Financial Services Alert - October 8, 2013

The SEC issued final rules requiring the registration of municipal advisors in SEC Release No. 34-70462 (the “Release”).  The rules implement Section 975 of the Dodd-Frank Act, which amended Section 15B of the Securities Exchange Act of 1934 (the “Exchange Act”) to require registration of “municipal advisors,” a new class of regulated persons that, among other things, provide advice to or on behalf of a municipal entity with respect to municipal financial products or the issuance of municipal securities.  Compared to the initial rule proposal, the final rule narrows the scope of the registration requirement and provides additional guidance about who is required to register as a municipal advisor and what constitutes municipal advice.

This article provides an overview of the definition, exemption and registration provisions of the final rule, noting important provisions that have changed materially from the initial rule proposal.

Definitions and Exemptions

Municipal advisor

The term “municipal advisor” is defined by statute to mean a person, other than a municipal entity or employee of a municipal entity, that provides advice to or on behalf of a municipal entity or obligated person (a person committed to support payment of the obligations on municipal securities sold in an offering) with respect to municipal financial products or the issuance of municipal securities, or undertakes a solicitation of a municipal entity or obligated person.  The Release clarifies that the term “municipal entity” used in the definition of “municipal advisor” is not limited to issuers of municipal securities.  As a result, persons that provide advice to or on behalf of a municipality that does not issue such securities, or that solicit investment by such municipalities, may still be considered “municipal advisors.”

The Release notes that the “municipal advisor” definition is “broad” and includes, among others, financial advisors, guaranteed investment contract brokers, third-party marketers, placement agents, and solicitors that engage in municipal advisory activities.

Rule 15Ba1-1 provides a number of exclusions from the “municipal advisor” definition.  For example, brokers, dealers, and municipal securities dealers serving as an underwriter of a particular issuance of municipal securities are not municipal advisors to the extent that they engage in activities within the scope of the underwriting.  Similarly, registered investment advisers and their associated persons are not municipal advisors to the extent that such registered investment adviser or associated person is providing investment advice in such capacity; the rule provides, however, that “investment advice” in this context does not include advice concerning the issuance of municipal securities or a solicitation of a municipal entity or obligated person.  Therefore, registered investment advisers that provide advice concerning the issuance of municipal securities would be required to register as municipal advisors. 

Persons that are registered as commodity trading advisors under the Commodity Exchange Act and their associated persons are also excluded from the definition of “municipal advisor” to the extent that such persons provide advice related to swaps.  Attorneys, engineers, accountants, public officials and employees, banks, registered swap dealers, and certain others are also not municipal advisors, generally to the extent that their activities are limited to the traditional scope of activities of such persons.  For example, an attorney is not a municipal advisor to the extent that he or she is providing services “that are of a traditional legal nature,” but would be required to register as a municipal advisor if he or she claimed to be a financial advisor or financial expert.

Proceeds of municipal securities

The statute prohibits the provision of advice to or on behalf of a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities, except by registered municipal advisors.  “Municipal financial products” is defined to include “investment strategies,” which is in turn defined to include plans or programs for the investment of proceeds of municipal securities that are not municipal derivatives, guaranteed investment contracts, and the recommendation of and brokerage of municipal escrow investments. 

However, Rule 15Ba1-1(d)(2)(vii) exempts from the definition of “municipal advisor” a “person that provides advice with respect to investment strategies that are not plans or programs for the investment of the proceeds of municipal securities or the recommendation of and brokerage of municipal escrow investments.”  “Proceeds of municipal securities” is in turn defined in paragraph (m) of that rule to mean, in part, “monies derived by a municipal entity from the sale of municipal securities, investment income derived from the investment or reinvestment of such monies, and any monies of a municipal entity or obligated person held in funds under legal documents for the municipal securities that are reasonably expected to be used as security or a source of payment for the payment of the debt service on the municipal services….”  Monies derived from a municipal security issued by a Section 529 college savings plan are, however, excluded from the “proceeds of municipal securities” definition.

The Release notes that the statute does not define what constitutes “advice” to a municipal entity.  Rule 15Ba1-1(d) provides an “advice standard” that excludes “the provision of general information that does not involve a recommendation regarding municipal financial products or the issuance of municipal securities (including with respect to the structure, timing, terms and other similar matters concerning such financial products or issues).”  Accordingly, persons may provide such general information without registering as a municipal advisor. 

Employee of a municipal entity

Employees of municipal entities are generally excluded from the definition of “municipal advisor.”  The term is defined broadly to include all employees, governing body members and members of advisory boards and committees, and other officials of municipal entities and obligated persons to the extent that they act within the scope of their employment or official capacity.  This represents a change from the original proposal, which would not have excluded members of advisory boards and committees unless they were paid as employees for their service.  The Release explains that these exclusions represent, in part, a recognition that the relevant employees and similar officials represent the municipal entity intended to be protected by the registration regime, and that such persons may already be subject to various state and local laws, including ethics laws and fiduciary duties.

However, registration would be required if any such individual provides municipal advice outside the scope of his or her employment or official capacity.  This could be the case if, for example, an individual provides advice for compensation to a municipal entity other than the municipal entity that employs her, or otherwise provides advice for compensation to a municipal entity outside the scope of her employment.

Obligated person

As noted above, a municipal advisor is, generally, a person that provides certain advice to or on behalf of a municipal entity or obligated person.  An “obligated person,” as defined in the Exchange Act, is “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.”

Rule 15Ba1-1(k) incorporates the statutory definition, but excludes from the term (1) a person who provides municipal bond insurance, letters of credit, or other liquidity facilities; (2) a person whose financial information or operating data is not material to a municipal securities offering, without reference to any municipal bond insurance, letter of credit, liquidity facility, or other credit enhancement; and (3) the federal government and its instrumentalities.  Accordingly, advisors to such excluded entities would not, on the basis of such advisory relationship, be required to register as municipal advisors.

The Release explains that the SEC believes that the municipal advisor registration regime should generally apply to advisors of obligated persons in the same way that it applies to advisors of municipal entities, because obligated persons are committed to supporting the payment of some or all of the obligations on municipal securities and because the default of an obligated person could harm municipal entities.

Solicitation of a municipal entity or obligated person

The definition of “municipal advisor” includes a person that undertakes a solicitation of a municipal entity or obligated person.  “Solicitation of a municipal entity or obligated person” is defined in the Exchange Act to refer to a communication with a municipal entity or obligated person made by a person for compensation on behalf of an unaffiliated broker, dealer, municipal securities dealer, municipal advisor, or investment adviser for the purpose of obtaining or retaining an engagement by the municipal entity or obligated person 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.  Rule 15Ba1-1(n) adopts the same definition, with certain clarifications.

The Release explains the SEC’s view that a placement agent that solicits a municipal entity to invest in a pooled investment vehicle that is not a municipal entity does not meet the definition of “solicitation of a municipal entity or obligated person” as a result of such solicitation because it is not soliciting on behalf of an unaffiliated broker, dealer, municipal securities dealer, municipal advisor, or investment adviser for the purpose of obtaining or retaining an engagement by a municipal entity or obligated person of such unaffiliated entity.  This represents a significant change from the position indicated by the SEC in the original proposal, and should result in some broker-dealer firms being able to withdraw from registration.  The Release notes that a placement agent that solicits a municipal entity to invest in a pooled investment vehicle may still meet the definition of “municipal advisor” on the basis of its other activities.

The Release clarifies that solicitation activity on one’s own behalf or on behalf of an affiliate would not be “solicitation of a municipal entity or obligated person.”  Advertising is also excluded from solicitation, as is assisting a municipal entity or obligated person in selecting a broker-dealer, investment adviser, or financial advisor as part of a request for proposal (“RFP”) process.

It is important to note that the fact that a person is engaging in an activity that is excluded from the definition of “solicitation of a municipal entity or obligated person” does not necessarily mean that such person has no obligation to register as a municipal advisor.  A person that assists a municipal entity in selecting an investment adviser as part of an RFP process, for example, but is also soliciting for compensation the municipal entity to select an unaffiliated broker-dealer would be required to register due to the latter activity even though the former is excluded from the solicitation definition.

The rule includes a provision stating that “solicitation of a municipal entity or obligated person” does not include solicitation of an obligated person that is not acting in such capacity.  For example, solicitation of an obligated person with respect to investment strategies that are unrelated to a municipal entity would not be captured by the definition.  The definition also excludes solicitations of obligated persons not in connection with the issuance of municipal securities or with respect to municipal financial products.

Registration and Regulation of Business

The rule addresses several issues related to registration as a municipal advisor.

Registration of municipal advisory firms

Firms that register as municipal advisors do so by completing and filing a Form MA.  Form MA solicits various types of information regarding the municipal advisor (including history, if any, of criminal or regulatory sanctions), its business practices, the persons who own and control the municipal advisor, and the persons who engage in municipal advisory activities on its behalf.  A municipal advisor must renew its Form MA annually by filing an annual update within 90 days after the end of its fiscal year; it must also “promptly” file an amendment to its Form MA whenever a material event occurs that changes the information provided in the form.

Every municipal advisor that is a non-resident of the United States must file a Form MA-NR in addition to its registration on Form MA.  A municipal advisor, whether or not resident in the United States, must also file a separate Form MA-NR for (i) every general partner and/or managing agent of the firm that is a non-resident of the United States, and (ii) every non-resident natural person associated with the firm and engaged in municipal advisory activities on the firm’s behalf.  Unlike Form MA and Form MA-I (discussed below), which are completed online and signed electronically, Form MA-NR must be printed out and signed manually by both the non-resident municipal advisor and the agent designated for service of process.  These signatures must be notarized, and a scanned copy of the form, including the signatures and notarizations, must be attached to the Form MA or Form MA-I.

Registration of natural person municipal advisors

The proposed rules would have required both firms and natural persons that fit the definition of “municipal advisor” to register.  Natural persons would have been required to register by filing a proposed Form MA-I.

Final Rule 15Ba1-3 exempts from the municipal advisor registration requirement natural persons who are associated persons of a registered municipal advisor and whose municipal advisory activities are conducted solely on behalf of a registered municipal advisor.  However, firms that are municipal advisors must now complete and file a Form MA-I for each of their associated natural persons that are engaged in municipal advisory activities on the firm’s behalf, including employees and independent contractors.  As finalized, Form MA-I is not a registration form, and now serves to solicit information about a natural person, including his or her residential and employment history and disciplinary history.  Form MA-I must be promptly updated or amended whenever any information previously provided on Form MA-I becomes inaccurate.

An employee that acts as a municipal advisor outside the scope of his or her employment would need to register as a municipal advisor separately from the employer.

Sole proprietors must register as municipal advisors on Form MA and also file a Form MA-I.

Registration timing

Registration applications on Form MA and Form MA-I are required to be submitted through EDGAR.  Therefore, municipal advisory firms should file Form ID to request an EDGAR access code early in the process.  EDGAR will accept Form MA and Form MA-I filings beginning on July 1, 2014.  However, the SEC has staggered the timing during which municipal advisors must register, with registration required during the months of July, August, September or October 2014, depending on the temporary registration number that a municipal advisor received when it registered pursuant to a temporary rule, Exchange Act Rule 15Ba2-6T, on Form MA-T.  Firms that begin municipal advisory activities on or after October 1, 2014 and do not have a temporary registration number as of October 1, 2014 must register with the SEC prior to engaging in municipal advisory activities.

Withdrawal of registration

A registered municipal advisor that is no longer required to be registered as such either because it has ceased municipal advisory activities or because it is no longer deemed to be a municipal advisor under the final rules, must electronically file a Form MA-W to withdraw its registration.  The notice of withdrawal generally becomes effective sixty days after the filing of the Form MA‑W, although longer periods are possible if the SEC determines that such increased notice period is necessary or appropriate in the public interest or the protection of investors or if the municipal advisor consents to such longer period.  The SEC may also agree to allow a shorter notice period.

Because Form MA-I, as adopted, is not a registration form, a Form MA-W is not used when a natural person whose information has been filed on a Form MA-I ceases to engage in municipal advisory activities on a firm’s behalf (whether because the natural person is no longer associated with the firm or because his or her duties have changed).  Instead, the firm must indicate this change by filing an amendment to the relevant Form MA-I.

Examination of municipal advisors

The SEC has delegated to the Financial Industry Regulatory Authority (“FINRA”) responsibility for conducting examinations of FINRA members that are also registered municipal advisors.  Such examinations will evaluate the members’ compliance with the statutory and regulatory obligations binding on registered municipal advisors.

The SEC will be responsible for examining registered municipal advisors that are not members of FINRA.  The Release states that the SEC anticipates that the “vast majority” of registered municipal advisors will not be members of FINRA.

Municipal Securities Rulemaking Board membership

The Dodd-Frank Act amended the Exchange Act to grant the Municipal Securities Rulemaking Board (the “MSRB”) the authority to adopt rules related to municipal advisors.  The MSRB has used that authority to require that a municipal advisor must register with the MSRB (which requires payment of both an initial fee and an annual fee) prior to engaging in municipal advisory activities.  Registration with the MSRB, in turn, subjects a municipal advisor to rules of the MSRB applicable to municipal advisors, such as those requiring municipal advisors not to engage in any deceptive, dishonest, or unfair practice.

The MSRB proposed additional rules for municipal advisors, including rules restricting political contributions, and then withdrew the rule proposals pending the adoption of the SEC’s municipal advisor rules.  It is expected that the MSRB will re-propose those rules for municipal advisors.

Goodwin Procter’s ERISA & Executive Compensation Practice issued a client alert that discusses the proposed “Pay Ratio” disclosure rules recently issued by the SEC.  Under the proposal, any filing by a public company required to include executive compensation disclosure under Item 402 of Regulation S-K would have to disclose the ratio of (i) the median of annual total compensation for all employees other than its principal executive officer to (ii) the annual total compensation of its principal executive officer.  The proposal also includes guidance on determining the median of annual total compensation for all employees.  Emerging growth companies, smaller reporting companies, foreign private issuers and certain other filers, such as registered investment companies, would be exempt from the proposed disclosure requirements.

The Treasury’s Office of Financial Research (the “OFR”) delivered a report to the Financial Stability Oversight Council (the “FSOC”) discussing ways that activities in the asset management industry might create, amplify, or transmit stress through the U.S. financial system.  The FSOC solicited the report to inform its consideration of whether to subject asset management firms to enhanced prudential standards and supervision under Section 113 of the Dodd-Frank Act.  The report addresses the following topics:

• the activities of asset management firms and the funds they manage;
• the key factors that make the industry vulnerable to shocks: (1) “reaching for yield” and asset class herding behaviors; (2) redemption risk in collective investment vehicles; (3) use of  leverage, which can amplify asset price movements and increase the potential for fire sales; and (4) firms as sources of risk;
• the key channels through which shocks can be transmitted, such as exposures across funds and firms and the impacts of fire sales; and
• the data available to measure those activities, vulnerabilities, and channels, and the nature of the gaps in those data, particularly with respect to separate accounts, privately owned firms, repurchase agreement markets, and securities lending activity.

The report notes that it does not focus on particular risks posed by money market funds and does not address the activities and risks posed by hedge funds, private equity, and other private funds, which will be subject to additional analysis as the OFR, SEC, and CFTC evaluate the information being filed on Form PF.

FRB Governor Jerome H. Powell delivered remarks on October 3, 2013 entitled “Community Banking: Connecting Research and Policy” to the Federal Reserve System/Conference of State Bank Supervisors, Community Banking Research Conference (the “Conference”) at the offices of the Federal Reserve Bank of St. Louis.  In his remarks Governor Powell stressed that community banks play a critical role in the U.S. economy and that although community banks “played no part in causing the [recent, major] financial crisis, [they] have been forced to fight to ensure that they are not swept up in a torrent of costly new regulations that were intended to address problems at those very large banks that did contribute to the crisis.”  Governor Powell stated that the FRB wants community banks to communicate their concerns about regulations and the costs of compliance to the FRB and noted that the FRB has established a community bank subcommittee of its Committee on Bank Supervision to see that regulatory proposals are “appropriately tailored for community banks.”

Governor Powell next discussed the research papers concerning community banks that have been presented at the Conference including papers entitled:

• Community Banks Play a Role in New Firm Survival
• Equipment Lease Financing: The Role of Community Banks
• Bank Failure: Relationship Lending and Local Economic Performance
• Small Business Lending and Social Capital:  Are Rural Relationships Different?
• Financial Derivatives at Community Banks
• Lessons from Community Banks that Recovered from Financial Distress
• The Effect of Distance on Community Bank Performance Following Acquisitions and Reorganizations
• Performance of Community Banks in Good Times and Bad Times: Does Management Matter?
• Estimating Changes in Supervisory Standards and Their Economic Effects
• The Impact of Dodd-Frank on Community Banks
• Capital Regulation at Community Banks: Lessons from 400 Failures
• Failure to Communicate:  The Pathology of Too Big To Fail

Governor Powell next stated that the FRB had recently launched an initiative to refine its examination programs by having its consumer compliance examiners “base the examination intensity more explicitly on the individual bank’s risk profile, including its consumer compliance culture and how effectively it identifies and manages consumer compliance risk.”  Governor Powell said the FRB plans to begin the new consumer compliance examination program for community banks in 2014.

Governor Powell next suggested that further research that could be useful might consider: (1) which regulations, whether new or existing, pose the heaviest regulatory burden on community banks and how that burden compares to the benefits derived from those regulations; and (2) can a regulatory agency modify a regulation or provide an exemption for community banks with respect to a specific regulation “without adversely affecting bank safety and soundness or financial stability?”

In concluding his remarks Governor Powell stated that community banks continue to do a good job of attracting stable and relatively inexpensive core deposits, but they face increased challenges.  He added that “as auto, mortgage, and credit card loans have become increasingly standardized, community banks have had to focus to a greater extent on small business and commercial real estate lending.”  These types of loans, noted Governor Powell, are not “cheap or easy to make.” It is critical, concluded Governor Powell, that the FRB and other bank regulatory agencies not adopt regulatory policies that exacerbate the regulatory burden and challenges to community banks unless the burden is outweighed by corresponding benefits.