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More on the New SEC Registration Requirements for Municipal Advisors under the Dodd-Frank Act - Advisors and Solicitors Who Must Register with Both the SEC and the MSRB

Client Alert

Authors: Gregory J. Nowak and Matthew R. Silver

2/04/2011

With certain exceptions, the Dodd-Frank Act1 makes it unlawful for a "municipal advisor" to provide advice to or on behalf of a "municipal entity or obligated person" with respect to municipal financial products or the issuance of municipal securities, or to undertake a solicitation of a municipal entity or obligated person unless that municipal advisor is registered in accordance with the Dodd-Frank Act. The universe of persons potentially affected is broad and encompasses individuals and entities providing investment advice to state and local governments and their instrumentalities. As proposed, the new implementing regulations could also require financial and other officers of bond obligors (such as hospitals and universities) to register.

The Dodd-Frank Act also expanded the jurisdiction of the Municipal Securities Rulemaking Board (MSRB) to require registration of municipal advisors. These registrations were due December 31, 2010, unless an exemption applies or unless the municipal advisory business is freshly minted.

Pepper Point: MSRB registration carries with it various other regulatory burdens. For example, MSRB Rules A-7, A-8, A-12 and A-14 on assessments, rulemaking procedures and registration; Rules D-11, D-13, D-14 and G-40 on registration; Rule G-17 on fair dealing; and Rule G-5 on disciplinary actions are already effective for MSRB-registered municipal advisors. The MSRB is currently requesting comment on a draft proposal to establish a new "pay-to-play" rule and to make certain conforming changes to existing rules for brokers, dealers, and municipal securities dealers (dealers) to make such rules applicable to municipal advisors.2 Notably, the proposed MSRB pay-to-play limits for municipal advisors are different from those that will be implemented next month by the SEC for registered investment advisers. SEC Rule 206(4)-5, under a SEC-level safe-harbor de minimis exemption, permits a "covered employee" to make aggregate contributions without triggering a two-year time-out provision, of up to $350, per election, to an elected official or candidate for whom the individual is entitled to vote, and up to $150, per election, to an elected official or candidate for whom the individual is not entitled to vote (totals being per individual elected official or candidate). The MSRB's equivalent de minimis exemption proposal applicable to "municipal advisor professionals" and "non-MAP executive officers" with regard to political contributions to officials or candidates has a $250 cap per election (per elected official or candidate) if the municipal advisor professional or non-MAP executive officer was entitled to vote for such official or candidate at the time of the contribution. A contribution of $1 to an official or candidate for whom the municipal advisor professional or non-MAP executive officer was not entitled to vote and for whom would result in a two year ban under the current MSRB proposal.3

 

According to the Securities and Exchange Commission (SEC)’s December 20, 2010 proposal,4 the three principal types of municipal advisors are:

  • financial advisors including, but not limited to, broker-dealers already registered with the SEC that provide advice to municipal entities with respect to their issuance of municipal securities and their use of municipal financial products
  • investment advisors that advise municipal pension funds and other municipal entities on the investment of funds held by or on behalf of municipal entities (subject to certain exclusions), and
  • third-party marketers and solicitors.

Municipal advisors are required to register first with the SEC and subsequently with the MSRB.5 More than 50 SEC municipal advisor registration initial filings were made between December 20, 2010 and December 31, 2010 (i.e., subsequent to the December 20 clarification) and additional initial filings are still being made in 2011, albeit at a slower pace. Significantly more entities have filed with the SEC as municipal advisors than with the MSRB — as of the close of 2010, there were fewer than 500 municipal advisors registered with the MSRB6 and more than 750 registrations with the SEC.7

Pepper Point: As both SEC registration and MSRB registration are based on the same basic standards and definitions and the MSRB requirements are being implemented in coordination with those of the SEC,8 parties that have registered with the SEC but not the MSRB should examine why they did not register with both entities. An accidental failure to register with the MSRB should be promptly corrected. It would be a simple matter for a regulator or client to cross-reference the publicly available MSRB-registered municipal advisor list with the publicly available SEC-registered municipal advisor list.9 Admittedly, the SEC registration requirements have been better publicized by the compliance community than those of the MSRB.

Pepper Point: Any municipal advisor that has previously registered with the MSRB as a broker, dealer or municipal securities dealer must register separately with the MSRB as a municipal advisor by updating its existing MSRB account.10 Merely maintaining an entity’s existing registration, say as a municipal dealer, is NOT sufficient. MSRB rules (besides for registration requirements) that are already directly applicable to MSRB-registered municipal advisors include Rule G-17 (concerning fair dealing) and Rule G-5 (concerning disciplinary actions).

The Dodd-Frank Act defines the term "municipal entity" to include any state, political subdivision of a state, or municipal corporate instrumentality of a state, including agencies and authorities (whether or not they issue municipal bonds). The Dodd-Frank Act further defines the term "municipal advisor" as including any person who provides advice to or on behalf of a municipal entity or obligated person11 with respect to municipal financial products or the issuance of municipal securities including advice with respect to the structure, timing, terms and other similar matters concerning such financial products or issues or who undertakes a solicitation of a municipal entity. The term "municipal financial product" means "municipal derivatives, guaranteed investment contracts (GICs), and investment strategies.

Pepper Point: The SEC has specifically noted that "[o]bligated persons can include entities acting as conduit borrowers such as private universities, nonprofit hospitals, and private corporations." If a nonprofit hospital is an "obligated person," its chief financial officer herself might very well be required to register as a municipal advisor. We are hoping that the SEC clarifies this rule, as there doesn’t appear to be much benefit to be derived from such "superfluous" registrations.

The SEC apparently does not believe that Congress intended to limit the requirement to register as a municipal advisor only to those persons who provide advice with respect to plans or programs for the investment of proceeds from municipal securities. The SEC and has interpreted the definition of "investment strategies" to include, without limitation, programs or pools of assets that invest funds held by or on behalf of a municipal entity, as well as plans or programs for the investment of the proceeds of municipal securities that are not municipal derivatives or guaranteed investment contracts, or the recommendation of or brokerage of municipal escrow investments.

As a result, unless subject to an exclusion, persons who provide advice with respect to "plans, programs or pools of assets" that invest funds held by, or on behalf of, a municipal entity, such as a 529 college savings plan, LGIP or public pension plan are "municipal advisors." Such plans, programs, and pools of assets are generally funded from sources other than proceeds of municipal securities, such as families who wish to save for college expenses, general monies of state and local governments being temporarily invested prior to their budgeted expenditure, and pension contributions from employees and state and local government employers. Also, because every bank account of a municipal entity is comprised of funds "held by or on behalf of a municipal entity," money managers providing advice to municipal entities with respect to their bank accounts could be municipal advisors. Parties providing other types of products (such as insurance contracts with an investment component), if the use of such contracts constituted an "investment strategy," could also be required to register as municipal advisors.

Pepper Point: Section 403(b) variable annuities are insurance products sold via salary reduction arrangements as retirement investments for public school teachers and others. Such insurance salesmen should probably register as municipal advisors, according to informal guidance we received from the MSRB.

The definition of "municipal advisor" also includes a person that undertakes a solicitation of a municipal entity or obligated person. The Security Exchange Act of 1934 (the Exchange Act) Section 15B(e)(9) 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 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.

Unless an exclusion applies, "any third-party solicitor that seeks business on behalf of a broker, dealer, municipal securities dealer, municipal advisor or investment adviser from a municipal entity" must register as a municipal advisor. For example, a third-party solicitor that seeks business on behalf of an investment adviser from a municipal pension fund or a local government investment pool must register as a municipal advisor.

Pepper Point: Whether a solicitation of a municipal entity requires the solicitor to register as a municipal advisor is not based on the number or size of investments that are solicited. Thus, the SEC "would consider a solicitation of a single investment of any amount [to a] municipal entity to require the person soliciting the municipal entity to register as a municipal advisor."

As the definition of "solicitation of municipal entity or obligated person" applies to solicitations on behalf of a broker, dealer, municipal securities dealer, municipal advisor, or investment adviser that does not control, is not controlled by, or is not under common control with the person undertaking such solicitation, persons soliciting on behalf of affiliated entities would not fall within the definition of municipal advisor and would not be required to register (however, they could voluntarily register and be subject to the rules and regulations applicable to registered municipal advisors).

Exclusions from Registration

Certain exclusions exist from the definition of "municipal advisor" and related registration requirements. Certain exclusions are hard-wired into the Dodd-Frank Act and certain are based on interpretations by the SEC (which the MSRB will follow):12

  • SEC-Registered Investment Advisers: An SEC (but not state-registered) investment adviser or a registered representative of an SEC-registered investment adviser is not required to register as a municipal advisor, unless the registered investment adviser or associated person engages in municipal advisory activities other than providing investment advice that would subject such adviser or person associated with such adviser to the Investment Advisers Act of 1940 (the Advisers Act). So, an SEC-registered investment adviser providing regular investment advice would be excluded from municipal advisor registration requirements, but, for example, an SEC-registered investment adviser providing advice with respect to how a municipal entity should structure or issue municipal securities would be required to register. An SEC investment adviser that solicits a municipal entity on behalf of a municipal advisor or broker would also be required to register as a municipal advisor.

  • Hedge and Private Equity Fund Managers that Are Not SEC-Registered Investment Advisers: To the extent that an advisor is providing advice to a pooled investment vehicle in which a municipal entity has invested funds along with other investors that are not municipal entities, the pooled investment vehicle would not be considered funds "held by or on behalf of a municipal entity" and, therefore, the parties providing advice to the pooled investment vehicle would not have to register as municipal advisors. So, provided that a fund adviser makes sure that the initial investor in each of its funds is not a municipal entity or considered by the SEC for purposes of municipal advisor registration to be a municipal entity (such as a municipal pension plan) and that each fund maintains at least one non-municipal investor at all times, such a fund adviser avoids municipal advisor registration requirements.
     

  • Broker, Dealer, or Municipal Securities Dealer Serving as an Underwriter: An exclusion from the definition of "municipal advisor" exists for a broker, dealer, or municipal securities dealer serving as an underwriter of a municipal securities offering. This exclusion does not apply when such parties are acting in a capacity other than as an underwriter on behalf of a municipal entity or obligated person. A broker, dealer or municipal securities dealer would have to register as a municipal advisor if it, for example, was advising a municipal entity with respect to the investment of bond proceeds or the advisability of the municipality investing in a derivative. In addition, "a broker-dealer acting as a placement agent for a private equity fund that solicits a municipal entity or obligated person to invest in the private equity fund would also be a municipal advisor with respect to that activity."13

    Pepper Point: The SEC has specifically stated that the fact that a party is providing advice or assistance to a municipal entity on an informal non-contractual (and non-compensated) basis does not negate the requirement to register. The services being rendered are the trigger for registration and the attachment of the corresponding fiduciary duty, not the title of the relationship, the terms of the contract, or the compensation payable or received. In fact, the SEC has stated that it does not believe "the issue of whether a municipal advisor is compensated for providing municipal advice should factor into the determination of whether the municipal advisor must register with the Commission."14
     

  • Commodity Trading Advisors: Registered commodity trading advisors and their related persons are excluded from registering as municipal advisors, but only when providing advice related to swaps. The exclusion would not apply to a commodity trading advisor or associated person of a commodity trading advisor to the extent that he or she engages in municipal advisory activities other than the provision of advice related to swaps. If a commodity trading advisor is providing advice to a municipal entity with respect to engaging in a swap transaction and also provides advice to the municipal entity with respect to the structure of a municipal securities offering, the advisor would have to register as a municipal advisor.15
     

  • Attorneys, Engineers and Other Professionals: The definition of municipal advisor generally excludes professionals such as attorneys offering legal advice and engineers providing engineering advice. The SEC also considers accountants preparing financial statements, auditing financial statements, or issuing letters for underwriters for, or on behalf of, a municipal entity or obligated person, to be outside the municipal advisor definition.

However, because accountants may provide advice to municipal entities that includes advice about the structure, timing, terms, and other similar matters (conducting feasibility studies or preparing financial projections were specifically noted by the SEC) concerning the issuance of municipal securities, the SEC does not believe it is appropriate to exclude accountants from the definition of municipal advisor entirely.

An attorney engaging in municipal advisory activities (other than offering legal advice or providing services that are of a traditional legal nature) to a client of the attorney that is a municipal entity or obligated person may similarly be required to register. Advice comparing the structures, terms, or associated costs of issuance of different types of securities or financial instruments (such as fixed-rate bonds or variable-rate demand obligations) given by an attorney hired to advise a municipal entity client embarking on a bond offering, would be considered to be services of a traditional legal nature, as would advice concerning the tax consequences of alternative financing structures or advice recommending a particular financing structure due to legal considerations such as the limitations included in existing contracts and indentures to which the issuer is a party. However, advice that is primarily financial in nature, such as advice concerning the financial feasibility of a project or financing, advice estimating or comparing the relative cost to maturity of an issuance depending on various interest rate assumptions or advice recommending a particular structure as being financially advantageous under prevailing market conditions, would be primarily financial advice and not services of a traditional legal nature and may result in a requirement that the attorneys providing that advice (and/or their law firm) register as municipal advisors.

For an engineer, costing out engineering alternatives would not subject the engineer to registration as a municipal advisor because such activity would be considered engineering advice. The exclusion would not include circumstances in which the engineer is engaging in municipal advisory activities, including cash-flow modeling or the provision of information and education relating to municipal financial products or the issuance of municipal securities, even if those activities are incidental to the provision of engineering advice. In addition, the exclusion would not include circumstances in which the engineer is preparing feasibility studies concerning municipal financial products or the issuance of municipal securities that include analysis beyond the engineering aspects of the project.

  • Employees of a Municipal Entity: The term "municipal advisor" excludes employees of a municipal entity. A person serving as an elected member of the governing body of a municipal entity (to the extent that person is acting within the scope of his or her role as an elected member of the governing body of the municipal entity) and appointed members of a governing body (to the extent such appointed members are ex officio members of the governing body by virtue of holding an elective office) are excluded from registration as municipal advisors unless another rule applies (i.e., the elected official is also employed by an investment manager).

Mechanics of Registration and Post-Registration Requirements

In September of 2010, the SEC had created a temporary online registration mechanism to allow municipal advisors to register on a temporary basis. These temporary registrations are effective through December 31, 2011.

The SEC’s December 20, 2010 proposal also includes a package of proposed forms designed to give effect to the provisions of the Dodd-Frank Act. If adopted, the proposed rules would establish a permanent registration regime with the SEC for municipal advisors and would impose certain record-keeping requirements on such advisors.16

The proposal would require municipal advisory firms to make and keep true, accurate, and current, certain books and records relating to its municipal advisory activities, based generally on Exchange Act Rules 17a-3 and 17a-4, and Advisers Act Rule 204-2, which set forth books and records requirements with respect to broker-dealers and investment advisers, respectively, with appropriate revisions to reflect the activities of municipal advisors.

A registered municipal advisor would be required to retain originals or copies of all communications received, and originals or copies of all communications sent (including inter-office memoranda and communications) relating to municipal advisory activities, including "tweets," messages sent via social networking sites, instant messages and e-mail. Municipal advisory firms would also have to keep all check books, bank statements, cancelled checks and cash reconciliations; a copy of each version of the municipal advisor’s policies and procedures, if any, in effect at any time within the last five years; and a copy of any document created by the municipal advisor that was material to making a recommendation to a municipal advisory client or that memorializes the basis for that recommendation. A municipal advisory firm would also be required to keep copies of all written agreements entered into by the municipal advisor with any municipal entity, employee of a municipal entity or an obligated person or otherwise relating to the business of the municipal advisor. A record of the names of persons who are, or have been in the past five years, associated persons of the municipal advisor; names, titles and addresses of persons associated with the municipal advisor; municipal entities or obligated persons with whom the municipal advisor has engaged in municipal advisory activities in the past five years; the names and business addresses of persons to whom the municipal advisor agrees to provide payment to solicit municipal entities on its behalf; and the names and business addresses of persons that agree to provide payment to the municipal advisor to make solicitations on their behalf would also be required to be retained and maintained.

The proposed rules would require municipal advisory firms to maintain and preserve all books and records required to be made under the proposed standards for a period of not less than five years, with the first two years in an easily accessible place. Corporate governance documents, such as articles of incorporation and stock certificate books of the municipal advisor and including those of any predecessor, would be required to be maintained in the principal office of the municipal advisor and preserved for three years after termination of the business or withdrawal from registration as a municipal advisor. Non-U.S.-resident municipal advisors (other than natural persons) would be required to maintain a copy of all such books and records within the United States.

As proposed, the records required to be maintained and preserved may be maintained and preserved for the required time on appropriate electronic storage media (meeting certain requirements) or on paper, provided that, in either case, documents are arranged and indexed in a way that permits easy location, access, and retrieval of any particular record so it can be provided promptly to the SEC upon request.

When a municipal advisory firm ceases doing business as a municipal advisor (whether by going out of business or simply adjusting their business in a way that registration is no longer required), it will be required to arrange for and be responsible for the continued preservation of their old required municipal advisor books and records for the standard two- or five-year period, and would be required to notify the SEC as to where such books and records will be maintained (such requirement being found "necessary for the [SEC] to perform effective inspections and examinations of municipal advisory firms").

Comments to the SEC are due by February 22, 2011 and may influence not only the requirements applicable to municipal advisors but which parties may ultimately be excluded from registration requirements.17

If you have any questions, or need any assistance with respect to these current and proposed rules, or if you are interested in expressing your opinion about the SEC’s proposal, please feel free to contact the authors, or any other member of the Investment Management Group of Pepper Hamilton.

Endnotes

1 The Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub.L. 111-203, H.R. 4173) (the "Dodd-Frank Act").

2 Proposal available at http://www.msrb.org/MSRB-For/Municipal-Advisors/Municipal-Advisor-News.aspx. Comments on MSRB pay-to-play proposals are due by February 25, 2011.

3 See http://www.msrb.org/Rules-and-Interpretations/Regulatory-Notices/2011/2011-04.aspx. The ban would prevent the municipal advisor associated with the person who made the offending contribution to an official or candidate running for office in such municipal entity from engaging in “municipal advisory business” with the municipal entity for compensation for up to two years after the date of the contribution. Under the current MSRB proposal, subject to special exemptive relief being afforded by the SEC (not the MSRB).

4 Release available at http://www.sec.gov/rules/proposed/2010/34-63576.pdf.

5 See http://www.msrb.org/MSRB-For/Municipal-Advisors/Municipal-Advisor-News.aspx and http://www.msrb.org/Rules-and-Interpretations/Regulatory-Notices/2010/2010-50.aspx.

6 List available at http://www.msrb.org/msrb1/pqweb/MARegistrants.asp.

7 List available at https://tts.sec.gov/MATR/index.html.

8 See http://www.msrb.org/Rules-and-Interpretations/Regulatory-Notices/2010/2010-49.aspx?n=1. On November 12, 2010, the SEC designated November 15, 2010 as the operative date for a Municipal Securities Rulemaking Board rule change consisting of amendments to Rule G-40 and Form G-40 (on electronic mail contacts) and certain definitions necessary to the MSRB rules governing rulemaking concerning municipal advisors and the process of registering municipal advisors with the MSRB.

9 The MSRB has worked to publicize MSRB registration requirements. See http://www.msrb.org/News-and-Events/Events-and-Training/~/media/Files/Training-Events/Outreach/NY-Outreach-Event-Municipal-Advisor-Rulemaking.ashx.

10 See http://www.msrb.org/Rules-and-Interpretations/Regulatory-Notices/2010/2010-50.aspx.

11 An "obligated person" 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." The SEC currently intends to exclude "providers of municipal bond insurance, letters of credit, or other liquidity facilities" from the definition of "obligated persons." The SEC has requested comment as to the circumstances with respect to municipal financial products or the issuance of municipal securities in which charter schools should be considered obligated persons. Charter schools, or persons that operate charter schools such as charter school management organizations that are organized as nonprofit corporations, may issue municipal securities through a municipal entity for capital needs such as facilities that are not provided for by state funding or other reasons. So can tax-exempt hospitals and universities.

12 As noted above, municipal advisors are required to register with the SEC before they may register with the MSRB. Additionally, the MSRB has not expressed a desire to require registration of municipal advisors that the SEC would consider exempt from registration. Additionally, MSRB 2010-60 specifically notes that "[i]n the SEC Proposal, the SEC discusses a number of interpretative issues relevant in determining whether a market participant is considered a municipal advisor for purposes of the Dodd-Frank Act and therefore is subject to the registration and regulatory requirements of the SEC and the MSRB. Any market participant that is uncertain about whether it is engaging in municipal advisory activities requiring registration with the SEC and the MSRB should review the SEC Proposal [of December 20, 2010]."

13 See page 32 of the SEC’s December 20, 2010 release.

14 See page 33 of the SEC’s December 20, 2010 release.

15 The proposal, as written, would require a CFTC-registered commodity trading advisor that provides advice to a municipality strictly on the topics of futures or options on futures and that amounted to an "investment strategy," to register with the SEC as a municipal advisor.

16 The primary proposed disclosure form is Form MA, which resembles Form ADV Part I that is completed by registered investment advisers. A proposed draft of Form MA is available at http://www.sec.gov/rules/proposed/2010/34-63576-ma.pdf; http://www.sec.gov/rules/proposed/2010/34-63576-ma-instructions.pdf.

17 Electronic comment form available at http://www.sec.gov/cgi-bin/ruling-comments?ruling=s74510&rule_path=/comments/s7-45-10&file_num=S7-45-10&action=Show_Form&title=Registration%20of%20Municipal%20Advisors.

Matthew R Silver and Gregory J. Nowak

More Resources on the Dodd-Frank Act

For additional information, please visit Pepper's Financial Services Reform Resource Center.

The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.