Proposed Municipal Advisor RulesUnder the Dodd-Frank Act

Timothy V. McGreeChapman and Cutler LLP

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Sources

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Section 975 of Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Public Act No. 111-203) as amending Section 15B of the Securities and Exchange Act

Release No. 34-63576 (the “Release”) of the SEC Proposing New Rules 15Ba1-1 through 15Ba1-7 and new Forms MA, MA-1, MA-W and MA-NR relating to Municipal Advisors. Note: This release deals with proposed rules.

Reasons for the New Provisions1. Municipal Advisors (MA) have previously been (in general)

unregulated2. Growth in the municipal bond market place since the last

major statutory regulatory actions (1975) has been enormous

a. MA’s participated in $315B in municipal debt in 2008b. In 1975, total outstanding municipal bond debt was

$235B. $474B was issued in 2009 alone. Total outstanding municipal bond debt as of March 2010 was over $2.8T

3. Complexity of market has increased—derivatives, VRDO’s, ARB’s

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Statute Requires registration and oversight of MA by SEC. Section 15B(a)(1)

“It shall be 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 the municipal advisor is registered in accordance with this subsection.” [Emphasis added]

1.Duty to register

2.Oversight and Responsibilities

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You can analyze the statute’s requirements as follows:– Who?– To Whom?– Providing What Advice?– What Consequences?

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As in many statutes and regulations, definitions are important– Who?

Municipal AdvisorA.A person (who is not a municipal entity or an employee of a

municipal entity) that—i. provides advice to or on behalf of a municipal entity or

obligated person 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

ii. undertakes a solicitation of a municipal entity;[Emphasis Added]

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Who includes—(B) financial advisors, guaranteed investment contract brokers, third-party marketers, placement agents, solicitors, finders, and swap advisors, if such persons are described in any of clauses (i) through (iii) of subparagraph (A)

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But Not—(C) does not include a broker, dealer, or municipal securities dealer serving as an underwriter (as defined in section 2(a)(11) of the Securities Act of 1933) (15 U.S.C. 77b(a)(11)), any investment adviser registered under the Investment Advisers Act of 1940, or persons associated with such investment advisers who are providing investment advice, any commodity trading advisor registered under the Commodity Exchange Act or persons associated with a commodity trading advisor who are providing advice related to swaps, attorneys offering legal advice or providing services that are of a traditional legal nature, or engineers providing engineering advice.Note the exclusion does not extend to accountants. Limits on exclusions are discussed below.

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To Whom?– Municipal Entities

A. [No surprises here] These are states, subdivisions, agencies, instrumentalities

B. [Broad reach here] Any plan, program, or pool of assets sponsored by any of the above listed in ( A) and

C. Any other issuer of municipal securities

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Obligated Persons (From Section 15B(e)(10) of the Exchange Act) (Also consistent with Rule 15c2-12)

“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 payment of all, or part of the obligations on the municipal securities to be sold in the Offering (other than providers of municipal bond insurance, letters of credit, or other liquidity facilities).”These persons include “conduit” obligors, such as universities hospitals, some economic development borrowers, and also governmental units participating in a joint action agency, such as municipalities in an electric or water joint action entity.

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For What? I.e. What constitutes advice “with respect to municipal

financial products or the issuance of municipal securities”1. The easy part. Issuance of municipal securities. What

you would expect: structuring, pricing, assisting in drafting offering documents, negotiating terms, etc.

2. The hard (broad) part. Municipal financial products:

Quoted from the Release. Footnotes omitted.

“Section 15B(e)(5) provides that the term “municipal financial product” means “municipal derivatives, guaranteed investment contracts, and investment strategies.” Exchange Act Section 15B(e(3) provides that “the term ‘investment strategies’ includes plans or programs for the investment of the proceeds of municipal

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(continued)

securities that are not municipal derivatives, guaranteed investment contracts, and the recommendation of and brokerage of municipal escrow investments”. . . .The Commission notes that the definition of “investment strategies” provides that it “includes” plans or programs for the investment of the proceeds of municipal securities and, therefore, the Commission interprets the definition to mean that it includes, without limitation, the investment of the proceeds of municipal securities. Further, the Commission interprets this definition to include plans, programs, or pools of assets that invest funds held by or on behalf of a municipal entity, and, therefore, any person that provides advice with respect to such funds must register as a municipal advisor unless it is covered by one of the exclusions discussed below. . . .

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(continued)

Based on these definitions, the Commission believes it was Congress’s intent to include in the definition of “municipal advisor” persons that 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. 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 a child’s college expenses, general monies of state and local governments being temporarily invested prior to their budgeted expenditures, and pension contributions from employees and state and local government employers. As a result, the Commission does not believe that it was Congress’s intent to limit the requirement to register as a municipal advisor only to those persons that provide advice with respect to plans or programs for the investment of

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(continued)

proceeds from municipal securities. 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.

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So you are giving advice subject to being a municipal advisor if you advise a municipal entity or obligated person (including pension plans or other pools) as to investment of any funds including any corporate funds including advice as to bank accounts.

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Solicitation You are a municipal advisor if you solicit (paid or unpaid) on

behalf of a broker, dealer, municipal securities dealer, municipal advisor or investment advisor

(So long as you are not employed by a firm controlling, controlled, or under common control of firm for whom solicitation made)

No de-minimus exception in proposed rules

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Review of Exclusions from Municipal Advisor Basic theme: Here are exclusions but they are limited to what

you do in excluded activity (Don’t cross the line.)1. Broker, Dealer or Municipal Securities Dealer acting as

underwriter in connection with the issuance of municipal securitiesBut — Not with respect to the investment of bond proceeds

orAdvisability of a derivatives product

orAs agent in a private placement

orUncompensated advice

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2. Registered Investment Advisers under the Investment Advisers Act of 1940But — These are mostly money managers

andNot bond structuring

orSolicitation

3. Commodity Trading Advisors which are registered under the Commodity Exchange Act

But — Only for swaps

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4. Attorneys, Engineers and Other ProfessionalsBut — Not accountants (limited to audits or comfort letters)

andAttorneys limited to advice of “traditional legal nature”

andEngineers limited to engineering services (not feasibility

studies or cash flow projections)

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5. Employees of Municipal Entities, Elected OfficialsBut — Not appointed board members (Rule likely to change)

6. Banks or trust companies are not within an excluded category, even if providing “traditional banking services” or trust companies providing “investment advisory services”

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What Consequences? If you are a municipal advisor — you must register (both firm

and individuals)– Be subject to oversight (register, testing, fees)– Have duties to your clients

Failure to register can result in fines, injunctions and, in extreme cases, possible criminal penalties.

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Registration Forms MA and MA-1 (in general) File electronically Information

– Identity– Addresses (5 years)– Employment history (10 years)– Disciplinary history– Signature– Other businesses– For Firms — Chief Compliance Officer– For Firms — Form of Organization– For Firms — Describe business– For Firms — Other information designed to discover conflicts of interest– Certain additional requirement for a non-resident firm

There is a separate form for withdrawal

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Keep books and records — applies only to municipal advisory firms (including sole proprietors) but not natural persons

Still covers almost all MA What? True, accurate and current

- All communications received or sent- Including inter-office communications- All financial records (checkbooks, etc.)- Any policies and procedures- Any document created relevant to advice- All contracts- All personnel

Time? 5 years2 years readily accessibleNote: For attorneys, waives any privilege

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Duties Dodd-Frank Act provides

– That a municipal advisor and any person associated with such municipal advisor shall be deemed to have a fiduciary duty to any municipal entity for whom such municipal advisor acts as a municipal advisor and prohibits municipal advisors from engaging in any act, practice, or course of business which is not consistent with a municipal advisor’s fiduciary duty or that is in contravention of any rule of the Board (amended Exchange Act §15B(c)(1)).

and directs Rule-making by MSRB to– Provide for appropriate classification of municipal advisors and

associated persons, applicable standards of training and competence, and testing;

– Add coverage of municipal financial products in rules designed to prevent fraudulent and manipulative acts and practices, promote just and equitable principles of trade;

– Add municipal entities and obligated persons to the goals of protection of investors and the public interest pursued by such rules;

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– Provide for periodic examination of municipal advisors;– Prescribe record-keeping requirements;– Provide for fees to be paid by municipal advisors, as well as municipal

securities brokers and municipal securities dealers, to the Board, including changes for failure to submit to the Board, or to any information system operated by the Board, within the prescribed timeframes, any items of information or document required to be submitted under any rule issued by the Board;

And specifically with respect to Municipal Advisors– Prescribe means reasonably designed to prevent acts, practices, and

courses of business as are not consistent with a municipal advisor’s fiduciary duty to its clients;

– Provide continuing education requirements for municipal advisors;– Provide professional standards; and– Not impose a regulatory burden on small municipal advisors that is not

necessary or appropriate in the public interest and for the protection of investors, municipal entities, and obligated persons, provided that there is robust protection of investors against fraud.

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Fees– For registration and in doing business are in place

MSRB Rules A-7, A-12, A-14 Applicability of Rules G-5 (c) No municipal advisor shall engage in municipal advisory activities

in contravention of any effective restrictions imposed upon such municipal advisor by the Commission pursuant to section 15B(c)(2) or (3) of the Act, and no natural person shall be associated with a municipal advisor in contravention of any effective restrictions imposed upon such person by the Commission pursuant to section 15B(c)(4) of the Act.

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G-17 In the conduct of its municipal securities or municipal advisory

activities, each broker, dealer,†municipal securities dealer, and municipal advisor†shall deal fairly with all persons and shall not engage in any deceptive, dishonest, or unfair practice.

Short section. Great duty of care.

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This document has been prepared by Chapman and Cutler LLP attorneys for informational

purposes only. It is general in nature and based on authorities that are subject to change. It

is not intended as legal advice. Accordingly, readers should consult with, and seek the

advice of, their own counsel with respect to any individual situation that involves the

material contained in this document, the application of such material to their specific

circumstances, or any questions relating to their own affairs that may be raised by such

material.

© 2011 Chapman and Cutler LLP

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