MSRB Forges Ahead With Municipal Advisor Rule Proposal Filings With the SEC

September 06, 2011


It appears there was no “summer recess” for the Municipal Securities Rulemaking Board (“MSRB”) as it filed three significant rule proposals concerning municipal advisors with the U.S. Securities and Exchange Commission (“SEC”) in late August.

  • A proposed rule change to establish “pay to play” and related rules for municipal advisors (“Rule G-42”) and to make certain conforming changes to the existing pay to play rules for brokers, dealers, and municipal securities dealers (“dealers”) (“Rule G-37”).
  • A proposed rule change consisting of proposed Rule G-36 (on fiduciary duty of municipal advisors) and a proposed interpretive notice concerning the application of proposed Rule G-36 to municipal advisors.1
  • A proposed rule change consisting of a proposed rule establishing supervision of municipal advisors (“Rule G-44”).2

In each instance, the MSRB requests that the proposed rule changes become effective 90 days after approval by the SEC.

Despite comments received by the MSRB urging it to withdraw or delay some or all of the provisions of the rule proposals and interpretative notices until the SEC had defined “municipal advisor,” the MSRB has refused to do so. This is particularly troubling for firms struggling with trying to navigate potentially conflicting rulemakings by regulators.

In an effort to appease those affected by the potential conflicting regulatory requirements in these filings, the MSRB requests in its filings that the proposed rule changes be made effective on the date that SEC rules defining the term “municipal advisor” under the Exchange Act first become effective or on such later date as the proposed rule change is approved. That being said, the MSRB also states that once the SEC definitional rules are effective, it may issue more guidance. This provides little solace for those struggling to sort out what regulatory scheme to apply to their current and anticipated activities. As a result, firms that do business with municipal entities should pay particular attention to what is being proposed in these rule changes if there is any chance that their activities may cause them to be municipal advisors.

I. Proposed Rule G-42 Pay to Play For Municipal Advisors

As noted in the MSRB’s filing with the SEC, Rule G-42 concerns political contributions made by all municipal advisors, both those that are dealers and those that are not.3 After receiving and reviewing comments regarding Proposed Rule G-42, the MSRB has modified the initial rule proposal and also clarified the following.

A. SEC Pay to Play And Rule G-42

1. Definition of “De Minimis” Political Contribution

A number of commenters requested that the MSRB harmonize Rule G-42 and G-37 with the SEC pay to play rule for investment advisers by defining a de minimis political contribution as one not exceeding $350 per election for an issuer official for whom a municipal advisor professional (“MAP”) may vote at the time of the contribution and $150 per election for other issuer officials. However, the MSRB has refused to make such a change. Instead, the MSRB proposes to apply the current Rule G-37 de minimis political contribution limit to municipal advisors under proposed Rule G-42.

 2. Look-Back Provision

Rule G-42 would apply a two-year “time out” from compensation for municipal advisory services triggered by non-de minimis political contributions made by an MAP within the two years prior to when the MAP was hired. As the MSRB notes, this standard is the same as the look-back period for solicitors in the SEC pay to play rule. The MSRB rejected a shorter six-month look-back period, which the SEC pay to play rule applies to employees who do not solicit investment advisory business. According to the MSRB, under both the SEC pay to play rule and Rule G-42, municipal advisors will need to elicit information about contributions made by prospective employees during the two years preceding their employment.
B. Rule G-37 and Rule G-42

In its proposed rule filing, the MSRB indicates that it will permit dealer municipal advisors to report their non-de minimis political contributions and municipal advisory activities on a “macroform” (Form G-37/G-42) and require that dealer municipal advisors report a list of the third-party business awarded during the calendar quarter by state, rather than all solicitations.

The MSRB also clarifies that it believes that the definition of supervisors that are MAPs is limited to those individuals who supervise municipal advisory activities and does not include individuals who supervise other, non-municipal activities of MAPs.

II. Rule G-36 (Fiduciary Duty of a Municipal Advisor)

On February 14, 2011, the MSRB requested comment on proposed Rule G-36 defining the fiduciary duty of municipal advisors and on a proposed interpretive notice (“Interpretive Notice”) concerning the application of proposed Rule G-36 to municipal advisors. On August 23, 2011, after receiving comments, the MSRB filed the proposed rule change with the SEC.

The proposed Rule G-36 filed with the SEC would articulate a duty of loyalty and a duty of care that a municipal adviser owes to a municipal entity client, although such duties would not be exclusive. The MSRB has made the following changes from its initial proposal in the rule proposal and revised Interpretive Notice it filed with the SEC.

A. Duty When Advising Obligated Person

The MSRB notes that the Exchange Act does not impose a fiduciary duty on municipal advisors with obligated person clients. The MSRB notes that the obligations of a municipal advisor to an obligated person client would be set forth in a companion notice relating to Rule G-17. 

Therefore, according to the MSRB, when a municipal advisor is advising an obligated person, its primary obligation of fair dealing is to its client. The municipal advisor would not be required to act in the best interest of the municipal entity acting as a conduit issuer, although the advisor would be prohibited from acting in a deceptive, dishonest, or unfair manner with regard to the municipal entity.

B. When Does the Fiduciary Duty Apply?

The MSRB notes that Rule G-36 would provide that a municipal advisor’s fiduciary duty applies when the advisor has a municipal entity client. Furthermore, the MSRB clarifies when a municipal entity is determined to be a client — specifically the Interpretive Notice states that “[a] municipal entity will be considered to be a client of the municipal advisor from the time that the advisor has been engaged to provide municipal advisory services (either pursuant to a written agreement or by informal arrangement) until the time that the agreed upon engagement ends.”

C. Excessive Compensation

The Interpretive Notice also states that excessive compensation is compensation that is so disproportionate to the nature of the municipal advisory services performed as to indicate that the municipal advisor is not acting in the best interests of its client. Further, the Interpretive Notice states that what is considered reasonable compensation will vary “…according to the municipal advisor’s expertise, the complexity of the financing, and the length of time spent on the engagement, among other factors.” The MSRB appears to recognize that there are many factors that may appropriately affect the amount of the fee.

The MSRB notes that under Section 15B(e)(4)(C) of the Exchange Act, dealers are not municipal advisors when they serve as underwriters. However, the MSRB states that the fair dealing obligations under Rule G-17 continue to apply to underwriters. The MSRB recognizes that underwriters would not be subject to the same requirement under Rule G-17 to disclose conflicts associated with various forms of compensation.

The MSRB includes an Appendix A to the Interpretive Notice for small municipal advisors to use when making disclosures regarding compensation. The MSRB, however, notes that Appendix A is not mandatory, and municipal advisors can draft their own disclosure addressing these conflicts.

D. Duty of Loyalty

The MSRB has revised the Interpretive Notice so that it provides that the municipal advisor must disclose all material conflicts “of which it is aware after reasonable inquiry.” The MSRB has determined to apply this standard to all conflicts “existing at the time the engagement is entered into, as well those discovered or arising during the course of the engagement.” While acknowledging the issues about comprising information barriers when making inquiries about other relationships with municipal entities, the MSRB states that it is not sufficient to disclose only those conflicts about which persons involved in the municipal advisory activity are aware. Instead, the MSRB states that all the conflicts of the firm must be disclosed. As a result, persons preparing the conflicts disclosure must make a reasonable inquiry into the activities of their firm to determine all conflicts that may exist. The MSRB states that this inquiry may include asking persons not specifically engaged in the municipal advisory activity. The MSRB states that this is a continuing obligation during the course of the engagement, and includes new conflicts arising after the engagement has begun.

The MSRB reiterates in the Interpretive Notice that “generalized disclosure,” without a discussion of the specific conflicts that relate to the municipal entity client, is not sufficient, and is an insufficient basis for the municipal entity to give informed consent. The MSRB clarifies that an RFP response is an appropriate place to make required disclosures if the proposed structure of the financing is adequately developed to permit the specific disclosures required by the Notice.

E. Unmanageable Conflicts

The MSRB states in the Interpretive Notice that a municipal advisor will not be considered to have an unmanageable conflict as a result of acting as principal when:

  • providing investments to the municipal entity on a temporary basis to ensure timely delivery for closing;
  • engaging in activities permitted under Rule G-23;
  • acting as a swap or security-based counterparty to a municipal entity represented by an “independent representative,” as defined in the Commodity Exchange Act or the Exchange Act, respectively, or 
  • if the firm is a municipal advisor solely because it recommends investments or municipal financial products provided or offered by it to a municipal entity as a counterparty.

The MSRB states that it will consider whether additional exceptions are appropriate after the SEC completes its rulemaking to define who is a “municipal advisor.”

F. Duty of Care

1. Duty of Inquiry

The MSRB clarifies in the Interpretive Notice that a client may not waive the duties imposed by proposed Rule G-36, as interpreted by the MSRB in the Interpretive Notice, if they are within the scope of the municipal advisor’s engagement. The MSRB states that if, for example, it is within the scope of the municipal advisor’s engagement to prepare a certificate that will be relied upon by the issuer, then the municipal advisor would be required to conduct a reasonable inquiry into the facts that underlie the certificate. The MSRB notes that review of the official books of the issuer and other factual information within the municipal advisor’s control might assist the municipal advisor in forming a reasonable basis for its certificate. However, the MSRB notes that if the certificate relies on the representations of others or facts not within the municipal advisor’s control, additional inquiry on the part of the municipal advisor may be required.

 2. Due Diligence

In the case of competitive underwritings, the adviser owes a duty to the municipal entity to make reasonable inquiry so that the appropriate disclosures are made in the official statement. Accordingly, the revised Interpretive Notice would no longer be phrased as requiring that the advisor exercise “due diligence.” Rather, the duty is that the municipal advisor “owes a duty to the municipal entity to make reasonable inquiries in order to help ensure the appropriate disclosures are made in the official statement.

III. Supervision of Municipal Advisory Activities — Proposed Rule G-44

On August 22, 2011, the MSRB filed proposed MSRB Rule G-44 (on supervision of municipal advisory activities), along with related proposed amendments to Rule G-8 (on books and records) and Rule G-9 (on preservation of records). As discussed in the prior Bingham Alert,4 Proposed Rule G-44 would require all municipal advisors to adopt a basic supervisory structure for municipal advisory activities not already subject to supervision under Rule G-27. Dealer financial advisory activities would continue to be supervised under Rule G-27.

In the filing with the SEC, the MSRB notes the following:

  • The MSRB does not think it necessary to extend the more detailed supervisory structure required by Rule G-27 to municipal advisory activities. For example, the MSRB did not recommend creation of “offices of municipal supervisory jurisdiction” for municipal advisors with multiple offices.
  • Many of the provisions of Rule G-27 concern dealer relationships with customers (e.g., the handling of customer complaints), which do not have a municipal advisor counterpart.
  • Proposed Rule G-44 provides flexibility to sole and small practitioners because the rule recognizes that procedures would vary depending on factors, such as the size of the firm, number of offices, and type of municipal advisory activities engaged in.

Proposed Rule G-44 would permit a municipal advisor principal to conduct the inspections required by proposed Rule G-44(d), just as Rule G-27(d)(iii) permits inspections by principals under its “limited in size and resources” rule for small dealers.

The MSRB has posted on its website a sample supervisory checklist, which it notes small municipal advisors may find useful in developing their written supervisory procedures.


The MSRB rule proposals filed with the SEC would create a number of new duties and obligations related to municipal advisors. Therefore, entities that are, or might be, municipal advisors should pay close attention to the proposed rules and consider whether aspects of the proposed rules suggest filing comments with the SEC. Indeed, because the SEC has yet to issue a final rule on the definition of a municipal advisor, firms that are not certain whether they will be considered municipal advisors should strongly consider the impact of these rules.


For additional information concerning this alert, please contact the following lawyers:

Amy Natterson Kroll, Partner, Broker-Dealer, 202.373.6118

David Boch, Partner, Broker-Dealer Group, 617.951.8485

Roger P. Joseph, Practice Group Leader, Investment Management; Co-chair, Financial Services Area, 617.951.8247

Edwin E. Smith, Partner, Financial Restructuring; Co-chair, Financial Services Area, 617.951.8615

Tim Burke, Practice Group Leader, Broker-Dealer Group; Co-chair, Financial Services Area, 617.951.8620

1 On August 2, 2011, the MSRB also filed a proposed interpretive notice related to the application of G-17 to underwriters of municipal securities and on August 12, 2011, the MSRB filed a proposed rule change consisting of the proposed interpretative notice concerning the application of G-17 to municipal advisors advising obligated persons or soliciting municipal entities on behalf of others. See Bingham Alert, Groundbreaking Proposal By MSRB Related To Municipal Securities Underwriters’ Obligations To State and Local Government Clients, (August 15, 2011).
2 The MSRB also issued other notices relating to municipal advisors in August, including one extending Rule G-20, concerning gifts and gratuities, to municipal advisors.
3 See Bingham Alert, Regulators’ Focus on ‘Pay-to-Play’ Issues Remains Robust Going Into the New Year — MSRB Seeks Comment on the New Draft Rule G-42 (“Pay-to-Play Rule”) for Municipal Advisors, (Feb. 3, 2011).
4 See Bingham Alert MSRB Seeks Comment on Proposed Supervisory Rule G-44 for Municipal Advisors, (June 2, 2011).

This article was originally published by Bingham McCutchen LLP.