Certain Banks, Broker-Dealers and Other Institutions Must Register as Municipal Advisors by October 1, 2010
Financial Regulatory Reforms Update
To view this Sidley update as a PDF, click here.
The Securities and Exchange Commission (“SEC”) recently adopted an interim final temporary rule, Rule 15Ba2-6T under the Securities Exchange Act of 1934 (“Exchange Act”), that establishes a means for “municipal advisors” to register with the SEC prior to October 1, 2010,1 as required by Section 975 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).2 Rule 15Ba2-6T is a temporary rule that will be effective through December 31, 2011, and is expected to be followed by a final rule to be issued by the SEC that will establish the permanent manner of registration for municipal advisors.
This update provides a brief overview of the new registration requirement and its potential application to different financial institutions. This update also identifies a number of ambiguities with respect to the new provisions, including several instances in which the provisions appear to conflict with other Exchange Act provisions and/or the rules of the Municipal Securities Rulemaking Board (“MSRB”).
I. New “Municipal Advisor” Registration Requirement
Effective October 1, 2010, Section 975 of the Dodd-Frank Act amends Section 15B of the Exchange Act to establish a new registration requirement for “municipal advisors.” Specifically, Section 15B(a)(1), as amended, renders it unlawful for a “municipal advisor” to provide advice to or on behalf of a municipal entity3 or obligated person4 with respect to municipal financial products (i.e., municipal derivatives, guaranteed investment contracts and investment strategies)5 or the issuance of municipal securities, or to undertake a “solicitation of a municipal entity or obligated person,”6 without registering with the SEC.
The SEC expressly determined not to adopt any interim, temporary exemption from the registration requirement. As a result, pursuant to the Dodd-Frank Act, amended Section 15B of the Exchange Act, and the SEC’s new Rule 15Ba2-6T, all “municipal advisors” must register with the SEC by October 1, 2010 in order to continue to engage in their municipal advisory services.
II. Who is a “Municipal Advisor”?
The term municipal advisor is defined in new Section 15B(e)(4)(A) of the Exchange Act to mean:
a person (who is not a municipal entity or an employee of a municipal entity) that (i) 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, including advice with respect to the structure, timing, terms and other similar matters concerning such financial products or issues; or (ii) undertakes a solicitation of a municipal entity.
Significantly, the definition of the term “municipal advisor” specifically includes “financial advisors, guaranteed investment contract brokers, third-party marketers, placement agents, solicitors, finders, and swap advisors” to the extent they provide municipal advisory services.7 A few limited exceptions to the definition of “municipal advisor” are discussed on pages 3-4 of this alert.
Municipal Financial Products
Pursuant to new Section 15B(e)(5), a “municipal financial product” is defined to mean “municipal derivatives, guaranteed investment contracts, and investment strategies.” “Investment strategies” include plans or programs for the investment of the proceeds of municipal securities that are not municipal derivatives, guaranteed investment contracts, and the recommendation and brokerage of municipal escrow investments.
Solicitation of Municipal Advisory Business on Behalf of Others
Parties that do not themselves advise municipal entities or obligated persons, but who solicit business from such entities on behalf of others, may also be subject to registration as “municipal advisors.” As previously noted, amended Section 15B(a)(1) not only renders it unlawful for a municipal advisor to provide advice to or on behalf of a municipal entity or obligated person without registering with the SEC, but also, in general, makes it unlawful for a municipal advisor to undertake a solicitation of a municipal entity or obligated person without registering with the SEC.8
The term “solicitation of a municipal entity or obligated person” is defined in new Section 15B(e)(9) to mean:
a direct or indirect communication with a municipal entity or obligated person made by a person, for direct or indirect compensation, on behalf of a broker, dealer, municipal securities dealer, municipal advisor, or investment adviser (as defined in section 202 of the Investment Advisers Act of 1940) that does not control, is not controlled by, or is not under common control with the person undertaking such solicitation for the purpose of obtaining or retaining an engagement by a municipal entity or obligated person of a broker, dealer, municipal securities dealer, or municipal advisor for or in connection with municipal financial products, the issuance of municipal securities, or of an investment adviser to provide investment advisory services to or on behalf of a municipal entity. (emphasis added).
Thus, for example, it appears that parties who, for compensation, act as “finders” or “solicitors” in referring municipal entities to such brokers, dealers, municipal advisors or investment advisers will also be required to register unless their solicitation and referral activities are conducted exclusively on behalf of entities with which they are in a “control” relationship (e.g., solicitation on behalf of, and referrals to, an affiliated broker-dealer).9
Certain Persons Excepted from the Definition
While the definition initially casts a wide net with respect to persons advising or soliciting municipal entities and/or obligated persons, certain categories of persons are specifically excluded from the definition. Notably, however, there is no exception for banks. Moreover, the exceptions for broker-dealers (including municipal securities dealers), investment advisers and commodity trading advisers are limited in certain respects.
Certain brokers, dealers and municipal securities dealers (including bank municipal securities dealers).The definition includes an explicit exception for “a broker, dealer, or municipal securities dealer serving as an underwriter (as defined in Section 2(a)(11) of the Securities Act of 1933).” The Adopting Release emphasizes, however, that a broker, dealer, or municipal securities dealer providing municipal advisory services while acting in a capacity other than as an underwriter would be a municipal advisor. Brokers, dealers and municipal securities dealers (including bank municipal securities dealers) should therefore carefully examine their current activities in order to determine whether they provide municipal advisory services only when serving as “underwriters” or whether they provide such services in other capacities that are not independently eligible for an exception.10 If the latter, such entities will need to promptly determine whether to (i) register as a municipal advisor; (ii) adjust their covered activities so as to fall within the exception from the definition; or (iii) suspend the covered activities.
Certain investment advisers and their associated persons. Also excluded from the municipal advisor definition are “any investment adviser[s] registered under the Investment Advisers Act of 1940, or persons associated with such investment advisers who are providing investment advice.” According to the Adopting Release, the SEC interprets this exclusion to mean that a registered investment adviser or an associated person of a registered investment adviser is excluded from the definition of the term “municipal advisor” if the investment adviser or associated person provides municipal advisory services, so long as those services qualify as “investment advice” for purposes of the Investment Advisers Act of 1940 (the “Advisers Act”). By contrast, the Adopting Release notes that a registered investment adviser or an associated person of a registered investment adviser would have to register as a municipal advisor if the adviser or associated person “provides any municipal advisory services other than investment advice within the meaning of the [Advisers Act].” Notably, the Dodd-Frank Act does not amend the Exchange Act to include a definition of the term “associated person of a registered investment adviser,” nor does it cross-reference to the definition set forth in the Advisers Act.11 While in one respect it would seem reasonable to conclude that the Advisers Act definition should apply, the SEC has not issued guidance on this point, and it is less than perfectly clear whether Congress intended for a parent or subsidiary company that is not itself a registered investment adviser (e.g., a parent or subsidiary that is a bank, broker, dealer or municipal securities dealer) to be able to rely upon this exception.
Certain commodity trading advisors and their associated persons. The definition excludes commodity trading advisors that are registered under the Commodity Exchange Act (“CEA”), as well as persons associated with such commodity trading advisors,12 so long as their municipal advisory services are related to swaps.
Lawyers and engineers. Finally, the definition specifically excludes attorneys offering legal advice or providing services that are of a traditional legal nature, as well as engineers providing engineering advice.
III. Banks as Municipal Advisors
The absence of any exception for banks is particularly noteworthy because banks, even in the post-Gramm-Leach-Bliley Act13 environment, are expressly permitted to effect transactions in municipal securities for the accounts of others (i.e., in an agency capacity), including providing related advice to municipal entities and obligated persons, without becoming subject to a broker registration requirement under Section 15(a) of the Exchange Act. This is because the Exchange Act’s general “broker” definition includes a specific statutory exception for banks effecting transactions in municipal securities.14 In addition, banks are permitted to, for compensation, refer prospective investment banking clients, including municipal entities and obligated persons, to broker-dealers without such referral activity triggering a broker registration requirement.15
While the Dodd-Frank Act does not amend the bank exceptions to the Exchange Act’s general “broker” definition (and hence banks can continue to engage in such activities without being deemed “brokers” for purposes of the Exchange Act), it appears that, effective October 1, 2010, a bank advising municipal entities and/or obligated persons with respect to municipal financial products and/or municipal securities issuances, or soliciting such business on behalf of broker-dealers, municipal advisors or investment advisers with which the bank is not in a control relationship, will be required to register as a “municipal advisor.” Banks should therefore carefully examine their activities to determine whether they are covered by the municipal advisor definition and related registration requirements and, if so, decide whether to (i) suspend the covered activities prior to October 1, 2010; (ii) register as a municipal advisor by October 1, 2010; or (iii) move such activities into another entity that is itself either registered as a municipal advisor or eligible for one or more of the exceptions from the definition.
IV. Regulation of Municipal Advisors
In addition to requiring municipal advisors to register with the SEC, the amended provisions of Section 15B generally (i) prohibit municipal advisors from engaging in fraud, and (ii) provide that municipal advisors have a fiduciary duty to the entities to which they provide municipal advisory services. Given the imposition of a fiduciary duty, firms considering acting as “municipal advisors” should carefully evaluate how such duty may affect their business, including any potential conflicts of interest.
The Dodd-Frank Act also directs the MSRB to adopt rules further regulating municipal advisors. Although the MSRB has not yet adopted any new rules regulating municipal advisors, it has made the following statement with respect to the nature and scope of municipal advisor rules it plans to adopt in the future:
The MSRB plans to implement its broadened statutory mandate under the Dodd-Frank Act by adopting a comprehensive set of rules for municipal advisors that seek to prohibit fraudulent and manipulative practices, set forth municipal advisors’ fiduciary obligation to their municipal clients, require fair treatment of investors, municipal entities, and other market participants, and restrict real and perceived conflicts of interest. They will also ensure rigorous standards of professional qualifications and promote market efficiency. An important element of this rulemaking program is an outreach effort to key market participants to allow participants to provide input to the MSRB during this transition period.16
V. The Temporary Registration Process and New Form MA-T
Under new Rule 15Ba2-6T, in order to temporarily satisfy the new registration requirements for municipal advisors, a municipal advisor will need to complete and file new Form MA-T with the SEC by October 1, 2010. Form MA-T, in general, requires the municipal advisor to indicate the purpose for which such advisor is submitting the form, provide certain basic identifying and contact information concerning its business, indicate the nature of its municipal advisory activities, and supply information about its disciplinary history and the disciplinary history of its associated municipal advisor professionals.
A municipal advisor that receives confirmation from the SEC that its Form MA-T was filed will be temporarily registered for purposes of Section 15B until the earliest of the following dates: (i) the date that the municipal advisor’s registration is approved or disapproved by the SEC pursuant to a final rule adopted by the SEC establishing the permanent manner of registration of municipal advisors and prescribing a form for such purpose; (ii) the date on which the municipal advisor’s temporary registration is rescinded by the SEC; or (iii) the expiration of the interim final temporary rule on December 31, 2011.
VI. Solicitation of Comments
Although the temporary rule goes into effect on October 1, 2010, the SEC is requesting comments on all aspects of the rule. Comments are due by October 8, 2010.
1See Exchange Act Release No. 62824 (Sep. 1, 2010), 75 FR 54465 (Sep. 8, 2010) (“Adopting Release”).
2See Pub. L. No. 111-203 (2010).
3 The term “municipal entity” is defined in new Section 15B(e)(8). Municipal entities include states and municipalities, agencies and plans established by states and municipalities, and other issuers of municipal securities.
4 The term “obligated person” is defined in new Section 15B(e)(10) to mean “any person, including an issuer of municipal securities, who is either generally or through an enterprise, fund or account of such person, committed by contract or other arrangement to support the payment of all or part of the obligations on the municipal securities to be sold in an offering of municipal securities.”
5See infra for a further discussion of “municipal financial products.”
6See infra for the definition of this term.
7 It should be noted that the second prong of the definition of “municipal advisor” in new Section 15B(e)(4)(A) refers to solicitation of municipal entities only (rather than also to solicitation of obligated persons). This is somewhat curious both because (i) amended Section 15B(a)(1) generally prohibits a municipal advisor from undertaking a solicitation of a municipal entity or an obligated person and (ii) new Section 15B(e)(9) specifically defines the term “solicitation of a municipal entity or obligated person.” (See infra for the definition of this term.) Moreover, new Section 15B(e)(4)(B) emphasizes that financial advisors, placement agents, finders, swap advisors and others are specifically covered by the definition “if such persons are described in any of clauses (i) through (iii) of [Section 15B(e)(4)(A)],” but the final version of that section includes only two definitional clauses, not three. It is therefore less than perfectly clear whether the definition was intended to include a third prong or otherwise also cover persons who do not themselves advise municipal entities or obligated persons and who only solicit obligated persons (and not also municipal entities) on behalf of others.
8But see supra note 7; see also MSRB Rule G-38, which generally prohibits brokers, dealers and municipal securities dealers from paying persons (other than “affiliated persons,” as defined therein) for the solicitation of municipal securities business.
9See also supra note 7 regarding the solicitation of obligated persons; cf. MSRB Rule G-38, which generally prohibits brokers, dealers and municipal securities dealers from paying persons (other than “affiliated persons,” as defined therein) for the solicitation of municipal securities business.
10 Note that some brokers, dealers and municipal securities dealers may be able to rely upon the investment adviser exception (discussed infra) to the extent their municipal advisory services involve the provision of “investment advice” within the meaning of the Investment Advisers Act of 1940.
11 Under the Advisers Act, the term “person associated with an investment adviser” includes “any partner, officer, or director of such investment adviser (or any person performing similar functions), or any person directly or indirectly controlling or controlled by such investment adviser, including any employee of such investment adviser, except that for the purposes of section 203 of [the Advisers Act] (other than subsection (f) thereof), persons associated with an investment adviser whose functions are clerical or ministerial shall not be included in the meaning of such term.” 15 USC § 80b-2(a)(17). Because a “person” includes both natural persons and companies (15 USC § 80b-2(a)(16)), associated persons of an investment adviser include entities that control or are controlled by an investment adviser. By contrast, when the Exchange Act refers to associated persons of a broker or dealer, it is understood to include, among others, persons (including companies) controlling, controlled by or under common control with, such broker or dealer. See 15 USC §§ 78c(a)(9), 78c(a)(18).
12 The Dodd-Frank Act does not amend the Exchange Act to include a definition of the term “associated person of a commodity trading advisor.” It is not entirely clear whether the CEA definition of the term (7 USC § 6k(3)) is intended to apply.
13 Pub. L. No. 106-102, 113 Stat. 1338 (1999).
14See Section 3(a)(4)(B)(x) of the Exchange Act, 15 USC § 78c(a)(4)(B)(x).
15 Such referral activity may be conducted in reliance upon the networking exception in Section 3(a)(4)(B)(i) of the Exchange Act, and the related provisions in Rules 700 and 701 of Regulation R, with respect to the referral of prospective investment banking business generally. 15 USC § 78c(a)(4)(B)(i); 17 CFR §§ 247.700-701. With respect to referrals of municipal securities business specifically, referral activity may also be conducted in reliance upon the aforementioned municipal securities exception in Section 3(a)(4)(B)(x) of the Exchange Act. 15 USC § 78c(a)(4)(B)(x). Note, however, that MSRB Rule G-38 generally prohibits a broker, dealer or municipal securities from paying persons (other than “affiliated persons,” as defined therein) for the solicitation of municipal securities business.
16 Statement appearing on MSRB website, on the “Municipal Advisors” page of the “Market Topics” section, available athttp://www.msrb.org/Market-Topics/Municipal-Advisors.aspx (last visited September 12, 2010).
This Sidley update is a collaboration of several of our practices serving the financial services industry. Our Financial Institutions practice serves depository and nondepository financial institutions and their holding companies. Sidley’s Structured Finance and Securitization practice is one of the most experienced in the world, and has been involved in virtually every industry innovation since the 1970s. Lawyers in our Securities practice handle all aspects of corporate finance and capital markets, and our Securities and Futures Regulatory practice represents major investment banks, broker-dealers, futures commission merchants, commercial banks, insurance companies, hedge fund complexes and exchanges on all aspects of securities and broker-dealer regulation. Our Investment Funds, Advisers and Derivatives practice team advises clients in the formation and operation of all types of alternative investment vehicles including mutual, private equity and hedge funds. Our Insurance practice offer s comprehensive services to insurers, reinsurers, receivers, brokers, creditors and guaranty associations.
To receive future Financial Regulatory Reforms updates via email, please click here.
This Sidley update has been prepared by Sidley Austin LLP for informational purposes only and does not constitute legal advice. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this without seeking advice from professional advisers.
Attorney Advertising - For purposes of compliance with New York State Bar rules, our headquarters are Sidley Austin LLP, 787 Seventh Avenue, New York, NY 10019, 212.839.5300 and One South Dearborn, Chicago, IL 60603, 312.853.7000. Prior results do not guarantee a similar outcome.