Several municipalities suffered losses stemming from investments in derivative securities and other complex transactions during the financial crisis of 2008. These reverses led to a call for increased oversight of the financial intermediaries who often recommended these investments. These reforms were incorporated into the Dodd-Frank Act. The Act requires municipal advisors—businesses that advise municipalities about how to raise money through bond offerings or how to invest the proceeds of these sales—to register with the Securities and Exchange Commission (SEC) and the Municipal Securities Rulemaking Board (MSRB).
Definition of a Municipal Advisor
A municipal advisor advises a municipal entity or an “obligated person” about the issuance of municipal securities or municipal financial products. Municipal entities include the states, their political subdivisions, agencies and authorities, and any other organization that may issue municipal securities. They also include investment programs or plans or asset pools sponsored by these entities.
An obligated person is “an entity such as a non-profit university or non-profit hospital that borrows the proceeds from a municipal securities offering” and is “obligated” to pay the money back, either in part or in full.
Municipal advisors may be financial advisors, guaranteed investment contract brokers, third-party marketers, placement agents, finders, solicitors, and swap advisors. All of these are considered municipal advisors if they are performing these services for a municipality or obligated person, or are soliciting them in hope of being hired to perform these services.
What Is Advice?
According to the SEC, whether something constitutes advice depends on the particular situation. The more tailored the communication is to the municipality’s specific needs, the more likely that it is advice. Anything that rises to the level of a recommendation—a call to action—is advice.
Registration is only required if the firm is advising the municipality about how to invest the proceeds of a municipal securities offering, or the funds in an escrow account, or if the firm is recommending investment strategies that include municipal derivatives. A firm that is advising a municipality about some other aspect of its finances does not need to register.
Several organizations and individuals are exempt from the definition of municipal advisor and do not need to register, as long as their activities do not overstep certain boundaries. These include:
- Public Officials and Employees of Municipalities
- Registered Investment Advisers
- Registered Commodity Trading Advisors
- Accountants, Attorneys, and Engineers
- Municipality Represented by an Independent Registered Municipal Advisor
The Registration Process
A municipal advisor must register with the SEC first before it can register with the MSRB. Firms that are also broker-dealers must notify FINRA of their intent to become municipal advisors.
An advisor registers with the SEC by completing Form MA online. The advisor will need to disclose information about its business structure, services, clients, compensation, other financial industry affiliations, and disciplinary history. Once the application is complete, the SEC has 45 days to review it. At that point, the SEC must either approve the advisor’s application or begin proceedings to show why it should be denied.
Municipal Advisor Representatives
A municipal advisor representative is an individual who is affiliated with a municipal advisor and engages in advisory activities on the firm’s behalf. People employed by the advisor whose duties are solely clerical or ministerial are NOT municipal advisor representatives.
A municipal advisor principal is an individual associated with a municipal advisor who manages the firm’s activities in this area and in larger firms supervises municipal advisor representatives. Every municipal advisor must have at least one qualified principal.
Acting as an Unregistered Broker-Dealer
The MSRB warned advisors that they need to be careful not to engage inadvertently in activities that are reserved for broker-dealers. The MSRB pointed to three scenarios where an advisor could cross the line between being an advisor and being a broker-dealer: One, the advisor acts as a place agent, finding potential investors for private issues of municipal securities and receives transaction-based compensation. Two, the advisor helps to arrange bank loans for municipalities that are secured by notes. These notes may actually be securities under the federal securities laws. Three, a bank purchases a variable rate demand obligation and the terms of the security are later significantly restructured. This transaction could be considered a new issue of municipal securities.
Fair Dealing (MSRB Rule G-17)
Municipal advisors have an obligation to deal fairly with the people they do business with. The purpose of this rule is to prevent fraud and manipulation and to protect municipal entities, obligated persons, investors, and the public. Advisors should have a process for reviewing their advertising and promotional materials, including their Web sites, to make sure they do not contain false or misleading information.
The MSRB specifically identified three practices that would violate this wide-ranging rule.
- Splitting fees with a third party without disclosing this arrangement to a client
- Giving financial advice to a municipal entity or making a recommendation about the issuance of securities and including a disclaimer that these activities do not actually constitute giving advice
- Falsely stating that the firm is an independent registered municipal advisor for a municipality
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—Securities Training Corporation