of the financing, whether the fee is contingent upon the closing of the transaction, and the length of time spent on the engagement, among other factors.  However, in certain cases and depending upon the specific facts and circumstances of the engagement, a municipal advisor’s compensation may be so disproportionate to the nature of the municipal advisory services performed as to indicate that the municipal advisor is engaging in an unfair practice in violation of Rule G-17.[12]  Payments from third parties are included in determining whether compensation is excessive.  Furthermore, the MSRB notes that municipal advisors subject to hourly billing arrangements must not submit bills that do not accurately reflect the nature of the services performed and the personnel performing them.

Kickbacks and Other Payments.  Kickback arrangements, or certain fee-splitting arrangements, with underwriters or the providers of investments or services to obligated persons also represent unfair, dishonest, and deceptive practices that are prohibited by Rule G-17,[13] as do payments by municipal advisors made for the purpose of obtaining or retaining municipal advisory business other than reasonable fees paid to a municipal advisor described in Section 15B(e)(9) of the Exchange Act.[14]

SOLICITATION OF A MUNICIPAL ENTITY

While the Dodd-Frank Act imposes a fiduciary obligation on municipal advisors acting on behalf of their municipal entity clients, municipal advisors are not required to exercise a fiduciary duty when soliciting municipal entities on behalf of unrelated third parties (in such capacity, a “solicitor”).  Solicitors are, however, subject to Rule G-17, and are required to deal fairly with the municipal entities they solicit and not engage in conduct that is deceptive, dishonest, or unfair.

FAIR DEALING

Disclosure of Material Facts about Solicitation.  Under its Rule G-17 duty to deal fairly, a solicitor must provide written disclosure of all material facts about the solicitation to the municipal entity being solicited, including:

(i) the name of the solicitor’s client;

(ii) the type of business being solicited;

(iii) the amount of the solicitor’s compensation;

(iv) the source of all compensation received by the solicitor;

(v) payments (including in-kind) made by the solicitor to facilitate the solicitation regardless of characterization; and

(vi) any relationships of the solicitor with any employees or board members of the municipal entity or any other persons affiliated with the municipal entity or its officials who may have influence over the selection of the solicitor’s client.

Material Information about Products or Services.  In addition to the disclosure obligations described above, if the solicitor has been engaged by its client to present information to the municipal entity about a product or service being offered by the client, the solicitor is required to disclose all material risks and characteristics of the product or service. The solicitor must also advise the municipal entity of any incentives received by the solicitor (other than compensation from its client) to recommend the product or service, as well as any other associated conflicts of interest regarding the product or service, and must not make material misstatements or omissions when discussing the product or service.

DECEPTIVE, DISHONEST, OR UNFAIR PRACTICES

Kickbacks and Other Payments.  Kickbacks, or fee-splitting arrangements with others, made or entered into by solicitors for the purpose of facilitating the solicitation represent unfair, dishonest, and deceptive practices that violate Rule G-17.  Persons and firms arranging, making and receiving such payments have been the subject of various enforcement actions by both the SEC and various state authorities.[15]

Lavish Gifts and Gratuities.  Lavish gifts and gratuities made to officials of the municipal entity or affiliated parties may improperly influence the decision of the municipal entity to engage the solicitor’s client.  Generally, a gift will be considered lavish if its value exceeds the limits imposed by MSRB Rule G-20 (on gifts).  Government officials controlling the award of public pension fund business have been found to violate federal and state securities laws by the acceptance of such gifts,[16]as have those making the gifts.[17]

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[1] Pub. Law. No. 111-203, 124 Stat. 1376 (2010).

[2] The term “municipal advisor” is defined in Section 15B(e)(4) of the Exchange Act and the rules and regulations promulgated thereunder.

[3] Section 15B(b)(2)(C) of the Exchange Act.

[4] Exchange Act Release No. 63599; File No. SR-MSRB-2010-16 (December 22, 2010).

[5] The term “obligated person” is defined in Section 15B(e)(10) of the Exchange Act to mean

any person, including an issuer of municipal securities, who is either generally or through an enterprise, fund, or account of such person, committed by contract or other arrangement to support the payment of all or part of the obligations on the municipal securities to be sold in an offering of municipal securities.

[6] Section 15B(e)(9) of the Exchange Act provides that,

the term “solicitation of a municipal entity or obligated person” means a direct or indirect communication with a municipal entity or obligated person made by a person, for direct or indirect compensation, on behalf of a broker, dealer, municipal securities dealer, municipal advisor, or investment adviser (as defined in section 202 of the Investment Advisers Act of 1940) that does not control, is not controlled by, or is not under common control with the person undertaking such solicitation for the purpose of obtaining or retaining an engagement by a municipal entity or obligated person of a broker, dealer, municipal securities dealer, or municipal advisor for or in connection with municipal financial products, the issuance of municipal securities, or of an investment adviser to provide investment advisory services to or on behalf of a municipal entity.

[7] See Section 15B(c)(1) of the Exchange Act.  State laws may, however, impose a fiduciary duty on a municipal advisor when providing advice to an obligated person client.  For purposes of this notice, the client of the municipal advisor will be presumed not to be a municipal entity.  Although a municipal advisor advising an obligated person does not have a fiduciary duty to the municipal entity that is the conduit issuer for the obligated person (but is not the client of the advisor), it still has a fair dealing duty to the municipal entity.

[8] For example, an obligated person that is exempt from tax under Section 501(c)(3) of the Internal Revenue Code of 1986, as amended, is subject to private inurement limitations that may affect how a transaction may be structured.  A municipal advisor’s obligation to consider an obligated person client’s tax status in making a suitability determination does not carry with it an obligation to provide tax advice to the client.

[9] For example, a conflict of interest may exist when the municipal advisor receives compensation from a swap provider for recommending the swap provider to the obligated person.

[10] Section 4s(h)(5) of the Commodity Exchange Act requires that a swap dealer with a special entity client (including states, local governments, and public pension funds) must have a reasonable basis to believe that the special entity has an independent representative that satisfies these criteria, among others.  Section 15F(h)(5) of the Exchange Act imposes the same requirements with respect to security-based swaps.

[11] See, e.g., In the Matter of Lazard Freres and Merrill Lynch, SEC Release No. 34-36419 (Oct. 26, 1995) (settlement in connection with alleged violation of Rule G-17 due to failure of underwriter and financial advisor to disclose payments made by underwriter to financial advisor); In re Wheat, First Securities, Inc., SEC Initial Dec. Release No. 155 (Dec. 17, 1999) (administrative law judge found violation of Rule G-17 by financial advisor for making false disclosure to municipal entity that it had not employed a lobbyist to secure its advisory contract with the county and that it had not entered into an arrangement with a third party to make payments contingent upon its securing the advisory contract); In re Pryor, McClendon, Counts & Co., Inc. et al., Exchange Act Release No. 48095 (Jun. 26, 2003) (settlement in connection with alleged violation of Rule G-17 for financial advisor’s failure to disclose payment to government official made to secure advisory assignment).

[12] See, e.g., the following cases for examples of excessive compensation arrangements: In re O’Brien Partners, Inc., Exchange Act Release No. 7594 (Oct. 27, 1998) (settlement in connection with investment adviser allegedly received “referral fees” from a finder that assisted in the reinvestment of municipal bond proceeds in guaranteed investment contracts, repurchase agreements and forwards; referral fees allegedly totaled $450,000 and represented 50-60% of finder commission); In the Matter of Mark S. Ferber, Exchange Act Release No. 38102 (Dec. 31, 1996) (settlement in connection with financial advisor allegedly received payments from broker-dealer totaling almost $6 million over two years in exchange for recommendations that his clients select that broker-dealer as underwriter or provider of other financial services, including interest rate swaps); In the Matter of Arthurs Lestrange & Co., Inc. and Michael Bova, SEC Release Nos. 33-7775, 34-42148 (Nov. 17, 1999) (settlement in connection with financial advisor allegedly engaged in fee splitting arrangement under which financial advisor contributed its financial advisory fee of $210,000 to pool of advisory and brokerage service compensation, received $1.5 million from the investment broker, and paid $500,000 to a finder); In the Matter of William R. Hough & Co., SEC Release Nos. 33-7826, 34-42632 (Apr. 6, 2000) (settlement in connection with financial advisor allegedly received $35,000 for its financial advisory services and $400,000 from the investment provider; financial advisor allegedly received $300,000 from a forward supply contract provider for “developing a forward supply assignment program”);  In the Matter of John S. Reger and Business & Financial Advisors, Inc., SEC Release No. 33-7973 (Apr. 23, 2001) (settlement in connection with financial advisor allegedly received $129,000 kickback from escrow securities provider, representing 40% of escrow provider’s profit).

[13] Id.  Rule G-17 does not preclude a municipal advisor from receiving payment for its municipal advisory services from a third party, as long as the municipal advisor discloses, and the obligated person client provides its informed written consent to, such payment arrangement and the amount of such payment.  As with the disclosure of other conflicts of interest, such disclosure must be made before the municipal advisory engagement is entered into, or at the time the conflict arises, if later.

[14] See the cases at note 12, supra.  Municipal advisors that are described in Section 15B(e)(9) of the Exchange Act because they solicit business from municipal entities on behalf of other municipal advisors are subject to all MSRB rules for municipal advisors.

[15] See, e.g., SEC v. Steven L. Rattner, SEC Lit. Release No. 21748 (November 18, 2010) (SEC alleged that defendant violated Section 17(a)(2) of the Securities Act of 1933 by securing investments in his private equity firm from a state retirement fund after he arranged for a firm affiliate to distribute a movie produced by the retirement fund’s chief investment officer and his brothers; defendant then allegedly caused his firm to retain an advisor and fundraiser for a former state comptroller as a “placement agent” and pay him more than $1 million in sham fees even though the defendant was already dealing directly with the state deputy comptroller and did not need an introduction to the retirement fund); SEC v. Henry Morris, et al., SEC Lit. Release Nos. 20963, 21001, 21018 and 21036 (filed March 19, 2009, April 15, 2009, April 30, 2009 and May 12, 2009, respectively) (SEC alleged that defendants and others required investment managers seeking to do business with the state retirement fund to make payments to unrelated finders and placement agents who then made payments or other benefits as directed by state officials);  see also Allocution to Violation of New York State’s Martin Act by Henry Morris, https://ag.ny.gov/media_center/2010/nov/Exhibit_A_ocr.pdf.

[16] Allocution to Violation of New York State’s Martin Act by Alan G. Hevesi, http://www.ag.ny.gov/media_center/2010/oct/pdfs/Hevesi_Allocution.pdf (state comptroller who controlled investment decisions of state retirement fund accepted paid vacation for himself and his family paid for by official of private equity fund soliciting business from the retirement fund).

[17] Announcement of Plea Agreement of Elliott Broidy with New York State Attorney General, http://www.ag.ny.gov/media_center/2009/dec/dec3b_09.html (plea to violation of New York State Martin Act by defendant for his involvement in a pay to play kickback scheme at the state comptroller office in connection with the state retirement fund’s investment in a fund operated by defendant’s firm; defendant paid at least $75,000 for first class airfare, luxury hotel suites, a car and driver, a helicopter tour, and security detail on vacation trips for high ranking official of the state retirement fund and concealed those payments through charities and false invoices).

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APPENDIX A  

DISCLOSURE OF CONFLICTS OF INTEREST WITH VARIOUS FORMS OF COMPENSATION

The Municipal Securities Rulemaking Board requires us, as your municipal advisor, to provide written disclosure to you about the actual or potential conflicts of interest presented by various forms of compensation.  We must provide this disclosure unless you have required that a particular form of compensation be used.  You should select a form of compensation that best meets your needs and the agreed upon scope of services.

Forms of compensation; potential conflicts.   The forms of compensation for municipal advisors vary according to the nature of the engagement and requirements of the client, among other factors. Various forms of compensation present actual or potential conflicts of interest because they may create an incentive for an advisor to recommend one course of action over another if it is more beneficial to the advisor to do so.  This document discusses various forms of compensation and the timing of payments to the advisor.

Fixed fee.  Under a fixed fee form of compensation, the municipal advisor is paid a fixed amount established at the outset of the transaction. The amount is usually based upon an analysis by the client and the advisor of, among other things, the expected duration and complexity of the transaction and the agreed-upon scope of work that the advisor will perform.  This form of compensation presents a potential conflict of interest because, if the transaction requires more work than originally contemplated, the advisor may suffer a loss. Thus, the advisor may recommend less time-consuming alternatives, or fail to do a thorough analysis of alternatives.  There may be additional conflicts of interest if the municipal advisor’s fee is contingent upon the successful completion of a financing, as described below.

Hourly fee.  Under an hourly fee form of compensation, the municipal advisor is paid an amount equal to the number of hours worked by the advisor times an agreed-upon hourly billing rate.  This form of compensation presents a potential conflict of interest if the client and the advisor do not agree on a reasonable maximum amount at the outset of the engagement, because the advisor does not have a financial incentive to recommend alternatives that would result in fewer hours worked.  In some cases, an hourly fee may be applied against a retainer (e.g., a retainer payable monthly), in which case it is payable whether or not a financing closes.  Alternatively, it may be contingent upon the successful completion of a financing, in which case there may be additional conflicts of interest, as described below.

Fee contingent upon the completion of a financing or other transaction.   Under a contingent fee form of compensation, payment of an advisor’s fee is dependent upon the successful completion of a financing or other transaction. Although this form of compensation may be customary for the client, it presents a conflict because the advisor may have an incentive to recommend unnecessary financings or financings that are disadvantageous to the client.  For example, when facts or circumstances arise that could cause the financing or other transaction to be delayed or fail to close, an advisor may have an incentive to discourage a full consideration of such facts and circumstances, or to discourage consideration of alternatives that may result in the cancellation of the financing or other transaction.

Fee paid under a retainer agreement.   Under a retainer agreement, fees are paid to a municipal advisor periodically (e.g., monthly) and are not contingent upon the completion of a financing or other transaction.  Fees paid under a retainer agreement may be calculated on a fixed fee basis (e.g., a fixed fee per month regardless of the number of hours worked) or an hourly basis (e.g., a minimum monthly payment, with additional amounts payable if a certain number of hours worked is exceeded).  A retainer agreement does not present the conflicts associated with a contingent fee arrangement (described above).

Fee based upon principal or notional amount and term of transaction.   Under this form of compensation, the municipal advisor’s fee is based upon a percentage of the principal amount of an issue of securities (e.g., bonds) or, in the case of a derivative, the present value of or notional amount and term of the derivative.  This form of compensation presents a conflict of interest because the advisor may have an incentive to advise the client to increase the size of the securities issue or modify the derivative for the purpose of increasing the advisor’s compensation.

[If applicable, describe other form of compensation for the engagement and associated conflicts with a comparable level of specificity].

Acknowledgement

The undersigned hereby acknowledges that he/she has received this disclosure and that he/she has been given the opportunity to raise questions and discuss the foregoing matters with the advisor.

 

________________________ [name of client]
By: _____________________
Name: __________________
Title: ___________________
Date: ___________________