6.2.1 Municipal Advisors and Underwriters

Municipal advisors and underwriters are both required to register with the SEC and to comply with rules promulgated by the MSRB. In a negotiated public offering, the municipal advisor is engaged by the issuer and the underwriters are selected by the issuer, and the lead role in coordinating the financing process may be undertaken by either the municipal advisor or the lead underwriter.111 Both municipal advisors and underwriters, moreover, may provide advice respecting the structure and timing of the transaction, rating agency and marketing strategy, disclosure and other questions. The roles and responsibilities of municipal advisors and underwriters in municipal securities offering, are, however, quite distinct.

A municipal security issuer’s municipal advisor has a fiduciary relationship with the issuer. Municipal advisors are required to follow the standards of conduct contained in MSRB Rule G-42 on Duties of Non Solicitor Municipal Advisors. Rule G-42(a)(2) states that “a municipal advisor to a municipal entity shall, in the conduct of activities for that client, be subject to a fiduciary duty that includes a duty of loyalty and a duty of care.” Both MSRB Rule G-23 and California Government Code Section 53691, moreover, require that financial advisory relationships be evidenced promptly in writing that sets forth the basis of compensation for financial advisory services. The regulations generally prohibit firms from acting as both a municipal advisor and an underwriter with respect to a particular municipal securities offering.

A broker dealer acting as an underwriter of municipal securities is obligated under MSRB Rule G-17 (Rule G-17) to “deal fairly with all persons,” including the issuer, and “not engage in any deceptive, dishonest, or unfair practice” and MSRB Notice 2012-38, interpreting Rule G-17, requires, among other things, that underwriters disclose in writing various risks, including potential conflicts of interest, to issuers. As underwriters, broker dealers do have a duty to treat issuers and investors fairly, but they do not have a fiduciary relationship with the issuer of municipal securities they underwrite. Because the underwriter maintains an “arm’s length” relationship with the issuer, the underwriter and the issuer are on opposite sides of the transaction and the underwriter may make decisions that are in the underwriter’s best interests rather than the issuer’s.

MSRB Rule G-23 prohibits a broker dealer from acting as an underwriter on an issue for which it is acting as a municipal advisor and, as a result, will ensure that it cannot be characterized as a “municipal advisor” to the issuer. An underwriter may provide factual and general information to an issuer without providing advice. During the course of a transaction an underwriter will usually ask the issuer to acknowledge that the purchase and sale of the securities is “an arm’s length commercial transaction;” that the underwriter is acting as a principal and not as an agent or a fiduciary of the issuer; that the underwriter has not assumed an advisory or fiduciary responsibility in connection with the offering or any obligation other than as provided in the purchase contract for the securities; and that the issuer has consulted its own legal, financial, and other advisors to the extent it has deemed appropriate.

Communications outside the course of a transaction, however, including a suggestion that the issuer consider taking advantage of a financing opportunity, raise issues under Rule 15Ba-1 promulgated by the SEC under Section 15B of the 1934 Act (the “Municipal Advisor Rules”) and MSRB Rule G-23.112 Broker dealers, therefore, generally try to fit within one of the three main exceptions to the broad definition of “municipal advisor” in the Municipal Advisor Rules:

The exclusion for activities as an underwriter of a particular issue “within the scope of an underwriting of such issuance of municipal securities.” For this exclusion to apply, the broker dealer must have been selected to serve as the underwriter for the issue that is the subject of the communication.
The exclusion for responses to requests for proposals or qualifications. A broker dealer may provide “advice” in the context of competing for the issuer’s business.
The exclusion for participation by an independent registered municipal advisor (IRMA). This requires that the issuer have engaged an IRMA and that the IRMA be an active participant in consideration of the advice offered by the broker dealer.

Underwriters, as sellers of municipal securities, may also face liability under SEC Rule 10b-5. Unlike issuers, however, underwriters have available a “due diligence” defense to a claim brought under SEC Rule 10b-5. “Due diligence” requires taking reasonable care to (a) avoid selling securities that have an offering document containing material misstatements or omissions, and (b) perform a reasonable investigation of the issuer and its financial position designed to ascertain relevant facts. “Diligence” efforts in municipal securities offerings generally include, in addition to obtaining representations as to the completeness and accuracy of disclosure, review of various documents and other information and questioning of key officials of the issuer.

The underwriters also generally require the receipt of so called “SEC Rule 10b-5 letters” from bond counsel, disclosure counsel, and/or underwriters’ counsel confirming that during the course of their participation in the financing no facts came to the attorneys’ attention that caused them to believe (subject to certain exclusions) that the offering documents contained material misstatements or omissions.

In addition, SEC Rule 15c2-12, promulgated by the SEC under Section 15(c)(2) of the 1934 Act, requires underwriters to obtain, review, and provide to prospective investors OSs and to obtain from municipal issuers undertakings to make annual disclosure reports and report certain events. See Section 8.4, Continuing Disclosure. Underwriters of municipal securities are also obligated to ensure that offered municipal securities are suitable investments for their investors, and underwriters’ MSRB Rule G-17 obligations require that municipal securities be offered at fair prices.