The SEC’s Municipal Advisor Rule Will Prompt New Practices For Market Participants

A new rule will take effect on July 1, 2014 that regulates persons and firms that provide advice to municipal issuers and obligated parties regarding municipal financial products or the issuance of municipal securities. Although the Municipal Advisor Rule (the Rule) was originally scheduled to take effect on January 13, 2014, the U.S. Securities and Exchange Commission (SEC) has postponed the effective date to allow the participants in the municipal securities marketplace more time to analyze, implement and comply with the Rule. In the meantime, the SEC staff has issued unofficial guidance in the form of frequently asked questions (FAQ). In addition, on January 9, 2014, the Municipal Securities Rulemaking Board (MSRB) issued for comment a draft regulatory notice regarding the Rule. Additional guidance will be issued by the MSRB, and likely the SEC as well, over the coming months.

The Rule will carry out a requirement of the Dodd-Frank Act, which provides that it is illegal for a municipal advisor to provide advice regarding municipal financial products or the issuance of municipal securities unless the Municipal Advisor is registered with the SEC. Prior to enactment of the Dodd-Frank Act, the only financial advisors subject to federal regulatory requirements were broker-dealers and banks. The Rule exempts certain persons from being considered a Municipal Advisor with respect to a specific transaction.

The Rule will change how information flows in the municipal securities market. The only persons who will legally be permitted to provide certain kinds of advice will be Municipal Advisors and those who fall within an exception.

A threshold issue for market participants is determining whether they meet the definition of a "Municipal Advisor" and, if excepted, what the limits of the applicable exception are. For municipal securities issuers and obligated persons (that is, generally, conduit borrowers such as tax-exempt health care institutions, developers of low income housing or providers of certain tax-advantaged facilities), the Rule may significantly restrict the flow of information from other market participants, such as underwriters. This Client Alert will touch briefly on who is treated as a Municipal Advisor, the standards applicable to Municipal Advisors, how the Rule may affect municipal securities issuers and obligated persons (collectively referred to as "Borrowers") as well as other market participants, and it will conclude with some suggestions as to how Borrowers and other market participants may promote the flow of information.

Who Is a Municipal Advisor?

The Rule defines a "Municipal Advisor" as a person that, unless excluded or exempted under the Rule, 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, or undertakes a solicitation of a municipal entity or an obligated person. Unless exempted, a Municipal Advisor must register with the SEC, owes certain duties to its clients, and cannot act in ways that are adverse to its clients. Thus, for example, a firm that is a Municipal Advisor to a Borrower may not serve as an underwriter for securities issued by that Borrower with respect to which the firm provided municipal advice. An unregistered person or firm that provides municipal advisory services and does not qualify for an exemption is violating federal securities laws and subject to sanctions by the SEC.

Unpacking the Definition

To understand the Rule and its potential impact, it is helpful to review the key terms, which are highlighted above.

Advice. According to the SEC, "advice" does not have bright-line definition. However, information of a general nature that does not involve a recommendation will not be considered to be "advice", whereas information that involves a recommendation, or that invites a Borrower to act or refrain from acting, with respect to an issuance of municipal securities or investment of the proceeds of such securities will likely be considered to be advice. The more the information addresses the specific needs, objectives, or circumstances of a Borrower with respect to municipal financial products or the issuance of municipal securities, the more likely the SEC would find that such information is "advice". Note that the SEC has stated that it does not believe that a person must receive compensation from a Borrower for providing advice in order to be considered a Municipal Advisor.

The FAQ provides further guidance. Information that is particularized to a Borrower could fall within the general information exclusion if it is "factual in nature and does not contain or express subjective assumptions, opinions or views, or constitute a recommendation." Further, disclosure and disclaimers bear upon whether or not a person's communications with a Borrower would be a recommendation. Similarly, business promotional materials are not "advice" if such materials are factual. Examples given include a "hypothetical new issue pricing range that takes into consideration current market conditions and certain factual information particularized to an issuer ... and mathematical calculations of an...