FIRST RIVER ADVISORY L.L.C.

Transcription

1 FIRST RIVER ADVISORY L.L.C RACE STREET, SUITE 1112 PHILADELPHIA, PENNSYLVANIA Member Firm OFFICE TELEPHONE MOBILE TELEPHONE (215) (734) SHELLEY J. ARONSON PRESIDENT Certified Independent Public Finance Advisor NAIPFA DIRECTOR AT LARGE, PERSPECTIVES ON THE ROLE OF FINANCIAL ADVISORS Financial executives of heath care organizations frequently entertain proposals from both financial advisory and investment banking firms to assist them with their capital formation processes. First River Advisory has observed that there seems to be a general lack of clarity as to the scopes of services, limitations and perspective of each type of firm. To compound the confusion, some of those differences are evolving due to a new regulatory context. NEW REGULATION OF FINANCIAL (MUNICIPAL) ADVISORS Financial advisors became regulated under the Dodd Frank Wall Street Reform and Consumer Protection Act (Dodd Frank) enacted in Under Dodd Frank, financial advisors are referred to as Municipal Advisors (MAs), so that term will be maintained here. Because nonprofit hospitals usually obtain financing through the issuance of municipal (tax-exempt) bonds, their financial advisors are now defined as MAs. In the usual construct, a bond issuing authority would be a municipal entity under Dodd Frank, and a hospital would be an obligated person. Dodd Frank requires that MAs register with the U.S. Securities and Exchange Commission (the SEC) and with the Municipal Securities Rulemaking Board (the MSRB). To date, hundreds of firms have registered, including First River Advisory. Some registered MAs are also investment banking firms, more formally referred to securities broker-dealers (BDs) by the SEC under the various federal securities laws and in the MA Rule. First River Advisory and many other MAs are Independent Registered Municipal Advisors (IRMAs). THE MA RULE The SEC issued its final MA rule (the MA Rule) which became effective on July 1, The MA Rule more clearly defines who needs to be registered as an MA, and delineates the respective roles of MAs and BDs. ADVICE Under the MA Rule, only bona-fide MAs may provide advice unless certain exemptions apply. The MA Rule defines Advice as a recommendation that is particularized to the specific needs, objectives or circumstances of a municipal entity or obligated person (e.g., a hospital) with respect to the issuance of municipal securities, including structure, timing, terms and other matters, based on all the facts and circumstances. In its adopting release for the MA Rule, the SEC stated that it

2 Perspectives / Role of Financial Advisors Page 2 will broadly construe Advice to include any communication to a municipal entity or obligated person that includes a recommendation, an expression of opinion or that includes information that is particularized to a municipal entity or obligated person. The more individually tailored the communication, the greater the likelihood that the communication may be viewed as Advice, especially where the information provided is targeted to a particular audience. EXEMPTIONS A BD can, however, offer Advice if any of the following Exemptions apply: 1. the Advice is given in a response to questions contained in a hospital s Request for Proposals (RFP) or Request for Qualifications (RFQ) (the RFP Exemption); 2. the BD has been formally engaged as the underwriter, but not before (the Underwriter Exemption); OR 3. the hospital has already engaged an IRMA like First River Advisory (the IRMA Exemption). Even if none of these Exemptions apply, the MA Rule does not preclude BDs from providing information of a general nature. However, because of the SEC s broad interpretation of Advice, the non-specific information which BDs can always provide may not be very useful to the hospital. RESPECTIVE ROLES OF MUNICIPAL ADVISORS AND BROKER-DEALERS MUNICIPAL ADVISORS First River Advisory and hundreds of other MAs are IRMAs because they are unaffiliated with BDs, banks and all other types of financial institutions. IRMAs provide only Advice on the issuance of municipal securities and cannot underwrite bonds. The scope of services provided by IRMAs in the context of a hospital s bond issue varies widely. In some instances, the engagement is very limited, say, to verify the reasonableness of the yields on the bonds. Other engagements are very comprehensive, encompassing in broad terms: P P development of an overall debt strategy which identifies all relevant factors to be considered, including the hospital s tolerance for risk and linkages to other organizational objectives; the decision to borrow at all or just pay cash in the current context, be it related to a financing of a new project or a refinancing of outstanding debt;

3 Perspectives / Role of Financial Advisors Page 3 P P P identification, refinement and evaluation of alternative formats for the borrowing, including, but not limited to: how much to borrow; what type(s) of debt instruments to issue; when to borrow; the debt issuance s fit within the overall debt strategy; presentation of the hospital s credit characteristics to rating agencies, lenders and/or investors in a manner which promotes the marketability of the debt instruments; and leadership of the financing team throughout the implementation process. Most of First River Advisory s engagements are comprehensive in nature and consistent with this paradigm. BROKER-DEALERS In the context of bond issues for non-profit hospitals, the BD s main role is to underwrite and purchase bonds issued on behalf of the hospital by a governmental bond issuing authority in an arm s-length commercial transaction. It might seem counterintuitive, but the investment banker representing the BD is marketing his/her firm s qualifications to buy a product (the bonds) from, not sell a product to, a hospital prospect. Historically, as hospitals bond issues have been prepared for market, BDs have ordinarily been providing Advice to hospital clients on the type of debt instrument to be issued, the structure and principal amount of the issue, and several other characteristics. BDs can no longer offer such Advice, unless one of the Exemptions apply. As an alternative to applying one of the Exemptions, a BD could choose to be an MA, rather than an underwriter, in connection with a hospital s bond issue. The BD would have to disclose which hat to wear early in its marketing process. The BD could then dispense Advice as soon as it became engaged as the hospital s MA. Existing MSRB rules limit the opportunity for a BD which has already been engaged as an MA to change hats and become the underwriter of securities resulting from that MA engagement.

4 Perspectives / Role of Financial Advisors Page 4 THE FIDUCIARY DUTY Dodd Frank and the MA Rule require that an MA maintain a fiduciary duty to its municipal entity but not obligated person clients such as non-profit hospitals. BDs have certain fiduciary duties to their customers to whom they sell securities, but not to either their municipal entity or obligated person clients. Even if a BD were able to apply one of the Exemptions, its Advice would not be subject to its fiduciary duty. In its draft Rule G-42, the MSRB proposed to extend MAs fiduciary duty to obligated person clients. Shelley Aronson, on behalf of First River Advisory filed a comment letter (attached) with the MSRB strongly supporting the MSRB s position. In doing so, First River Advisory was the first IRMA to go on the record in support of this provision; representatives of many other IRMAs concurred subsequently. Though Rule G-42 has not yet been finalized, it does not appear that it will include the extension of fiduciary duty to obligated persons. First River Advisory, since its inception in 1995, has, at least informally, adhered to the fiduciary duty standard with respect to both its municipal entity and obligated person clients (most are obligated persons ). Even though not required by the MA Rule or MSRB Rule G-42, First River Advisory expects to formalize its voluntary acceptance of the fiduciary duty standard as a matter of course in agreements with obligated person clients. IS THE MA RULE A GAME-CHANGER? Well, maybe. First River Advisory believes that the SEC takes the position or interprets Congressional intent that issuers of tax-exempt bonds should not be taking meaningful advice from professionals who do not have a fiduciary duty, unless certain conditions can be met. The MA Rule distinguishes between MAs role of providing unbiased advice and BDs role of executing transactions. The Government Finance Officers Association (GFOA) supports this distinction. As stated by Tim Firestine, chief administrative officer of Montgomery County, Maryland, and president of the GFOA, in a Commentary published in the December 9, 2013 edition of The Bond Buyer (also attached), the SEC s final [MA] Rule aims to set a clear line between advice and the underwriting of bonds. First River Advisory does not believe that the MA Rule will curtail the flow of capital markets information to hospitals, as some market participants contend. General information will continue to be disseminated widely by BDs. Hospitals will still be able to obtain information which reflects their circumstances from BDs as long as they have applied one of the Exemptions. That same information can also be obtained from MAs without limits. First River Advisory and other MAs have access to much the same market information as BD personnel. But First River Advisory s acceptance of the fiduciary duty standard ensures that this information is delivered in an unbiased manner and applied in the hospital s best interests.

5 Perspectives / Role of Financial Advisors Page 5 Some market participants have expressed concerns that discussions regarding the implementation of securities issuances with the various professionals involved in the financing will be stifled. First River Advisory contends that if the hospital has engaged an IRMA, then the IRMA Exemption can be applied, and these discussions can continue as they have in the past. Regardless of the existence of an IRMA or the application of the IRMA Exemption, generally, once these kinds of discussions begin to take place, the BD will have already been engaged as the underwriter, so that the hospital can then rely on the Underwriter Exemption. WHY FIRST RIVER ADVISORY? ON YOUR SIDE When faced with the choice of engaging First River Advisory or a BD, hospital executives should discern between Advice that will be given by a professional with a fiduciary duty standard and Advice that will not. When choosing between First River Advisory and another MA, hospitals should ask whether each is willing to apply the fiduciary duty standard by contract. Lynda Kirker, the retired CFO of Flagler Hospital in St. Augustine, Florida, had been the veteran of several bond issues for her institution involving most common financing techniques. In late 2007, she contacted First River Advisory, which had just completed the first-ever conversion of auction rate securities (ARS) backed by a Radian Asset Assurance bond insurance policy for another client, precisely Flagler s predicament with respect to nearly $34 million of its Series 2003 ARS. First River Advisory was engaged to take charge of the process in early November, and completed the assignment just seven weeks later. Ms. Kirker s highly favorable evaluation of First River Advisory s performance led to its engagement in connection with four subsequent transactions. More importantly, though, Ms. Kirker felt that for the first time, the firm engaged to manage Flagler s capital financing process was truly on her organization s side. According to Ms. Kirker, prior to First River Advisory s involvement, her investment bankers presented financing ideas which seemed to be beneficial to us [Flagler], but sometimes didn t turn out that way. She added, in those instances, Flagler had to address adverse consequences well after the investment bankers had moved on. I would never again go into the capital financing process without an independent financial advisor at my side, and I d recommend that other hospitals do the same rather than rely on the advice of investment bankers who don t have the same fiduciary duty, Ms. Kirker concluded. NO CONFLICTS FINANCIAL INSTITUTIONS PLAYING MULTIPLE ROLES First River Advisory has observed instances in which the same financial institution, in a single set of coordinated transactions, underwrites a hospital s bonds for resale to investors, purchases other bonds directly for its own account and acts as a counterparty for an interest rate

6 Perspectives / Role of Financial Advisors Page 6 swap. In many of those cases, the hospital had not engaged an IRMA to represent its interests. A hospital CFO may contend that the financial institution has always done a good job, and that the investment banker, the person who likely orchestrated the series of transactions, is his/her best friend forever. But how can the CFO know for certain, especially if he/she is the CFO of a hospital whose entries into the capital markets are infrequent? Can the CFO truly rely on his/her investment banker to negotiate pricing, terms, conditions and covenants relating to the direct purchase and the swap with others who are employed by the same organization? First River Advisory routinely represents hospitals whose financing plans specify multiple products. Due to the emergence of full-service financial institutions, it is entirely conceivable that the same institution can provide all such products, and sometimes package deals can be beneficial. Nevertheless, First River Advisory takes the approach that each product will be evaluated on its own merits, and the provisions of each such product will be negotiated separately. First River Advisory s clients gain the benefit of having a savvy owner s rep on their sides.

7 FIRST RIVER ADVISORY L.L.C RACE STREET, SUITE 1112 PHILADELPHIA, PENNSYLVANIA Member Firm OFFICE TELEPHONE January 16, 2014 MOBILE TELEPHONE (215) (734) SHELLEY J. ARONSON PRESIDENT Certified Independent Public Finance Advisor NAIPFA DIRECTOR AT LARGE, Mr. Ronald W. Smith, Corporate Secretary Municipal Securities Rulemaking Board 1900 Duke Street, Suite 600 Alexandria, VA Dear Mr. Smith I appreciate the opportunity, on behalf of my firm, to comment on the Draft MSRB Rule G- 42, on Duties of Non-Solicitor Municipal Advisors, released on January 9, My firm, First River Advisory L.L.C., is a registered Municipal Advisor (MA) specializing in the non-profit health care sector. Since First River Advisory s formation in 1995, nearly all of its clients have been obligated persons rather than municipal entities. I strongly support the MSRB s initiative to apply the fiduciary standard to obligated persons as well as to municipal entities. Obligated person clients of MAs deserve the same consideration with respect to the fiduciary standard as other issuers and borrowers in the municipal bond market. I do not believe that carrying forward this distinction due to differences in the services provided to municipal entity and obligated person clients, or for any other reason, is warranted. As a principal of a small MA firm, I do not believe that a requirement to accept the fiduciary standard with respect to all clients would represent a compliance burden. In comparing notes with leaders of other firm members of the National Association of Independent Public Finance Advisors (NAIPFA) whose practices are more oriented to municipal entity clients, I have found that my firm s engagements are far more extensive and complex. For instance, First River Advisory s agreement with a current client was executed in September 2013 for a financing that is not expected to be concluded until the first calendar quarter of One of my activities earlier this week was my participation in an all-day planning session with this client s executives and its architects and construction managers to produce a comprehensive schedule for an ambitious facilities improvement project. My primary role was to ensure that accurate and complete project development information would be available in a timely manner for disclosure in a preliminary official statement. Due to these more extensive and complex engagements with obligated person clients during which more comprehensive scopes of services are ordinarily provided, it may be even more important that MAs be required to apply the fiduciary standard to obligated person clients than to municipal entity clients.

8 Comment on the Draft MSRB Rule G-42 January 16, 2014 Page 2 For the past 18½ years, First River Advisory has routinely accepted the fiduciary standard with respect to all of its clients. Between the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) in the autumn of 2010 and the release by the U.S. Securities and Exchange Commission of its Final Rule regarding Municipal Advisors in September 2013 (the SEC Final Rule), First River Advisory had taken the position that it has a fiduciary duty to obligated person clients, even though not specifically required by Dodd-Frank. It had been First River Advisory s expectation that the fiduciary standard inconsistency between municipal entity clients and obligated person clients would eventually be corrected. Further, it had always seemed to First River Advisory that in order to comply with MSRB Rule G-17, First River Advisory would have had to maintain a de facto fiduciary duty to its obligated person clients. First River Advisory s acceptance of the fiduciary standard was included in all client agreements executed during this period. In order to prepare for the effective date of the SEC Final Rule, First River Advisory has prepared Written Policies and Procedures. First River Advisory s declared policy is the acceptance of the fiduciary standard, including the duty of loyalty and the duty of care, to all clients. This policy has been reflected in the one obligated person client agreement executed since the release of the SEC Final Rule. First River Advisory has had a few municipal entity clients during its existence. They were not treated any differently than obligated person clients with respect to the fiduciary standard. I believe that it would be impractical for an MA firm to apply the fiduciary standard differently with respect to different types of clients. Moreover, I would not want to be put in a position to explain to an obligated person client that First River Advisory s municipal entity clients get the benefit of my firm s adherence to the fiduciary standard but that they are not entitled to such benefit. I can also envision conflicts arising in connection with financings involving a conduit issuer (a municipal entity) which has its own MA. The objectives and concerns of conduit issuers and their borrowers (obligated persons) are not always aligned. In those cases, without consistent application of the fiduciary standard, the conduit issuer s MA would be required to accept the fiduciary standard, but the borrower s MA would not. Again, I would envision the borrower s executives asking how come... questions, the responses to which would not likely be considered satisfactory by those executives.

9 Comment on the Draft MSRB Rule G-42 January 16, 2014 Page 3 Thank you for the opportunity to submit these comments. I may submit comments on other aspects of Draft Rule G-42, either on behalf of First River Advisory or in concert with other NAIPFA member firms. Cordially,

10 Friday, May 30, 2014 as of 3:55 PM ET Tim Firestine DEC 9, :46pm ET In September the Securities and Exchange Commission finalized the long awaited municipal advisor definition. The Government Finance Officers Association supports regulating those professionals who provide advice to state and local governments and believes that the Dodd Frank Act and this rule will help to ensure that those who provide advice have a fiduciary duty to their government clients. The SEC s final Rule aims to set a clear line between advice and the underwriting of bonds. Differentiating these two practices is key to the implementation of the municipal advisor rule and will encourage best practices by issuers and other professionals, resulting in a stronger municipal market. There is no doubt that for decades, investment bankers acting as underwriters have contributed to essential infrastructure financings. They have brokered hundreds of thousands of deals that provide everything from a new public safety facility in Sedgwick County, Kansas, to a Resource Recovery Facility here in Montgomery County, Maryland. However, it is equally undeniable that the financial interests of investment banks and issuers are not aligned and that issuers need to look out for their own interests, either directly or with the assistance of qualified advisors who have to put the interests of their clients first. I know that many governments are overwhelmed with a wide variety of financial responsibilities that limit their ability to fully engage in the day to day events of the municipal securities market. This is why GFOA s Best Practices, Selecting Financial Advisors, Selecting Underwriters in a Negotiated Sale, and Selecting and Managing the Method of Sale for State and Local Government Bonds, recommend that governments hire a financial advisor for their transactions, unless they have sufficient in house expertise to understand all facets of the bond transaction. Unfortunately, for many governments, critical financial advice about bond transactions has come from parties subject to varying and unclear contractual or regulatory duties (or none at all) and not all that advice has been in the best interest of or suitable for those governments. The final Rule addresses and will help to rectify some of the market practices that however well intentioned, caused a blurring of the lines between underwriting and the fiduciary role of a professional advisor. It continues down an important path set in 2011 when the MSRB changed rule G-23 to stop the practice of role-switching that allowed a professional to serve as both the FA and underwriter on the same transaction. The changes to Rule G-23 also set the stage for ensuring that the issuer knows up front whether the professional coming to the office seeks to be hired as an FA or an underwriter. The MSRB continued this theme in Rule G-17 by developing disclosure standards that the underwriter must provide to an issuer about its role in a transaction, its conflicts of interest, and that it does not have a fiduciary duty to the issuer. The SEC MA Rule further advances the market down this path by defining this line and clarifying the separate roles of a financial advisor and underwriter.

11 There has been vocal opposition, primarily from the broker/dealer community that this Rule will stifle the ability to have important conversations and a flow of ideas between underwriters and issuers. I believe these concerns are exaggerated, and are unhelpful to having the market move forward with finding appropriate ways to adapt to the new Rule. Unlike some of the rhetoric I ve heard, conversations between underwriters and issuers may still occur after Jan. 13. It is the advice component of these conversations that will have to change, unless an issuer follows the GFOA s Best Practices, and has a financial advisor on a transaction, an RFP out for underwriters, and/or has secured a professional as an underwriter. While the goal and intent of the Rule are set, there are areas where interpretations from the SEC would be helpful. These include the need to give additional guidance about how the term RFP may be interpreted; how underwriters, issuers and other market participants can better understand the difference between advice and general information; how an issuer should disclose that it has a financial advisor; and when an underwriter may qualify as engaged with an issuer to trigger the underwriter exemption of the Rule. There s no doubt about it - the MA Rule is an important step forward for ensuring that municipal capital markets truly serve the public interest. Many of the discussions currently being held in the market seem to blur the lines of the Rule, and what it does for this sector and issuers. We find the spirit and letter of the rule in line with the GFOA s Best Practices that will help to ensure that our citizens receive the best deal possible for the financing of essential infrastructure that our taxpayers depend on and deserve. Tim Firestine is chief administrative office of Montgomery County, Md., and president of the Government Finance Officers Association SourceMedia. All rights reserved.