MSRB Issues Guidance on New Underwriter Disclosure Requirements

July 31, 2012

On August 2, 2012, a new Municipal Securities Rulemaking Board (“MSRB”) interpretive notice1 (the “Notice”) will take effect and will establish guidelines for a municipal securities underwriter’s obligations to issuers under MSRB Rule G-17. The MSRB has issued implementation guidance2 (the “Guidance”) to advise dealers of the MSRB’s expectations on how firms should incorporate the Notice into their procedures and operations.

The Notice describes the “robust” disclosure obligations that are required of municipal securities dealers when they act as underwriters to municipal issuers, specifically with respect to their roles, compensation, and actual or potential material conflicts of interest with respect to municipal securities issuances. The Notice also requires disclosure related to complex financings and explains non-disclosure-related obligations concerning underwriter compensation, pricing, and retail order commitments.

The Notice largely excludes competitive offerings from its requirements, and thus is generally limited to negotiated underwritings. However, the MSRB notes that it has a narrow view of what constitutes a competitive offering, i.e., new issues sold on the basis of the lowest priced bid by potential underwriters and not just where the issuer publishes a request for proposal. The Notice generally applies to primary offerings by a dealer acting as underwriter as well as placement agent, as well as to dealers serving as a primary distributor (but not to dealers acting solely as selling dealers).

The Notice’s requirements can be divided into three broad categories: prohibitions on misrepresentations, fairness of financial aspects of an underwriting, and required disclosures to issuers. The Guidance provides summaries of these requirements accompanied by “practical considerations” that illustrate how the MSRB expects its members to implement the Notice. The Guidance states that dealers are required to update, test, and verify their written supervisory procedures and to provide appropriate training for any revisions to such procedures.

I. Prohibitions on Misrepresentations

a. Basic Fair Dealing Principle. The Notice establishes a “basic fair dealing principle” that underwriters “must not misrepresent or omit the facts, risks, potential benefits, or other material information about municipal security activities undertaken” with an issuer. This principle applies to any representation, written or oral, and requires underwriters to have a reasonable basis for the representations and other material information contained in documents they prepare for themselves or issuers, and to refrain from including representations or other information they know or should know is inaccurate or misleading. When an underwriter is uncomfortable with an issuer relying upon a representation or information, it should either refrain from making the representation or provide appropriate disclosures regarding the reliability of the representation. In addition, underwriters should be careful to distinguish statements representing opinion as such rather than as fact.

The Guidance provides several examples to which the basic fair dealing principle applies, including any representations made in certificates. Other examples include:

  • Information provided for use in the official statement. The MSRB cautions that the “reasonable basis” requirement extends to the assumptions underlying the materials information provided to issuers, and that the less certain an underwriter is of its assumptions, the more cautious it should be in using the assumptions and fully disclosing the degree and nature of its uncertainties.
  • Responses to requests for proposals (RFP), which must (1) fairly and accurately represent the underwriter’s capacity, resources, and knowledge to perform the specific underwriting and not contain any representations or material information that the underwriter knows or should know to be inaccurate or misleading; (2) contain only items that are either within the personal knowledge of those preparing it or confirmed by those with knowledge; and (3) not represent that the underwriter has the requisite knowledge or expertise for the financing unless those personnel the underwriter intends to have work on the financing in fact have such knowledge or expertise. The MSRB states that a response to an RFP should “not be treated merely as a sales pitch without regulatory consequence, but instead should be treated with full seriousness that issuers have the expectation that representations made in such responses are true and accurate.”
  • Representations made in negotiations with an issuer, including regarding the price negotiated, the level of investor demand, and the effort exerted to obtain favorable pricing for the issuer.
  • Representations regarding investors, including (1) whether they meet the issuer’s definition of “retail,” for which the underwriter must take reasonable measures to determine that retail clients are bona fide; (2) the underwriter’s agreement to underwrite a transaction with a retail order period and not allocate securities in a manner inconsistent with an issuer’s requirements without the issuer’s consent; and (3) placing or accepting an order framed as a retail order when it does not comport with the issuer’s expectations regarding retail orders (for example, a number of small orders placed by an institutional investor that would otherwise not qualify as a retail customer).

b. Prohibition on Discouraging the Use of a Municipal Advisor. Underwriters in a negotiated underwriting cannot recommend against an issuer retaining a municipal advisor, or otherwise imply that hiring a municipal advisor would be redundant to hiring the underwriter.

II. Fairness of Financial Aspects of an Underwriting

a. Excessive Compensation. Underwriters cannot charge or collect compensation (either direct payments or indirect payments such as payments, values, or credits received from the issuer or any other party in connection with the underwriting) that is, in light of the specific facts and circumstances of the offering, “so disproportionate to the nature of the underwriting and related services performed as to constitute an unfair practice to the issuer.” Relevant factors for determining whether an underwriter’s compensation is disproportionate to the nature of the underwriting include the credit quality of the issue, the size of the issue, market conditions, the length of time spent structuring the issue, and who is paying the fees of underwriter’s counsel or any other costs related to the financing.

b. New Issue Pricing. The price an underwriter pays to an issuer for an offering must be fair and reasonable under all relevant factors, including the underwriter’s best judgment as to the fair market value of the issue at the time of pricing. The application of this principle may depend on the type of offering:

  • In a competitive offering where the issuer may reject any and all bids, a dealer satisfies its duty of fairness in pricing to the issuer if the dealer’s bid is bona fide based on its best judgment of the fair market value of the securities.
  • In a negotiated underwriting, the underwriter must negotiate in good faith with the issuer and stand by the accuracy of any representations it makes during negotiations, as described above.

c. Profit Sharing Arrangements. An arrangement to directly or indirectly share profits between the underwriter and an investor purchasing new issue securities from the underwriter could constitute a violation of the underwriter’s fair dealing obligations to the issuer under Rule G-17, depending on the facts and circumstances (in particular if such resale occurs reasonably close in time to the original sale by the underwriter to the investor). In any event, such arrangements, whether a violation of the duty of fair dealing, are subject to the disclosure obligations described below. Such arrangements can be inferred in the absence of a written agreement, from a pattern of trading or other behavior, and may not only violate MSRB Rule G-25(c), but also the underwriter’s duty of fair pricing.

d. Payments to Issuer Personnel. Underwriters cannot characterize “excessive or lavish” expenses for the personal benefit of issuer personnel as expenses for which it seeks reimbursement from the issuer or issue proceeds. This prohibition is in addition to the requirements of MSRB Rule G-20, which limits the value of gifts and gratuities for the personal benefit of issuer personnel.

III. Required Disclosures to Issuers —Substance of Disclosures

a. Disclosure of Role. In a negotiated underwriting, an underwriter must disclose to the issuer the following specific information regarding its role in an issuance of municipal securities:

  • That the underwriter is required by Rule G-17 to deal fairly with both issuers and investors.
  • That the underwriter’s primary role in an issuance is purchasing securities with a view to distribution in an arm’s-length commercial transaction with the issuer, and that the underwriter has financial and other interests that differ from the issuer’s interests. However, in a private placement where the dealer is acting as placement agent, takes on a true agency role with the issuer, and does not take a principal position (including not taking a “riskless principal” position), this disclosure would be inapplicable and may be omitted.
  • That, unlike a municipal advisor, the underwriter is not a fiduciary under federal law and thus is not required to act in the best interests of the issuer without regard to its own financial or other interests. As with the preceding disclosure, in a private placement where the dealer acts as a true placement agent, this disclosure would be inapplicable.
  • That the underwriter has a duty to purchase securities from the issuer at a fair and reasonable price, but must balance its duty to sell the securities to investors at fair and reasonable prices.
  • That the underwriter will review the official statement in accordance with its responsibilities to investors under the federal securities laws. However, where no official statement will be produced, as in some private placements, this disclosure would be inapplicable.

b. Disclosure of Conflicts of Interest. In a negotiated underwriting where there is a real or potential material conflict of interest, the underwriter must disclose such a conflict to the issuer. The categories of disclosures regarding conflicts include, but are not limited to:

  • Whether the underwriter’s compensation will be contingent on the closing of a transaction, and that compensation that is contingent on the closing or size of a transaction presents a conflict of interest, because it may lead the underwriter to recommend a transaction or transaction size that it is unnecessary.
  • Whether the underwriter will receive any compensation from parties other than the issuer (including affiliates of the underwriter) in connection with its underwriting of the transaction or “any collateral transactions integrally related to the underwriting.” However, this would not apply to third-party arrangements for products and services “of the type that are routinely entered into in the normal course of business, so long as any specific routine arrangement does not give rise to an actual or potential conflict of interest.”
  • Whether the underwriter has agreed with third parties to market the issuer’s securities.
  • Whether the underwriter has any profit-sharing arrangements with an investor, which may, as noted above and depending on the facts and circumstances (including in particular if such resale occurs reasonably close in time to the original sale by the underwriter to the investor), constitute a violation of Rules G-17 and/or Rule G-25(c).
  • Whether the underwriter has issued or purchased credit default swaps (“CDS”) (1) for which the reference is the issuer or an issuer obligation, (2) that are based on baskets or indices of municipal issuers and either the issuer or its obligation(s) represents more than 2 percent of the total notional amount of the CDS, or (3) for which the underwriter otherwise caused the issuer or its obligation(s) to be included in the basket or index.
  • Whether the underwriter has any incentives to recommend a Complex Financing and associated conflicts of interest, regardless of the level of sophistication of issuer personnel.
  • Note that when the conflict relates to any payments, values, or credits, the amounts of such payments need not be disclosed.

c. Disclosures in Complex Financings. In a negotiated underwriting where the underwriter recommends a “complex municipal securities financing”, the underwriter must disclose the material financial characteristics and reasonably foreseeable material financial risks of the Complex Financing. The Guidance defines a Complex Financing as “a new issue financing that is structured in a unique, atypical, or otherwise complex manner that issuer personnel responsible for the issuance of municipal securities would not be well positioned to fully understand or to assess the implications of the financing in its totality.” The Guidance gives as examples: (1) variable rate demand obligations (VRDOs) (the Guidance provides specific disclosure requirements for VRDO financings); (2) financings involving derivatives (such as CDS); and (3) financings in which the interest rate is benchmarked to an index that is commonly used in the municipal market (e.g., LIBOR or SIFMA), which may be complex to an issuer that does not understand the index or its possible interaction with other indexes.

If a financing is a Complex Financing only because of a unique, atypical or complex element, and the issuer personnel have knowledge or experience with respect to the routine elements of the financing, then the underwriter’s disclosure of material risks and characteristics may be limited to such specific element and any material impact such element may have on the other routine features.

Disclosure is only required if the underwriter recommends the Complex Financing, and the MSRB recognizes that not all transactions involve a recommendation by the underwriter. Where there is a recommendation, the level of disclosure may vary according to the issuer’s knowledge with the structure of the Complex Financing, and may also vary over time. If the issuer gains experience with a particular Complex Financing structure over multiple issues, the required level of disclosure may decrease. But if an issuer replaces seasoned personnel with less experienced staff, the level of disclosure may increase.

Disclosures regarding Complex Financings must address the specific financings at issue, rather than being broad and general “boilerplate” disclosures. Such disclosures can be drawn from individualized descriptions created in advance for structures or products that the underwriter recommends for various clients. However, such standardized descriptions still must be tailored for each issuer client, as appropriate.

In determining what constitutes a Complex Financing, underwriters must make reasonable judgments premised on the view that a structure or product common in the market may still be a Complex Financing.

The MSRB provides the following non-exclusive, non-exhaustive list of practical factors as tools for identifying Complex Financings:

  • Whether the underwriter’s internal risk management process for approving an underwriting engagement could be helpful in identifying Complex Financings.
  • Whether the particular type of structure or product is handled exclusively by the underwriter’s most experienced or specialized professionals.
  • Whether the particular type of structure or product gives rise to significant disclosures when assisting the issuer in preparing the official statement.
  • Whether a particular feature or other characteristic of the structure or product creates more difficult secondary market pricing determinations as compared to the rest of the marketplace.

With respect to recommended VRDO financings, the underwriter’s disclosure of material financial risks must include: (1) the risk of interest rate fluctuations; and (2) material risks of any associated credit or liquidity facilities, for example, the risk that the issuer might not be able to replace the facility upon its expiration and might be required to repay the facility provider over a short period of time.

Where a recommended VRDO financing also includes a recommendation that the issuer swap the floating rate interest payments on the VRDOs to fixed rate payments, the underwriter must also disclose:

  • The material financial risks of the financing, which include the above risks generally applicable to VRDO financing, and also market risk, credit risk, and liquidity risk. Such disclosures:
    • Must be accompanied by a statement that there may be accounting, legal, and other risks associated with the swap and that the issuer should consult with other professionals concerning such risks.
    • Should be sufficient to allow the issuer to assess the magnitude of its potential exposure as a result of the Complex Financing.
    • May be provided to the underwriter by its affiliated swap dealer or the issuer’s swap or other financial adviser, provided that the underwriter has a reasonable basis for belief in the truthfulness and completeness of such disclosure.
    • Are not required to be provided by the underwriter with regard to a swap entered into between the issuer and another dealer not recommended by the underwriter.
  • The material financial characteristics of the recommended swap, including, but not limited to:
    • The material economic terms of the swap.
    • The material terms relating to the operation of the swap.
    • The material rights and obligations of the parties during the term of the swap.
  • Any other disclosures required by the CFTC or the SEC, to the extent applicable.

d. Disclosures in Routine Financings. Even in routine, non-Complex Financings, if an underwriter reasonably believes the issuer official responsible for the issuance lacks knowledge or experience with its recommended structure, the underwriter must disclose its material aspects, even if the structure is commonly understood in the markets. To the extent such disclosures are required, they need not be as particularized as those required for a Complex Financing.

IV. Required Disclosures to Issues — Manner and Timing of Disclosures

a. Timing of Disclosures: The required disclosures to issuers generally must be made when the underwriter is engaged by the issuer (for example, in the engagement letter). An exception is disclosure regarding the arm’s-length nature of the underwriter-issuer relationship, which must be made upon the underwriter’s earliest contact with the issuer, even if the underwriter has not yet been engaged (for example, in promotional materials or a response to the RFP). The timing of disclosures regarding Complex Financings or conflicts of interest that arise after the underwriter has been engaged must allow the issuer sufficient time before the execution of any contract to evaluate the matter disclosed.

The Guidance notes that not all issuances proceed on the timeframes specified in the Notice, and the timing of disclosure should ultimately be consistent with the overarching goals of Rule G-17. Specifically, disclosures should be timed so that:

“...the issuer (i) has clarity throughout all substantive stages of a financing regarding the roles of its professionals, (ii) is aware of conflicts of interest promptly after they arise and well before it effectively becomes fully committed (either formally or due to having already expended substantial time and effort) to completing the transaction with the underwriter, and (iii) has the information required to be disclosed with sufficient time to take such information into consideration before making certain key decisions on the financing.”

b. Manner of Disclosures: The disclosures must be made in writing, to an issuer official that the underwriter reasonably believes has the authority to contractually bind the issuer, and that, to the knowledge of the underwriter, is not part of a disclosed conflict. Disclosures must be designed by the underwriter to clearly communicate the subject matter and its implications. Disclosures relating to the role and compensation of underwriter may be made by a syndicate manager on behalf of other syndicate members, but disclosures regarding other conflicts must be made by each underwriter subject to such conflicts. For Complex Financings, if the underwriter does not reasonably believe that the recipient of the disclosures is capable of independently evaluating the disclosures, the underwriter must make additional efforts reasonably designed to inform the issuer. The Guidance states that “[p]age after page of complex legal jargon in small print would not satisfy” the disclosure requirements for Complex Financings.

The MSRB notes that for any Complex Financings involving a swap, the Commodity Exchange Act and Securities Exchange Act each require that any swap dealer with a special entity client (including states, local governments, and public pension funds) has the separate obligation to have a reasonable basis to believe that the special entity has an independent representative that has sufficient knowledge to evaluate the transaction and its risks, as well as the pricing and appropriateness of the transaction.

c. Issuer Acknowledgement of Disclosures. The underwriter must attempt to obtain written acknowledgement (other than by automatic e-mail receipt) by the issuer official of the disclosures. If the official will not provide such acknowledgement, the underwriter must, prior to proceeding with the engagement, document “with specificity” why it was unable to obtain the acknowledgement.

V. Application of the Notice to Financings in Process on the Effective Date

The Notice becomes effective on August 2, 2012. As noted above, because the MSRB takes the view that the underwriters have existing, basic fair-practice obligations under Rule G-17, underwriters should not interpret the release of the Notice to mean that, prior to its effective date, they could engage in conduct specifically prohibited in the Notice without potentially violating its general fair practice under Rule G-17. However, the MSRB acknowledges that since the Notice contains more detailed articulations of the applicability of Rule G-17 to certain matters, the agencies charged with enforcing MSRB rules will take into account whether, in a particular set of facts and circumstances, “the lack of such detailed guidance prior to the effective date would be relevant in determining whether a dealer should be viewed as having violated Rule G-17 based on actions prior such effectiveness.” Since the Notice contains elements that either create newly defined obligations or provide new insight on fair dealing obligations, the MSRB has specified that such elements will take effect as follows:

a. Prohibition on Discouraging the Use of a Municipal Advisor. The prohibition against recommending an issuer not retain a municipal advisor is new. Therefore, this requirement will become obligatory as of August 2, 2012.

b. Disclosures. The specific disclosure obligations, and the manner and timing for providing them, are generally new as of August 2, 2012, so those specific disclosures become obligatory as of that date.

 i. New Issues Sold Prior to Effective Date: For new issues in a negotiated offering for which a final commitment was made prior to August 2, 2012 (i.e., the bond purchase agreement was signed), the required disclosures under the Notice will not be required even if the new issue has not yet settled.

 ii. Continuous Offerings: For continuous offerings, a dealer acting as primary distributor already under contract to serve in such capacity for a plan prior to August 2, 2012, would not be obligated to make the required disclosures under the Notice. However, if the dealer recommends any new material terms with respect to the plan on or after August 2, 2012 that “constitute complex new features of the plan or would substantially affect the overall character of such plan with the effect of causing it to become” a Complex Financing, then disclosures regarding such new material terms would be required prior to the issuer’s commitment to such new terms.

 iii. New issues sold on or after August 2, 2012: For new issues in recommended negotiated offering for which a final commitment is made on or after August 2, 2012, the required disclosures under the Notice generally must be made by the underwriter. However, the MSRB has stated that for issues expected to be sold on or about August 2, 2012 effective date, it understands strict compliance with the earlier deadlines for disclosures on the underwriter’s role and conflicts of interest would likely not be possible. The underwriter would be viewed as achieving substantial compliance with such disclosure obligations so long as the issuer has been provided with the full set of disclosures, including any required disclosures with regard to a Complex Financings, with sufficient opportunity to consider such disclosures before signing the bond purchase agreement.

*This alert was co-authored by W. Hardy Callcott, Elizabeth Baird, Paul Tyrrell and former Bingham associate Timothy Foley.


If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:


1 SEC Release No. 34-66927 (May 4, 2012).

2 MSRB Notice 2012-38 (July 18, 2012).

This article was originally published by Bingham McCutchen LLP.