SEC Municipal Advisor Rule & Fiduciary Responsibilities

Transcription

1 California Association of County Treasurers and Tax Collectors SEC Municipal Advisor Rule & Fiduciary Responsibilities David Leifer Senior Managing Director KNN Public Finance, LLC Presented by: October 13, 2016 Leo Karwejna Chief Compliance Officer The PFM Group

2 Introduction and context TTC s interact with various professionals in connection with the issuance of securities and investment activities Municipal Advisors, Broker-Dealers, Registered Investment Advisors This presentation focuses on: SEC Municipal Advisor Rule/MSRB Regulations Who is a Municipal Advisor? Advice Standard Exclusions & Exemptions Municipal Advisor Standards of Conduct (MSRB Rule G-42) Investment of Bond Proceeds Fiduciary Duty and Responsibilities of Various Professionals 2

3 SEC Municipal Advisor Rule and ensuing MSRB Regulations Today s environment

4 Background SEC Municipal Advisor Rule Definitions Advice Standard Exclusions Exemptions 4

5 Municipal Advisor Definition Municipal Advisor defined to include a person (who is not a municipal entity or an employee of a municipal entity) who provides advice to a municipal entity or obligated person with respect to municipal financial products or the issuance of municipal securities Today s educational discussion focuses on the municipal financial product part of this definition (as it relates to the investment of bond proceeds) 5

6 Municipal Advisor Definition Municipal Financial Product defined to include: Guaranteed investment contracts Investment strategies Investment Strategies defined to include: plans or programs for the investment of the proceeds of municipal securities recommendation of and brokerage of municipal escrow investments 6

7 What are implications of being a Municipal Advisor? Required to register with the SEC and the MSRB Statutory Fiduciary Duty For municipal entity clients, not obligated person clients Subject to MSRB rules (e.g., record-keeping, professional qualifications) MSRB G-42 7

8 How Not to be Municipal Advisor Don t meet the statutory definition Not advice Not either bond proceeds or municipal escrow investments You are a municipal entity or an employee of a municipal entity Meet one of the Statutory Exclusions Meet one of the Exemptions established by SEC Rules 8

9 Advice Standard SEC Rules provide that advice excludes... the provision of general information that does not involve a recommendation regarding municipal financial products. Brokerage distinguished: purchase and sale of escrow investments upon the direction of an obligated person or its financial advisor without rendering advice is merely a provision of brokerage services and does not render such person a municipal advisor. (SEC MA Rule) 9

10 General Information exclusion to Advice Examples of the General Information Exclusion from Advice (c) information regarding a financial institution s currentlyavailable investments (e.g., the terms, maturities, and interest rates at which the financial institution offers these investments) or price quotes for investments available for purchase or sale in the market that meet criteria specified by a municipal entity or obligated person; (SEC FAQ page 3) 10

11 Municipal Advisor Exclusions Underwriter Exclusion But only applies for underwriting activities, and SEC has stated that advice on investment strategies is outside the scope of the underwriter exclusion Investment Adviser Exclusion for any investment adviser registered under the Investment Advisers Act of

12 Municipal Advisor Exemptions Banks, if providing advice with respect to: any investments that are held in a deposit account, savings account, certificate of deposit, or other deposit instrument issued by a bank any extension of credit... including the issuance of a letter of credit, the making of a direct loan, or the purchase of a municipal security by the bank for its own account any funds held in a sweep account any investment made by a bank acting in the capacity of an indenture trustee or similar capacity 12

13 Municipal Advisor Exemptions Independent Registered Municipal Advisor ( IRMA ) More commonly used in context of the issuance of municipal securities part of the municipal advisor definition Rules establish elements to qualify for IRMA exemption Independent measured at firm and individual level Person seeking to use exemption receives a representation in writing that it is represented by, and will rely on the advice of, an independent registered municipal advisor RFP/RFQ Exemption for any person providing a response in writing or orally to a request for proposals or qualifications from a municipal entity or obligated person for services in connection with a municipal financial product or the issuance of municipal securities. 13

14 Yes Are you being provided advice that requires registration? Is it regarding: START HERE Issuance of municipal securities Municipal derivatives Guaranteed Investment Contracts (GICs) Investment Strategies o Bond Proceeds o Municipal escrow investments Municipal derivatives Yes Are you receiving a: Specific recommendation Suggestion Marketing presentation Trade idea No Are you being provided with: Education General market information/data* Advertising NO REGISTRATION *Includes information regarding a financial institution s currently-available investments (e.g., the terms, maturities, and interest rates at which the financial institution offers these investments) or price quotes for investments available for purchase or sale in the market that meet criteria specified by a municipal entity or obligated person Is an exemption available: NEEDED Banks o Extensions of credit (loans) o Deposit accounts o Sweep accounts o Indenture trustee Responses to RFPs or RFQs Independent Municipal Advisor Registered Investment Advisor Underwriter Swap Dealers and Commodity Trading Advisors 529 Plans No MUNICIPAL ADVISOR REGISTRATION NEEDED

15 New Municipal Advisor Regulations

16 MSRB Rulemaking Topic MSRB Rule Effective Date Supervision and Compliance Obligations Rule G-44 April 23, 2015 Professional Qualifications Rule G-3 April 27, 2015 Gifts and Gratuities Rule G-20 May 6, 2016 Core Standards of Conduct Rule G-42 June 23, 2016 Pay-to-Play Rule G-37 August 17, 2016 Source: MSRB Webinar, Approved Rule G-42 on Duties on Non-Solicitor Municipal Advisors, April 28, 2016 ( MSRB Webinar )

17 Overview of Rule G-42 Standards of conduct Duty of Care Duty of Loyalty Disclosure of conflicts of interest and legal or disciplinary events; Documentation of the municipal advisory relationship; Suitability of recommendations; and Specific prohibitions against certain activities Source: MSRB Webinar 17

18 Duty of Care A municipal advisor must exercise due care in performing its municipal advisory activities, which includes: Knowledge and Expertise Must possess the degree of knowledge and expertise necessary to provide the client informed advice Inquiry and Investigation Must make reasonable inquiry as to the facts Source: MSRB Webinar 18

19 Duty of Care (continued) Inquiry and Investigation Must make reasonable inquiry as to facts that are relevant to a client s determination as to whether to proceed with a course of action or that form the basis of advice to the client Must conduct a reasonable investigation to determine that it is not basing any recommendation on materially inaccurate or incomplete information Must have a reasonable basis for: (i) any advice to or on behalf of the client; (ii) any representations in a certificate to be relied upon by the client, other parties to the transaction; and (iii) information in an official statement for an issue as to which the municipal advisor is advising Source: MSRB Webinar 19

20 Duty of Loyalty Municipal advisors owe a duty of loyalty to their municipal entity clients when performing their municipal advisory activities The duty of loyalty requires advisors to deal honestly and with the utmost good faith, and to act in the client s best interest, without regard for the financial or other interests of the municipal advisor A municipal advisor must not engage in municipal advisory activities for a municipal entity client if it cannot manage or mitigate conflicts in a manner that will permit it to act in the client s best interest Source: MSRB Webinar 20

21 Disclosure of Conflicts of Interest and Other Information Prior to or upon beginning services for a client, an MA must disclose in writing, all material conflicts of interest, including: Advice, services or products provided by an affiliate if directly related to the MA activities to be performed Payments made by the MA to obtain new business Payments received from third parties Fee-splitting arrangements Conflicts related to continent fee compensation Other actual or potential conflicts Must disclose no known material conflicts Source: MSRB Webinar 21

22 Disclosure of Conflicts of Interest and Other Information (continued) In addition, MAs must disclose to the client any legal or disciplinary events that are material to a client s evaluation of the MA The disclosure may be fulfilled by identifying the specific type of event and a specific reference to the relevant portions of the most recently filed SEC Forms MA and MA-I Detailed information must be provided about where the client can access SEC Forms MA and MA-I electronically Source: MSRB Webinar 22

23 Documentation of the Relationship Prior to, upon or promptly after beginning a municipal advisory relationship with a client, a municipal advisor must detail the relationship in writing, including: Form and basis of direct and indirect compensation Disclosures related to material conflicts of interest Legal or disciplinary events and where SEC Forms MA or MA-I can be electronically accessed Source: MSRB Webinar 23

24 Documentation of the Relationship (continued) Date of the last material change or addition to a legal or disciplinary event on SEC Forms MA or MA-I Scope of the MA services Basis of termination of the MA relationship Any terms relating to withdrawal from the municipal advisory relationship Source: MSRB Webinar 24

25 Suitability of Recommendations Under MSRB Rule G-42(d), if a municipal advisor makes a recommendation on a municipal securities transaction or a municipal financial product, or if the review of a recommendation of another party is requested and within the scope of the engagement, the municipal advisor must use reasonable diligence to determine whether a recommended transaction or municipal financial product is suitable or not for the client Source: MSRB Webinar 25

26 Suitability of Recommendations (continued) The municipal advisor must inform the client of: The material risks, potential benefits, structure, and other characteristics of the municipal securities transaction or municipal financial product The basis upon which it believes the recommended transaction or product is suitable, or, in the case of review of a recommendation of another party, is or is not suitable for the client Whether the municipal advisor investigated or considered other reasonably feasible alternatives to the recommended municipal securities transaction or financial product Source: MSRB Webinar 26

27 Suitability of Recommendations (continued) A determination of whether a municipal securities transaction or financial product is suitable must be based on factors relating to the client, including, but not limited to, the client s: Financial situation and needs; Objectives; Tax status; Risk tolerance; Liquidity needs; Source: MSRB Webinar 27

28 Suitability of Recommendations (continued) Experience with municipal securities; Financial capacity to withstand changes in market conditions; and Any other material information known about the client and the municipal securities transaction or financial product, after reasonable inquiry Source: MSRB Webinar 28

29 Specified Prohibitions A municipal advisor is prohibited from certain unfair practices or activities, including but not limited to: Receiving excessive compensation in relation to the municipal advisory activities actually performed; Delivering an invoice that does not accurately reflect activities performed or the personnel that actually performed those activities; Materially misrepresenting, by an affirmative representation or an omission, the extent of the municipal advisor s knowledge or qualifications; Source: MSRB Webinar 29

30 Specified Prohibitions (continued) Participating in fee-splitting arrangements with underwriters; Participating in undisclosed fee-splitting arrangements with providers of investments or services to a client of the municipal advisor; Making payments to secure or retain municipal advisory business, with limited exceptions; and Engaging or an affiliate engaging in a principal transaction with a municipal entity client that is directly related to the municipal securities transaction or municipal financial product for which the municipal advisor is providing or has provided advice Source: MSRB Webinar 30

31 Bond Proceeds

32 What are proceeds? (Rules) monies derived by a municipal entity from the sale of municipal securities investment income derived from the investment or reinvestment of such monies monies of a municipal entity or obligated person held in funds under legal documents for the municipal securities that are reasonably expected to be used as security or a source of payment of the debt service investment income derived from the investment or reinvestment of monies in such funds 32

33 What are proceeds? SEC did not agree that once proceeds of a municipal offering are commingled with other funds, they lose their character as proceeds But did provide that once the proceeds are spent to carry out the authorized purposes of municipal securities, they cease to be proceeds of municipal securities. (Rules) Pension Bonds proceeds of pension obligation bonds lose their character as proceeds of municipal securities... upon their contribution to the public pension plan. 33

34 How does this effect the investment of bond proceeds? A few practical considerations

35 Broker letters, representations, certifications Some Brokers/Market Participants have gone to great lengths to make it the municipality's problem and municipalities should resist This is not the municipality's issue (it is the broker s regulatory issue) The MA Rule applies to protect municipal entities Attempt to force municipalities to spend time and resources for convenience so they (the brokers) do not have to monitor their own behavior in this regard 35

36 Bond Proceeds GFOA Guidance Investment bankers will be deemed to have made a recommendation when they advise their government clients to buy a particular security Additionally, the underwriter may not provide advice related to the investment of bond proceeds unless; (1) the government issuer has in place a municipal advisor or an investment adviser, or (2) the underwriter is responding to the government s request for proposal process regarding how to invest the bond proceeds ( 36

37 What can a municipal entity do? Municipal entities do not have to sign representations, and instead state they will not rely on broker for advice Municipal entities do not sign representations, and instead state they will not rely on broker for advice as they have an RIA (however the RIA does not have a statutory safe harbor) - this relies upon the instruction to the broker not to provide direct advice Entities sign the representations, and instruct that they have an IRMA (the IRMA must have competency with bond proceed investing within scope of services) Whenever trading securities, municipal entities issue mini-rfp by means of circulating a bid/offer sheet for brokers to respond to by providing information for entities to consider/execute Do nothing? 37

38 What should a municipal entity do? It may depend upon the size of the entity, staffing, investment portfolio, and volume of trading Can this have portfolio structure implications? What if a municipal entity is accustomed to taking broker recommendations for trades? What role can someone play as a registered investment adviser? 38

39 Considerations regarding Fiduciary Duty and Responsibilities

40 General Federal Regulatory Requirements Most federally registered broker-dealers ( BDs ), municipal advisors ( MAs ), and investment advisers ( RIAs ) are very familiar with how the federal securities laws and the rules of the Securities Exchange Commission ( SEC ) and any applicable self-regulatory organization ( SRO ) impact their business practices. As required by the SEC and SROs, BDs and RIAs have written compliance procedures and assign compliance officers to oversee their firm s investment, advisory, and trading activities. 40

41 Broker Dealers Regulation and Requirements A broker-dealer is subject to the Securities Exchange Act of 1934, as amended ( Exchange Act ), and is required to register pursuant to rules established by the SEC and an applicable SRO, if he or she on an interstate basis effects securities transactions or induces another party to enter into the purchase or sale of securities. BDs, pursuant to the Exchange Act, are subject to antifraud provisions. These provisions have been interpreted by the SEC and FINRA to establish a duty of fair dealing. According to the Second Circuit, the Exchange Act establishes a special relationship between the BD and the client whereby the BD is in a position of trust such that the client should be able to assume statements made by the BD are thoughtful and accurate. FINRA Rule 2010 also provides that a BD in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade. 41

42 A Broker Dealer may not Anti-fraud Provisions: cause a client to enter into a securities transaction by means of any manipulative, deceptive, or other fraudulent device or contrivance. use any manipulative or deceptive device or contrivance contrary to the rules established by the SEC or SRO to protect the interest of clients. 42

43 Broker Dealers Regulatory Duty to Customers Inherent in this duty of fair dealing is a requirement that a BD make a suitability determination with respect to securities transactions it recommends to its customers. Thus, BDs, based upon a number of criteria, must make a determination that a recommended trade is suitable for at least some investors in general (reasonable basis suitability) and is suitable for a particular customer (customer-specific suitability and quantitative suitability). BDs are also subject to a duty of best execution and a duty to disclose conflicts in certain situations. However, federal securities laws do not impose a fiduciary duty on BDs. 43

44 Broker Dealers - Duty to Customers Duty to deal fairly with clients; Duty to make suitability determination. reasonable-basis after reasonable due diligence, reasonable basis to believe recommendation is suitable for at least some investors. customer-specific suitable for the specific client given such client s investment profile. quantitative - reasonable basis to believe that a series of recommended transactions is not excessive or otherwise unsuitable given such client s investment profile. Duty of best execution use reasonable diligence to achieve as favorable of a price as possible under prevailing market conditions. Duty to disclose conflicts in certain situations. 44

45 Registered Investment Advisers - Requirements RIAs do owe a fiduciary duty to their clients. Part and parcel to this fiduciary duty is that RIAs owe a duty of loyalty to their clients. An RIA must serve the interests of his client with undivided loyalty. the RIA as a fiduciary must not put himself into a position where his or her own interests may come in conflict with those of his [client], though there is an exception to this general prohibition where the [client] gives informed consent to such dealings. 45

46 Registered Investment Advisers Requirements the RIA should not make investment decisions, including trades in securities, in a manner that will benefit the RIA without first disclosing the existence of the conflict to the client. The content and frequency of such disclosure varies based upon the facts and circumstances of the situation. In effect, informed consent given by a client to the RIA is permitted by the Advisers Act and will overcome a breach of the duty of loyalty owed by the RIA to the client. The SEC also holds RIAs to a duty to make a determination of suitability in delivering investment advice to a client and, if the RIA has discretion to make trades through BDs, RIAs are required to seek best execution. 46

47 Registered Investment Advisers may not Antifraud provisions - act in a manner designed to manipulate, defraud, or deceive its clients or prospective clients. engage in any course of conduct that will have the effect of manipulating, defrauding, or deceiving a client or prospective client. 47

48 Registered Investment Advisers Fiduciary Duties Duty to disclose material facts; Duty of loyalty (including a duty to not engage in transactions involving a conflict of interest unless such conflicts are disclosed); Duty to determine suitability (including a duty to inquire) reasonable determination that advice is appropriate based upon client s financial situation, investment experience, and investment objectives; Duty of best execution seek best price at which trades could be executed in light of facts and circumstances (dealer mark ups and mark downs, brokerage commissions, etc.). RIA must also consider compensation paid to the RIA. SEC regulations specifically address agency cross transactions, principal trades, custody, and proxy voting. 48

49 Municipal Advisors - Requirements Dodd-Frank requires municipal advisors to put their clients interests first without regard to their own financial or other interests SEC MA Rule provisions MSRB rulemaking further addresses the application of fiduciary duty for municipal advisors MSRB regulation, primarily MSRB Rule G-42 49

50 Municipal Advisors MSRB Regulation MSRB Rule G-17 applies to municipal advisors as well as municipal securities dealers (Underwriters) Must deal fairly with all persons Must not engage in any deceptive, dishonest or unfair practice Elements of MSRB Rule G-42 Duty of loyalty and care to municipal entity Recommendations must be in best interest of municipal entity Achieved necessary qualifications to render informed advice Obligation to investigate reasonably feasible alternatives Disclosure of conflicts of interest and receipt of municipal entity's informed consent Addressing certain unmanageable conflicts, for example: Kick-backs Fee-splitting 50

51 CA Considerations selected California case law What is a fiduciary relationship? A fiduciary relationship is any relation existing between parties to a transaction wherein one of the parties is in duty bound to act with the utmost good faith for the benefit of the other party. Such a relation ordinarily arises where a confidence is reposed by one person in the integrity of another, and in such a relation the party in whom the confidence is reposed, if he voluntarily accepts or assumes to accept the confidence, can take no advantage from his acts relating to the interest of the other party without the latter s knowledge or consent. (Wolf v. Superior Court (2003) 107 Cal.App.4th 25, 29 [130 Cal.Rptr.2d 860], internal citations omitted.) "[A] fiduciary relationship is a recognized legal relationship such as guardian and ward, trustee and beneficiary, principal and agent, or attorney and client [citation]." (Richelle L. v. Roman Catholic Archbishop (2003) 106 Cal.App.4th 257, 271.) 51

52 CA Considerations selected California case law What are a fiduciary s duties? Every agent owes his principal the duty of undivided loyalty. During the course of his agency, he may not undertake or participate in activities adverse to the interests of his principal. In the absence of an agreement to the contrary, an agent is free to engage in competition with his principal after termination of his employment but he may plan and develop his competitive enterprise during the course of his agency only where the particular activity engaged in is not against the best interests of his principal. (Sequoia Vacuum Systems v. Stransky (1964) 229 Cal.App.2d 281, 287 [40 Cal.Rptr. 203].) A fiduciary must give "priority to the best interest of the beneficiary. [Citation.]" (Committee on Children's Television, Inc. v. General Foods Corp. (1983) 35 Cal.3d 197, 222 (Children's Television).) In addition to this duty of preference toward the beneficiary, the fiduciary also is required to manage the subject matter of the relationship (or res) with due care, must account to the beneficiary, and must keep the beneficiary fully informed as to all matters pertinent to the beneficiary's interest in the res. (See Chodos, The Law of Fiduciary Duties (2000), pp. LIV- LV.) 52

53 Questions and Answers 53

54 KNN Disclosures Disclosure of Conflicts of Interest and Legal or Disciplinary Events Pursuant to Municipal Securities Rulemaking Board ( MSRB ) Rule G-42, on Duties of Non-Solicitor Municipal Advisors, Municipal Advisors are required to make certain written disclosures to clients which include, amongst other things, Conflicts of Interest and any Legal or Disciplinary events of KNN Public Finance, LLC ( KNN Public Finance ) and its associated persons. Conflicts of Interest KNN Public Finance represents that in connection with the issuance of municipal securities, KNN Public Finance may receive compensation from an Issuer or Obligated Person for services rendered, which compensation is contingent upon the successful closing of a transaction and/or is based on the size of a transaction. Consistent with the requirements of MSRB Rule G-42, KNN Public Finance hereby discloses that such contingent and/or transactional compensation may present a potential conflict of interest regarding KNN Public Finance s ability to provide unbiased advice to enter into such transaction. This conflict of interest will not impair KNN Public Finance s ability to render unbiased and competent advice or to fulfill its fiduciary duty to the Issuer. If KNN Public Finance becomes aware of any additional potential or actual conflict of interest after this disclosure, KNN Public Finance will disclose the detailed information in writing to the Issuer in a timely manner. Legal or Disciplinary Events KNN Public Finance, LLC, has never been subject to any legal, disciplinary or regulatory actions nor was it ever subject to any legal, disciplinary or regulatory actions previously, when it was a division of Zions First National Bank or Zions Public Finance, Inc. A regulatory action disclosure has been made on Form MA-I for one of KNN Public Finance municipal advisory personnel relating to a 1998 U.S. Securities and Exchange Commission ( SEC ) order that was filed while the municipal advisor was employed with a prior firm, (not KNN Public Finance). The details of which are available in Item 9; C(1), C(2), C(4), C(5) and the corresponding regulatory action DRP section on Form MA and Item 6C; (1), (2), (4), (5) and the corresponding regulatory action DRP section on Form MA-I. Issuers may electronically access KNN Public Finance s most recent Form MA and each most recent Form MA-I filed with the Commission at the following website: The SEC permits certain items of information required on Form MA and Form MA-I to be provided by reference to such required information already filed on a regulatory system (e.g., FINRA CRD). The above noted regulatory action has been referenced on both Form MA and MA-I due to the information already filed on FINRA s CRD system and is publicly accessible through BrokerCheck at For purposes of accessing such BrokerCheck information, the Municipal Advisor s CRD number is