Request for Comment on Draft Amendment to Limit Dealer Consents to Changes in Authorizing Documents for Municipal Securities

INTRODUCTION

The Municipal Securities Rulemaking Board (“MSRB”) is requesting comment on a draft amendment to MSRB Rule G-11 (on primary offering practices) (the “Draft Rule G-11 Amendment”) concerning the practice by brokers, dealers, and municipal securities dealers (“dealers”) of consenting to changes in authorizing documents for municipal securities.  The Draft Rule G-11 Amendment seeks to address concerns raised in comments received by the MSRB from market participants on an earlier draft interpretive notice relating to such practice, as described below.

Comments should be submitted no later than August 13, 2012, and may be submitted in electronic or paper form.  Comments may be submitted electronically by clicking here.  Comments submitted in paper form should be sent to Ronald W. Smith, Corporate Secretary, Municipal Securities Rulemaking Board, 1900 Duke Street, Suite 600, Alexandria, VA 22314.  All comments will be available for public inspection on the MSRB’s website.[1] 

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

BACKGROUND

On February 7, 2012, the MSRB published MSRB Notice 2012-04 in which it requested comment on a draft interpretive notice concerning the application of MSRB Rule G-17 to the provision of bondholder consents by underwriters of municipal securities (the “Draft Notice”).  The Draft Notice would have provided that, depending upon the facts and circumstances, the practice by underwriters of consenting to amendments to bond authorizing documents, such as trust indentures and bond resolutions, could be a violation of the duty of dealers under MSRB Rule G-17 to deal fairly with all persons in the conduct of their municipal securities activities.  In cases where the amendments reduced the security for the existing bondholders, the Draft Notice would have stated that the provision of consents by underwriters would be a violation of their Rule G-17 duty of fair dealing unless: (i) the authorizing document expressly provided that an underwriter could provide bondholder consent; and (ii) the offering documents for the existing securities expressly disclosed that bondholder consents could be provided by underwriters of other securities issued under the authorizing document. 

In publishing the Draft Notice for comment, the MSRB cited its concern that the practice of underwriters providing consents to changes in the authorizing documents, particularly to changes that reduced the security for existing parity holders, had not been explicitly provided for in the authorizing documents, nor had it been specifically disclosed in the offering documents for the existing bonds.  The MSRB was concerned that existing bondholders, while aware of the consent provisions in the authorizing documents, would not have contemplated that an owner with no prior or future economic interest in the bonds, such as an underwriter who may hold the bonds only momentarily during the initial distribution process without any investment purpose, could provide consent in lieu of existing bondholders, who have a vested interest in assessing the potential impact of any amendment to the authorizing documents.

The MSRB also recognized the desire of some issuers or obligated persons to amend their authorizing documents in a cost effective manner.  In an effort to balance the concerns of issuers and existing bondholders, the Draft Notice would have provided that underwriters would not violate their Rule G-17 duty by providing consents to changes that reduced the security for existing bondholders if the ability of an underwriter to provide such consents had been explicitly authorized and disclosed in the authorizing and offering documents for existing bonds.  

DISCUSSION OF COMMENTS ON DRAFT NOTICE

The MSRB received 10 comment letters on the Draft Notice.[2]  In summary, various commenters said that the Draft Notice was too broad and may have unintended consequences that would prove harmful to investors and issuers by prohibiting amendments that would benefit both bondholders and issuers.  Some commenters said that the practice of underwriters, as initial holders, consenting to amendments is long standing and is an efficient way to modernize indentures and other authorizing documents to which there has been no significant resistance. Some commenters noted that because most bonds were issued in book entry form, there was no simple way to confirm beneficial ownership of the bonds or to communicate with beneficial owners except at the time of purchase, with another commenter suggesting changes to the Depository Trust Company (“DTC”) process to improve consent solicitations, including considering a solicitation process similar to that used for corporate issues.  Various commenters said that the terms of the governing documents outline the provisions for voting and consent, and those provisions should control.  Others said that the amendment process was usually fully disclosed and that prior bondholders should be aware that a majority of prior and new bondholders could consent to a broad range of amendments.

After reviewing the comment letters, the MSRB recognizes concerns on the part of commenters about the ability to identify what constitutes a reduction in security, as well as the ability to balance the short and long term consequences of certain changes and to balance the interests of bondholders and those of the issuer.  The MSRB also recognizes that such evaluations could result in varying interpretations by different underwriters.  The MSRB, however, remains concerned that key rights of bondholders could be seriously affected by the provision of consents by parties (such as underwriters and remarketing agents) that had no prior or future economic interest in the bonds, and that existing bondholders might not have contemplated that such a disinterested owner could provide consents as bondholders.  The MSRB also appreciates that while the practice of obtaining underwriter consents may be an efficient way for an issuer to modernize its governing documents, the practice, depending on the facts and circumstances, could be considered as unfair and deceptive because it is exercising rights in a manner that the existing bondholders did not explicitly contemplate.

DRAFT RULE G-11 AMENDMENT

As a result of these continuing concerns, the MSRB has determined to request comment on the Draft Rule G-11 Amendment, which would establish a new section (k) of Rule G-11 to prohibit certain consents by dealers to amendments to bond authorizing documents for municipal securities, rather than providing interpretive guidance under Rule G-17 as previously proposed in the Draft Notice.

The Draft Rule G-11 Amendment would prohibit a dealer from providing bondholder consent to any amendment to authorizing documents for municipal securities, either as an underwriter, remarketing agent, or as an agent for owners, or in lieu of owners, subject to limited exceptions.  The exceptions consist of consents given: (1) by a dealer for securities owned by it other than in its capacity as an underwriter or remarketing agent; (2) by a remarketing agent for all securities affected by such consent, provided that all such securities had been tendered to it as a result of a mandatory tender; and (3) by a dealer if all owners of securities that would be affected by such amendments (other than the securities for which the dealer provides its consent) had provided or would have provided consent to such amendments prior to their taking effect.  The Draft Rule G-11 Amendment would not affect other methods used by issuers to obtain consents from owners of newly issued bonds, such as consents received (in writing or constructively) from bondholders upon initial purchase of the bonds, provided that the Draft Rule G-11 Amendment would prohibit the dealer from providing any such constructive or deemed consent for or in lieu of bondholders, and the MSRB expresses no opinion on the legal validity of any constructive or “deemed” consents received from bondholders under the terms of any particular authorizing document.

The Draft Rule G-11 Amendment would apply only in connection with consents that the authorizing documents state are to be provided by bond owners (including beneficial owners of bonds).  Consents from dealers solely in their capacity as an underwriter or a remarking agent required or permitted under authorizing documents, and not as an agent for or in lieu of bondholders, would not be subject to the Draft Rule G-11 Amendment.  For example, if an authorizing document provides that a dealer, in its role as remarketing agent, must consent to a change relating to the manner or timing for tendering bonds, the dealer serving as remarketing agent would be permitted to provide such consent.  However, if the authorizing document also requires consent from bond owners to such change, the remarketing agent would not be permitted to provide consent on behalf of or in lieu of bondholders.

The first exception from the prohibition under the Draft Rule G-11 Amendment noted above would allow dealers that own securities as an investment to provide bondholder consents with respect to those securities.  There would be no precise holding period established for purposes of determining whether the dealer no longer holds the securities in its capacity as underwriter or remarketing agent – rather, the dealer would look, among other things, to how its holding is treated for its other regulatory and internal risk management purposes as well as whether its own financial interests would be affected by the proposed amendment to the authorizing documents.

The second exception would allow a dealer, as a remarketing agent, to provide consents for securities that have been tendered to it as a result of a mandatory tender, provided that all securities affected by the consent had been tendered.  Thus, if a bondholder elects to exercise a right to “hold” bonds subject to a mandatory tender in lieu of tendering, a dealer acting as the remarketing agent would be prohibited from providing consents to changes in the authorizing documents unless the remarketing agent also received the specific written consent of such bondholder to such change.

The third exception would allow a dealer (whether acting as underwriter or remarketing agent) to consent to an amendment to authorizing documents in circumstances where the amendment would not become effective until all bondholders affected by such amendment (other than the holders of the securities for which such dealer provides consent) had also provided consent.  This might occur, for example, when an issuer may be accumulating, over time, bondholder consents from individual owners of bonds previously outstanding under the authorizing document through traditional methods of written bondholder consents, and the amendment to the authorizing document would not become effective for all bondholders until all such existing bondholders have consented or their bonds have matured or been redeemed.

REQUEST FOR COMMENT

The MSRB requests comments on all aspects of the Draft Rule G-11 Amendment.  In addition, the MSRB seeks comments on the following specific matters:

• The MSRB recognizes that dealers, acting in a capacity other than as underwriter or remarketing agent, may be permitted to consent to changes to bond authorizing documents that may affect bondholders.  Should dealers acting in such other capacities (for example, auction agents for auction rate securities) be permitted to consent to changes under the exceptions set forth in the Draft Rule G-11 Amendment, or should the Draft Rule G-11 Amendment explicitly prohibit dealers acting in other capacities, such as auction agents, from providing consents to changes to the authorizing documents?
• Would the Draft Rule G-11 Amendment help to protect investors, and are there other benefits that would be realized from adopting the Draft Rule G-11 Amendment?
• Would the Draft Rule G-11 Amendment have any negative effects on issuers, investors or other market participants?  If so, please describe in detail.
• Are issuers able to obtain consents from beneficial holders of bonds effectively and efficiently through existing mechanisms?  The MSRB welcomes comments and suggestions for streamlining and improving methods of identifying and obtaining consents from bondholders, including those available through DTC and otherwise.
• What would be the burdens on issuers or other market participants of adopting a rule that limits obtaining bondholder consents in the manner contemplated by the Draft Rule G-11 Amendment?
• Are there alternative methods the MSRB should consider to providing the protections sought under the Draft Rule G-11 Amendment that would be more effective and/or less burdensome, resulting in an appropriate balance between the need for a cost effective and efficient manner of obtaining consents and the duty of dealers under Rule G-17 to deal fairly with all persons?

 July 5, 2012

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TEXT OF DRAFT RULE G-11 AMENDMENT

Rule G-11: Primary Offering Practices

(a) – (j) No change.

(k) Prohibitions on Consents by Brokers, Dealers, and Municipal Securities Dealers.  No broker, dealer, or municipal securities dealer shall provide bond owner consent to amendments to authorizing documents for municipal securities, either in its capacity as an underwriter or remarketing agent, or as agent for or in lieu of bond owners.  Notwithstanding the foregoing, a broker, dealer, or municipal securities dealer may provide bond owner consent to amendments to authorizing documents for municipal securities if:

(i) such securities are owned by such broker, dealer, or municipal securities dealer other than in its capacity as underwriter or remarketing agent;

(ii) all securities affected by such amendment are held by the broker, dealer, or municipal securities dealer, acting as remarketing agent, as a result of a mandatory tender of such securities; or

(iii) all bond owners of securities that would be affected by such amendments, other than the securities for which the broker, dealer or municipal securities dealer provides consent, have provided or will provide consent to such amendments prior to their taking effect.

For purposes of this section, the term “authorizing document” shall mean the trust indenture, resolution, ordinance, or other document under which the securities are issued, and the term "bond owner consent" shall mean any consent specified in an authorizing document that may be or is required to be given by an owner of municipal securities issued pursuant to such authorizing document.