SEC Approves MSRB’s New Underwriter Disclosure Requirements

May 16, 2012

On May 4, 2012, the Securities and Exchange Commission approved a new Municipal Securities Rulemaking Board interpretive notice1 (the “Notice”) regarding MSRB Rule G-17. The Notice describes certain disclosure and other obligations of municipal securities dealers when they act as underwriters to municipal security issuers. The Notice, which is generally limited to negotiated underwritings, requires underwriters to make “robust disclosure”2 as 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 financing structures and underscores certain non-disclosure-related obligations concerning underwriter compensation, pricing and retail order commitments.

The Notice takes effect on Aug. 2, 2012. The MSRB states that while Rule G-17 already requires dealers to deal fairly with all persons in connection with municipal security underwritings, the Notice is necessary in light of the Dodd-Frank Act’s mandate to the MSRB to protect Issuers.

Basic Fair Dealing Principle. The Notice expressly extends Rule G-17’s fair-dealing requirement from the underwriter-customer relationship to the underwriter-Issuer relationship. Accordingly, 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, even in the absence of fraud.

Required Disclosures by Underwriter. The Notice establishes specific disclosure requirements for underwriters, which are intended to clarify and identify the underwriter’s role, and any actual or potential material conflicts of interest, with respect to an issuance.

Timing of Disclosures: Required disclosures must generally be made when the underwriter is engaged by the issuer. One exception to this timing requirement 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. Additionally, timing of disclosures regarding Complex Financings (defined below) must allow the issuer sufficient time before the execution of the underwriting contract to evaluate the issuance structure.

Manner of Disclosures: The recipient of the disclosures must be 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 the underwriter may be made by a syndicate manager on behalf of other syndicate members, but disclosures regarding other conflicts must be made by the underwriter subject to such conflicts. As discussed further below, 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.

Acknowledgement of Disclosures. The underwriter must attempt to receive written acknowledgement (other than by automatic email receipt) by the issuer official of the disclosures and 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.

Substance of Disclosures: The Notice requires the underwriter to disclose to the issuer:

Role and Compensation of Underwriter:

  • That the underwriter is required by Rule G-17 to deal fairly at all times 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;
  • That, unlike a municipal adviser, 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;
  • That the underwriter has a duty to purchase securities from the Issuer at a fair and reasonable price, but must balance that with its duty to sell municipal securities to investors at fair and reasonable prices;
  • That the underwriter will review the official statement for the issuance in accordance with its responsibilities to investors under the federal securities laws, as applied to the facts and circumstances of the transaction; and
  • 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 cause the underwriter to recommend a transaction or transaction size that it is unnecessary.

Other Conflicts Disclosures:

  • Whether the underwriter will receive any compensation from parties other than the Issuer (including affiliates of the underwriter), and whether the underwriter has entered into any third-party arrangements for the marketing of the issuer’s securities; however, the underwriter does not need to disclose the amount of such payments;
  • Whether the underwriter has entered into profit-sharing arrangements with an investor, which may, 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 indeces 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; and
  • Whether the underwriter has any incentives to recommend a Complex Financing and associated conflicts of interest.

Financing Structures:

  • Where an underwriter reasonably believes the responsible issuer official lacks knowledge or experience with its recommended structure of a municipal financing, the material aspects of the issuance structure recommended; and
  • Where an underwriter recommends a municipal financing that is structured in a “unique, atypical or otherwise complex manner” (examples include variable rate demand obligations (“VRDOs”) and derivative financings such as swaps) (a “Complex Financing”), the material financial characteristics and reasonably foreseeable material financial risks of the Complex Financing. The level of disclosure required may vary according to the issuer’s particular knowledge or expertise with the structure of the Complex Financing.

Prohibitions. Underwriters are prohibited from recommending that an issuer not retain a municipal advisor in connection with an issuance.

Representations to Issuers and Preparation of Issuer Documents. The Notice specifies that (1) all of an underwriter’s representations to an issuer, whether written or oral, “must be truthful and accurate and must not misrepresent or omit material facts,” (2) that underwriters must have a reasonable basis for the representations and other material information contained in documents they prepare for themselves or issuers, and (3) underwriters must refrain from including representations or other information they know or should know is inaccurate or misleading.

Underwriter Compensation and New Issuance Pricing

Excessive Compensation. The Notice provides that an underwriter’s compensation for a new issuance (including both direct compensation paid by the issuer and other separate compensation paid by issuer or any other party in connection with the underwriting) must be proportionate depending upon the specific facts and circumstances of the issuance, including credit quality, size, market conditions, the length of time spent structuring the issuance, and whether the underwriter is paying its counsel’s fees or any other relevant costs related to the financing.

Fair Pricing. The Notice specifies that Rule G-17’s fair-dealing obligation includes an implied representation that the price an underwriter pays to an Issuer is fair and reasonable, taking into consideration all relevant factors, including the underwriter’s best judgment as to the fair market value of the issue at the time it is priced. In a negotiated underwriting, Rule G-17 obligates the underwriter to negotiate in good faith with the issuer, that obligation includes ensuring the accuracy of representations made during the course of such negotiations. In a competitive underwriting where the Issuer may reject any and all bids, an underwriter’s fair-pricing duties to the issuer will be deemed satisfied provided the underwriter’s bid is a bona fide bid (as defined in Rule G-13) that is based on the Underwriter’s best judgment of the fair market value of the bid-upon securities.

Retail Order Periods

The Notice states Rule G-17 requires Underwriters to honor agreements to underwrite a transaction with a retail order period, and to not act inconsistently with the Issuer’s requirements concerning the retail order period, without the Issuer’s consent. Rule G-17 further requires underwriters to take reasonable measures to verify that any retail orders are from bona fide retail customers according to each issuer’s definition of “retail.”

Dealer Payments to Issuer Personnel

The Notice warns dealers to be mindful of payments made to, and expenses reimbursed for, issuer personnel in the course of an issuance, especially payments for which dealers seek reimbursement from bond proceeds or issuers. The Notice reminds dealers that such payments may violate MSRB Rules G-20 and G-17 if they involve excessive or lavish expenses.

A Dissent at the SEC

Commissioners Paredes and Gallagher dissented from the SEC's approval of the MSRB guidance stating that the Commission's consideration of the rulemaking lacked rigor and relied too much on “conclusory statements” offered by the MSRB. In particular, they believe that the Commission has not adequately considered the fact that some of the cost of the additional disclosures would have to fall on the municipal issuers, and by extension the taxpayers, and that this would be at odds with the goal of protecting municipal issuers. They also believe that this rulemaking is premature because the SEC has not yet adopted a final definition for “municipal advisor.” 


Although most underwriters have always viewed themselves as having a duty of fair dealing to municipal issuers, the MSRB’s Notice will require underwriters to formalize their procedures between now and August 2. Underwriters will have to develop a mandatory disclosure that they deliver to all issuers, as well as a checklist of potential conflict disclosures that they may have to disclose depending on the nature of the transaction or the relationship with the client. In addition, underwriters will need to develop procedures for receiving written acknowledgement by the issuer official of the disclosures and, in instances where the acknowledgement is not obtained, documenting why it was not obtained. Finally, underwriters will need to rethink how they approach Complex Financings. At a minimum, underwriters will have to establish procedures for how they determine whether the recipient of the disclosures is capable of independently evaluating the disclosures. But, recognizing that if a Complex Financing works out poorly, issuers will always claim that they did not understand it, underwriters may decide to restrict substantially to whom they offer a Complex Financing.

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


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 2012-25 (May 7, 2012).

This article was originally published by Bingham McCutchen LLP.