SEC Municipal Advisor Rule Fiduciary Responsibilities · 2016-10-04 · Suggestion Marketing...

California Association of County Treasurers and Tax

Collectors

SEC Municipal Advisor Rule

&

Fiduciary Responsibilities

Presented by:

October 13, 2016

David Leifer

Senior Managing Director

KNN Public Finance, LLC

Leo Karwejna

Chief Compliance Officer

The PFM Group

Introduction and context

2

• TTC’s interact with various professionals in connection with

the issuance of securities and investment activities

– Municipal Advisors, Broker-Dealers, Registered Investment Advisors

• This presentation focuses on:

– SEC Municipal Advisor Rule/MSRB Regulations

• Who is a Municipal Advisor?

• Advice Standard

• Exclusions & Exemptions

– Municipal Advisor Standards of Conduct (MSRB Rule G-42)

– Investment of Bond Proceeds

– Fiduciary Duty and Responsibilities of Various Professionals

SEC Municipal Advisor Rule and

ensuing MSRB Regulations

Today’s environment

Background

4

• SEC Municipal Advisor Rule

– Definitions

– Advice Standard

– Exclusions

– Exemptions

Municipal Advisor Definition

• “Municipal Advisor” defined to include a person (who is not a

municipal entity or an employee of a municipal entity) who

provides advice to a municipal entity or obligated person with

respect to municipal financial products or the issuance of

municipal securities

• Today’s educational discussion focuses on the municipal

financial product part of this definition (as it relates to the

investment of bond proceeds)

5

Municipal Advisor Definition

• “Municipal Financial Product” defined to include:

– Guaranteed investment contracts

– Investment strategies

• “Investment Strategies” defined to include:

– “plans or programs for the investment of the proceeds of municipal

securities”

– “recommendation of and brokerage of municipal escrow investments”

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What are implications of being a Municipal

Advisor?

• Required to register with the SEC and the MSRB

• Statutory Fiduciary Duty

– For municipal entity clients, not obligated person clients

• Subject to MSRB rules (e.g., record-keeping, professional

qualifications)

– MSRB G-42

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How Not to be Municipal Advisor

• Don’t meet the statutory definition

– Not “advice”

– Not either bond proceeds or municipal escrow investments

– You are a “municipal entity” or “an employee of a municipal entity”

• Meet one of the Statutory Exclusions

• Meet one of the Exemptions established by SEC Rules

8

Advice Standard

• SEC Rules provide that “advice excludes . . . the provision of

general information that does not involve a

recommendation regarding municipal financial products.”

• Brokerage distinguished: “purchase and sale of escrow

investments upon the direction of an obligated person or its

financial advisor without rendering advice is merely a

provision of brokerage services and does not render such

person a municipal advisor.” (SEC MA Rule)

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• Examples of the General Information Exclusion from Advice…

(c) information regarding a financial institution’s currently-

available investments (e.g., the terms, maturities, and

interest rates at which the financial institution offers these

investments) or price quotes for investments available for

purchase or sale in the market that meet criteria specified by a

municipal entity or obligated person; (SEC FAQ page 3)

General Information exclusion to “Advice”

10

Municipal Advisor Exclusions

• Underwriter Exclusion

– But only applies for underwriting activities, and SEC has stated that

“advice on investment strategies” is outside the scope of the

underwriter exclusion

• Investment Adviser Exclusion – for “any investment adviser

registered under the Investment Advisers Act of 1940”

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Municipal Advisor Exemptions

• Banks, if providing advice with respect to:

– “any investments that are held in a deposit account, savings account,

certificate of deposit, or other deposit instrument issued by a bank”

– “any extension of credit . . . including the issuance of a letter of credit,

the making of a direct loan, or the purchase of a municipal security by

the bank for its own account”

– “any funds held in a sweep account”

– “any investment made by a bank acting in the capacity of an indenture

trustee or similar capacity”

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Municipal Advisor Exemptions

• Independent Registered Municipal Advisor (“IRMA”) – More commonly used in context of the “issuance of municipal

securities” part of the municipal advisor definition

• Rules establish elements to qualify for IRMA exemption – Independent – measured at firm and individual level

– Person seeking to use exemption “receives a representation in writing that it is represented by, and will rely on the advice of, an independent registered municipal advisor”

• RFP/RFQ – Exemption for any person “providing a response in writing or orally to a

request for proposals or qualifications from a municipal entity or obligated person for services in connection with a municipal financial product or the issuance of municipal securities.”

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Is it regarding:

Issuance of municipal securities

Municipal derivatives

Guaranteed Investment Contracts (GICs)

Investment Strategies

o Bond Proceeds

o Municipal escrow investments

Municipal derivatives

Is an exemption available:

Banks

o Extensions of credit (loans)

o Deposit accounts

o Sweep accounts

o Indenture trustee

Responses to RFPs or RFQs

Independent Municipal Advisor

Registered Investment Advisor

Underwriter

Swap Dealers and Commodity Trading

Advisors

529 Plans

Are you being provided advice that requires registration?

Are you receiving a:

Specific recommendation

Suggestion

Marketing presentation

Trade idea

Are you being provided with:

Education

General market

information/data*

Advertising

NO

REGISTRATION

NEEDED

MUNICIPAL

ADVISOR

REGISTRATION

NEEDED

START HERE

Yes

No

No Yes

*Includes information regarding a financial institution’s currently-available investments (e.g., the terms, maturities, and interest rates at which the financial institution offers these investments) or price quotes for investments available for purchase or sale in the market that meet criteria specified by a municipal entity or obligated person

New Municipal Advisor Regulations

Topic MSRB Rule Effective Date

Supervision and Compliance Obligations Rule G-44 April 23, 2015

Professional Qualifications Rule G-3 April 27, 2015

Gifts and Gratuities Rule G-20 May 6, 2016

Core Standards of Conduct Rule G-42 June 23, 2016

Pay-to-Play Rule G-37 August 17, 2016

MSRB Rulemaking

Source: MSRB Webinar, Approved Rule G-42 on Duties on Non-Solicitor Municipal Advisors,

April 28, 2016 (“MSRB Webinar”)

• Standards of conduct

– Duty of Care

– Duty of Loyalty

• Disclosure of conflicts of interest and legal or disciplinary

events;

• Documentation of the municipal advisory relationship;

• Suitability of recommendations; and

• Specific prohibitions against certain activities

Overview of Rule G-42

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Source: MSRB Webinar

Duty of Care

• A municipal advisor must exercise due care in

performing its municipal advisory activities, which

includes:

– Knowledge and Expertise

• Must possess the degree of knowledge and expertise

necessary to provide the client informed advice

– Inquiry and Investigation

• Must make reasonable inquiry as to the facts

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Duty of Care (continued)

– Inquiry and Investigation

• Must make reasonable inquiry as to facts that are relevant to

a client’s determination as to whether to proceed with a

course of action or that form the basis of advice to the client

• Must conduct a reasonable investigation to determine that it

is not basing any recommendation on materially inaccurate

or incomplete information

• Must have a reasonable basis for: (i) any advice to or on

behalf of the client; (ii) any representations in a certificate to

be relied upon by the client, other parties to the transaction;

and (iii) information in an official statement for an issue as to

which the municipal advisor is advising

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• Municipal advisors owe a duty of loyalty to their

municipal entity clients when performing their municipal

advisory activities

• The duty of loyalty requires advisors to deal honestly and

with the utmost good faith, and to act in the client’s best

interest, without regard for the financial or other interests

of the municipal advisor

• A municipal advisor must not engage in municipal

advisory activities for a municipal entity client if it cannot

manage or mitigate conflicts in a manner that will permit

it to act in the client’s best interest

Duty of Loyalty

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• Prior to or upon beginning services for a client, an MA

must disclose in writing, all material conflicts of interest,

including:

– Advice, services or products provided by an affiliate if

directly related to the MA activities to be performed

– Payments made by the MA to obtain new business

– Payments received from third parties

– Fee-splitting arrangements

– Conflicts related to continent fee compensation

– Other actual or potential conflicts

• Must disclose “no known” material conflicts

Disclosure of Conflicts of Interest and Other

Information

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• In addition, MAs must disclose to the client any legal or

disciplinary events that are material to a client’s

evaluation of the MA

– The disclosure may be fulfilled by identifying the specific

type of event and a specific reference to the relevant

portions of the most recently filed SEC Forms MA and

MA-I

• Detailed information must be provided about where the client

can access SEC Forms MA and MA-I electronically

Disclosure of Conflicts of Interest and Other

Information (continued)

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• Prior to, upon or promptly after beginning a municipal

advisory relationship with a client, a municipal advisor

must detail the relationship in writing, including:

– Form and basis of direct and indirect compensation

– Disclosures related to material conflicts of interest

– Legal or disciplinary events and where SEC Forms MA or

MA-I can be electronically accessed

Documentation of the Relationship

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– Date of the last material change or addition to a legal or

disciplinary event on SEC Forms MA or MA-I

– Scope of the MA services

– Basis of termination of the MA relationship

– Any terms relating to withdrawal from the municipal

advisory relationship

Documentation of the Relationship (continued)

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• Under MSRB Rule G-42(d), if a municipal advisor makes

a recommendation on a municipal securities transaction

or a municipal financial product, or if the review of a

recommendation of another party is requested and within

the scope of the engagement, the municipal advisor

must use reasonable diligence to determine whether a

recommended transaction or municipal financial product

is suitable or not for the client

Suitability of Recommendations

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• The municipal advisor must inform the client of:

– The material risks, potential benefits, structure, and other

characteristics of the municipal securities transaction or

municipal financial product

– The basis upon which it believes the recommended

transaction or product is suitable, or, in the case of review

of a recommendation of another party, is or is not suitable

for the client

– Whether the municipal advisor investigated or considered

other reasonably feasible alternatives to the recommended

municipal securities transaction or financial product

Suitability of Recommendations (continued)

26


• A determination of whether a municipal securities

transaction or financial product is suitable must be based

on factors relating to the client, including, but not limited

to, the client’s:

– Financial situation and needs;

– Objectives;

– Tax status;

– Risk tolerance;

– Liquidity needs;


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– Experience with municipal securities;

– Financial capacity to withstand changes in market

conditions; and

– Any other material information known about the client and

the municipal securities transaction or financial product,

after reasonable inquiry


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• A municipal advisor is prohibited from certain unfair

practices or activities, including but not limited to:

– Receiving excessive compensation in relation to the

municipal advisory activities actually performed;

– Delivering an invoice that does not accurately reflect

activities performed or the personnel that actually

performed those activities;

– Materially misrepresenting, by an affirmative

representation or an omission, the extent of the municipal

advisor’s knowledge or qualifications;

Specified Prohibitions

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– Participating in fee-splitting arrangements with

underwriters;

– Participating in undisclosed fee-splitting arrangements with

providers of investments or services to a client of the

municipal advisor;

– Making payments to secure or retain municipal advisory

business, with limited exceptions; and

– Engaging or an affiliate engaging in a principal transaction

with a municipal entity client that is directly related to the

municipal securities transaction or municipal financial

product for which the municipal advisor is providing or has

provided advice

Specified Prohibitions (continued)

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Bond Proceeds

What are “proceeds”? (Rules)

• “monies derived by a municipal entity from the sale of municipal securities”

• “investment income derived from the investment or reinvestment of such monies”

• “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 of the debt service”

• “investment income derived from the investment or reinvestment of monies in such funds”

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What are “proceeds”?

• SEC did not agree that once proceeds of a municipal offering

are commingled with other funds, they lose their character as

proceeds

• But did provide that once the proceeds “are spent to carry out

the authorized purposes of municipal securities, they cease to

be proceeds of municipal securities.” (Rules)

• Pension Bonds – “proceeds of pension obligation bonds lose

their character as proceeds of municipal securities . . . upon

their contribution to the public pension plan.”

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How does this effect the investment

of bond proceeds?

A few practical considerations

Broker letters, representations, certifications

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• Some Brokers/Market Participants have gone to great lengths to make it the municipality's problem and municipalities should resist

• This is not the municipality's issue (it is the broker’s regulatory issue)

• The MA Rule applies to protect municipal entities

• Attempt to force municipalities to spend time and resources for convenience so they (the brokers) do not have to monitor their own behavior in this regard

Bond Proceeds – GFOA Guidance

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• “Investment bankers will be deemed to have made a “recommendation” when they advise their government clients to buy a particular security

• Additionally, the underwriter may not provide advice related to the investment of bond proceeds unless;

– (1) the government issuer has in place a municipal advisor or an investment adviser, or

– (2) the underwriter is responding to the government’s request for proposal process regarding how to invest the bond proceeds”

(http://www.gfoa.com/gfoa-alert-ma-rule-and-issuers)

http://www.gfoa.com/gfoa-alert-ma-rule-and-issuers











What can a municipal entity do?

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Municipal entities do not have to sign representations, and instead state they will not rely on broker for advice

Municipal entities do not sign representations, and instead state they will not rely on broker for advice as they have an RIA (however the RIA does not have a statutory safe harbor) - this relies upon the instruction to the broker not to provide direct advice

Entities sign the representations, and instruct that they have an IRMA (the IRMA must have competency with bond proceed investing within scope of services)

Whenever trading securities, municipal entities issue mini-RFP by means of circulating a bid/offer sheet for brokers to respond to by providing information for entities to consider/execute

Do nothing?

What should a municipal entity do?

38

• It may depend upon the size of the entity,

staffing, investment portfolio, and volume of

trading

• Can this have portfolio structure implications?

• What if a municipal entity is accustomed to

taking broker ‘recommendations’ for trades?

• What role can someone play as a registered

investment adviser?

Considerations regarding

Fiduciary Duty and Responsibilities

• Most federally registered broker-dealers (“BDs”), municipal

advisors (“MAs”), and investment advisers (“RIAs”) are very

familiar with how the federal securities laws and the rules of

the Securities Exchange Commission (“SEC”) and any

applicable self-regulatory organization (“SRO”) impact their

business practices.

• As required by the SEC and SROs, BDs and RIAs have

written compliance procedures and assign compliance

officers to oversee their firm’s investment, advisory, and

trading activities.

General – Federal Regulatory Requirements

40

• A broker-dealer is subject to the Securities Exchange Act of 1934, as amended (“Exchange Act”), and is required to register pursuant to rules established by the SEC and an applicable SRO, if he or she on an interstate basis effects securities transactions or induces another party to enter into the purchase or sale of securities.

• BDs, pursuant to the Exchange Act, are subject to antifraud provisions. These provisions have been interpreted by the SEC and FINRA to establish a duty of fair dealing.

• According to the Second Circuit, the Exchange Act establishes a “special relationship” between the BD and the client whereby the BD is in a position of trust such that the client should be able to assume statements made by the BD are thoughtful and accurate.

• FINRA Rule 2010 also provides that a BD “in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.”

Broker Dealers – Regulation and Requirements

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Anti-fraud Provisions:

• cause a client to enter into a securities transaction “by means

of any manipulative, deceptive, or other fraudulent device or

contrivance.”

• use “any manipulative or deceptive device or contrivance”

contrary to the rules established by the SEC or SRO to

protect the interest of clients.

A Broker Dealer may not…

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• Inherent in this duty of fair dealing is a requirement that a BD make a “suitability” determination with respect to securities transactions it recommends to its customers.

• Thus, BDs, based upon a number of criteria, must make a determination that a recommended trade is suitable for at least some investors in general (reasonable basis suitability) and is suitable for a particular customer (customer-specific suitability and quantitative suitability).

• BDs are also subject to a duty of best execution and a duty to disclose conflicts in certain situations. However, federal securities laws do not impose a fiduciary duty on BDs.

Broker Dealers – Regulatory Duty to Customers

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• Duty to deal fairly with clients;

• Duty to make suitability determination. – “reasonable-basis” – after reasonable due diligence, reasonable basis

to believe recommendation is suitable for at least some investors.

– “customer-specific” – suitable for the specific client given such client’s investment profile.

– “quantitative” - reasonable basis to believe that a series of recommended transactions is not excessive or otherwise unsuitable given such client’s investment profile.

• Duty of best execution – use reasonable diligence to achieve as favorable of a price as possible under prevailing market conditions.

• Duty to disclose conflicts in certain situations.

Broker Dealers - Duty to Customers

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• RIAs do owe a fiduciary duty to their clients.

• Part and parcel to this fiduciary duty is that RIAs owe a duty

of loyalty to their clients. An RIA must “serve the interests of

his client with undivided loyalty.”

• the RIA as a fiduciary “must not put himself into a position

where his or her own interests may come in conflict with

those of his [client],” though there is an exception to this

general prohibition “where the [client] gives informed consent

to such dealings.

Registered Investment Advisers - Requirements

45

• the RIA should not make investment decisions, including trades in securities, in a manner that will benefit the RIA without first disclosing the existence of the conflict to the client.

• The content and frequency of such disclosure varies based upon the facts and circumstances of the situation. In effect, informed consent given by a client to the RIA is permitted by the Advisers Act and will overcome a breach of the duty of loyalty owed by the RIA to the client.

• The SEC also holds RIAs to a duty to make a determination of “suitability” in delivering investment advice to a client and, if the RIA has discretion to make trades through BDs, RIAs are required to seek “best execution”.

Registered Investment Advisers – Requirements

46

Antifraud provisions -

• act in a manner designed to manipulate, defraud, or deceive

its clients or prospective clients.

• engage in any course of conduct that will have the effect of

manipulating, defrauding, or deceiving a client or prospective

client.

Registered Investment Advisers may not…

47

• Duty to disclose material facts;

• Duty of loyalty (including a duty to not engage in transactions involving a conflict of interest unless such conflicts are disclosed);

• Duty to determine suitability (including a duty to inquire) – reasonable determination that advice is appropriate based upon client’s financial situation, investment experience, and investment objectives;

• Duty of best execution – seek best price at which trades could be executed in light of facts and circumstances (dealer mark ups and mark downs, brokerage commissions, etc.). RIA must also consider compensation paid to the RIA.

• SEC regulations specifically address agency cross transactions, principal trades, custody, and proxy voting.

Registered Investment Advisers – Fiduciary Duties

48

• Dodd-Frank requires municipal advisors to put their clients’

interests first without regard to their own financial or other

interests

– SEC MA Rule provisions

• MSRB rulemaking further addresses the application of

fiduciary duty for municipal advisors

– MSRB regulation, primarily MSRB Rule G-42

Municipal Advisors - Requirements

49

• MSRB Rule G-17 applies to municipal advisors as well as municipal securities dealers (Underwriters)

– Must deal fairly with all persons

– Must not engage in any deceptive, dishonest or unfair practice

• Elements of MSRB Rule G-42

– Duty of loyalty and care to municipal entity

– Recommendations must be in best interest of municipal entity

– Achieved necessary qualifications to render informed advice

– Obligation to investigate reasonably feasible alternatives

– Disclosure of conflicts of interest and receipt of municipal entity's informed consent

– Addressing certain unmanageable conflicts, for example:

• Kick-backs

• Fee-splitting

Municipal Advisors – MSRB Regulation

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What is a fiduciary relationship?

• “A fiduciary relationship is ‘ “ ‘any relation existing between parties to a transaction wherein

one of the parties is in duty bound to act with the utmost good faith for the benefit of the

other party. Such a relation ordinarily arises where a confidence is reposed by one person in

the integrity of another, and in such a relation the party in whom the confidence is reposed, if

he voluntarily accepts or assumes to accept the confidence, can take no advantage from his

acts relating to the interest of the other party without the latter’s knowledge or consent. …”

(Wolf v. Superior Court (2003) 107 Cal.App.4th 25, 29 [130 Cal.Rptr.2d 860], internal

citations omitted.)

• "[A] fiduciary relationship is a recognized legal relationship such as guardian and ward,

trustee and beneficiary, principal and agent, or attorney and client [citation]." (Richelle L. v.

Roman Catholic Archbishop (2003) 106 Cal.App.4th 257, 271.)

CA Considerations – selected California case law

51

What are a fiduciary’s duties?

• “Every agent owes his principal the duty of undivided loyalty. During the course of his

agency, he may not undertake or participate in activities adverse to the interests of his

principal. In the absence of an agreement to the contrary, an agent is free to engage in

competition with his principal after termination of his employment but he may plan and

develop his competitive enterprise during the course of his agency only where the particular

activity engaged in is not against the best interests of his principal.” (Sequoia Vacuum

Systems v. Stransky (1964) 229 Cal.App.2d 281, 287 [40 Cal.Rptr. 203].)

• A fiduciary must give "priority to the best interest of the beneficiary. [Citation.]" (Committee

on Children's Television, Inc. v. General Foods Corp. (1983) 35 Cal.3d 197, 222 (Children's

Television).)

• In addition to this duty of preference toward the beneficiary, the fiduciary also is required to

manage the subject matter of the relationship (or res) with due care, must account to the

beneficiary, and must keep the beneficiary fully informed as to all matters pertinent to the

beneficiary's interest in the res. (See Chodos, The Law of Fiduciary Duties (2000), pp. LIV-

LV.)

CA Considerations – selected California case law

52

Questions and Answers

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Disclosure of Conflicts of Interest and Legal or Disciplinary Events

Pursuant to Municipal Securities Rulemaking Board (“MSRB”) Rule G-42, on Duties of Non-Solicitor Municipal Advisors, Municipal Advisors are required to make certain written disclosures to clients which include, amongst other things, Conflicts of Interest and any Legal or Disciplinary events of KNN Public Finance, LLC (“KNN Public Finance”) and its associated persons.

Conflicts of Interest

KNN Public Finance represents that in connection with the issuance of municipal securities, KNN Public Finance may receive compensation from an Issuer or Obligated Person for services rendered, which compensation is contingent upon the successful closing of a transaction and/or is based on the size of a transaction. Consistent with the requirements of MSRB Rule G-42, KNN Public Finance hereby discloses that such contingent and/or transactional compensation may present a potential conflict of interest regarding KNN Public Finance’s ability to provide unbiased advice to enter into such transaction. This conflict of interest will not impair KNN Public Finance’s ability to render unbiased and competent advice or to fulfill its fiduciary duty to the Issuer.

If KNN Public Finance becomes aware of any additional potential or actual conflict of interest after this disclosure, KNN Public Finance will disclose the detailed information in writing to the Issuer in a timely manner.

Legal or Disciplinary Events

KNN Public Finance, LLC, has never been subject to any legal, disciplinary or regulatory actions nor was it ever subject to any legal, disciplinary or regulatory actions previously, when it was a division of Zions First National Bank or Zions Public Finance, Inc.

A regulatory action disclosure has been made on Form MA-I for one of KNN Public Finance municipal advisory personnel relating to a 1998 U.S. Securities and Exchange Commission (“SEC”) order that was filed while the municipal advisor was employed with a prior firm, (not KNN Public Finance). The details of which are available in Item 9; C(1), C(2), C(4), C(5) and the corresponding regulatory action DRP section on Form MA and Item 6C; (1), (2), (4), (5) and the corresponding regulatory action DRP section on Form MA-I. Issuers may electronically access KNN Public Finance’s most recent Form MA and each most recent Form MA-I filed with the Commission at the following website: www.sec.gov/edgar/searchedgar/companysearch.html.

The SEC permits certain items of information required on Form MA and Form MA-I to be provided by reference to such required information already filed on a regulatory system (e.g., FINRA CRD). The above noted regulatory action has been referenced on both Form MA and MA-I due to the information already filed on FINRA’s CRD system and is publicly accessible through BrokerCheck at http://brokercheck.finra.org. For purposes of accessing such BrokerCheck information, the Municipal Advisor’s CRD number is 4457537.

KNN Disclosures

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http://www.sec.gov/edgar/searchedgar/companysearch.html

http://brokercheck.finra.org/

SEC Municipal Advisor Rule Fiduciary Responsibilities · 2016-10-04 · Suggestion Marketing...

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Transcript of SEC Municipal Advisor Rule Fiduciary Responsibilities · 2016-10-04 · Suggestion Marketing...