NATIONAL ASSOCIATION OF BOND LAWYERS TELECONFERENCE ON MUNICIPAL ADVISOR RULES. June 25, 2014

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1 NATIONAL ASSOCIATION OF BOND LAWYERS TELECONFERENCE ON MUNICIPAL ADVISOR RULES June 25, 2014 Following is a brief outline of the certain provisions of Rule 15Ba1-1 (the Rule ) adopted by the U.S. Securities and Exchange Commission (the SEC ) under the Securities Exchange Act of 1934, as authorized by Section 975 of the Dodd-Frank Wall Street Reform and Investor Protection Act ( Dodd-Frank ) and to become effective July 1, The Commission adopted and explained the Rule in Exchange Act Release No , adopted September 20, 2013 (the Release ). SEC staff provided interpretive guidance on the Rule in answers to frequently asked questions ( FAQs ) on January 16, 2014 and May 19, The FAQs are posted on the SEC s website. See This outline summarizes provisions of the Rule that are most applicable to lawyers with a public finance practice. I. OVERVIEW. Section 975 of Dodd-Frank (a) defines municipal advisor, (b) requires that municipal advisors register with the SEC, (c) imposes a federal fiduciary duty on municipal advisors to municipal entities, and (d) requires the Municipal Securities Rulemaking Board (the MSRB ) to adopt business conduct rules and minimum qualifications for municipal advisors. II. MUNICIPAL ADVISORY ACTIVITIES. Under Section 975 of Dodd-Frank, as construed by the Rule, a municipal advisor is defined as a person that 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..., or undertakes a solicitation of a municipal entity or obligated person for compensation to engage a third party for such a transaction, unless the person qualifies for an exemption. A. Municipal Entity and Obligated Person. Municipal Entity: means "any State, political subdivision of a State, or municipal corporate instrumentality of a State, including (A) any agency, authority, or instrumentality of the State, political subdivision, or municipal corporate instrumentality; (B) any plan, program, or pool of assets sponsored or established by the State, political subdivision, or municipal corporate instrumentality or any agency, authority, or instrumentality thereof; and (C) any other issuer of municipal securities," including public pension funds (whether or not controlled by a governmental unit), local government investment pools, and Section 529 plans. 1

2 Obligated Person: means "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," excluding (a) credit enhancers, the federal government, and immaterial obligors on municipal securities and (b) persons who have not yet begun the process of applying to or negotiating with a municipal entity to issue municipal securities. The FAQs also exclude new issue advice to existing obligated persons before they apply to a municipal issuer, if the advice is not with respect to outstanding municipal securities. B. Advice. 4. Standard: Neither Dodd-Frank nor the Rule defines or provides a standard for determining what constitutes "advice. Common usage includes both opinions and information. According to the Release, whether a statement is advice depends on facts and circumstances. The Release states that advice includes recommendations that are particular to the needs, objectives, or circumstances of a municipal entity or obligated person. While the FAQs reiterate a facts and circumstances test, they state that in general a statement is advice if it reasonably would be viewed as a recommendation to take or refrain from taking action. Exclusion for General Information: The Rule expressly excludes from advice "general information that does not involve a recommendation." The Release interprets "general information" to include factual information without subjective assumptions, opinions or views (even if particularized to a municipal entity or obligated person or type), information that is not particularized to a specific municipal entity or type of municipal entity, and certain widely disseminated or general educational material, in each case so long as the information or material does not include "a recommendation that is particularized to the specific needs, objectives, or circumstances of the relevant municipal entity or obligated person." Recommendations: The Release notes that a statement would be viewed as a "recommendation" if it "reasonably could be viewed as a call to action" and "reasonably would influence the advisee to take action. The FAQs clarify that, in general, a statement that would not be objectively viewed as a recommendation is not advice, and that specified disclaimers are a factor in determining whether a statement is a recommendation. The FAQs include examples of statements that would not be viewed as a recommendation (e.g., hypothetical refunding results using the same debt structure and general pricing ranges) and would be viewed as a recommendation (hypotheticals using a different debt structure or rates tailored to the issuer). Indirect Advice: Dodd-Frank and the Rule includes advice to or on behalf of a municipal entity or obligated person within the definition of municipal advisor. 2

3 The FAQs confirm that a broker-dealer that gives advice specific to an issuer to the issuer s financial advisor would be a municipal advisor, unless the broker-dealer qualifies for the IRMA exemption or another exemption described below. C. Subjects of Advice. Issuance of Municipal Securities: Neither Dodd-Frank nor the Rule defines issuance. The Release states that the term (a) should be construed broadly to extend from pre-issuance planning through (contrary to common usage) repayment of municipal securities and (b) does not include advice with respect to a tender for the purchase of municipal securities or mere remarketing agent services for demand securities (except in connection with a primary offering). The FAQs also exclude (a) statements by an institutional purchaser describing the structure, terms, and timing of municipal securities that it would be willing to purchase from an issuer and (b) assistance (without assumptions, opinions, or views, e.g., as to whether an event is material) in complying with continuing disclosure obligations. Investments of Proceeds : Under Dodd-Frank and the Rule, "advice" is regulated if given to covered persons with respect to "guaranteed investment contracts," "municipal escrow investments," or "investment strategies." The Rule defines "guaranteed investment contracts" and "investment strategies" to exclude transactions that do not involve an investment of "proceeds" of municipal securities, but extend the terms to include even a single recommendation of a single investment. Under the Rule, "proceeds" include not only sale proceeds and investment proceeds, but also money "held in funds under legal documents for the municipal securities that are reasonably expected to be used as security or a source of payment" for debt service on the securities, intended to be "similar" to or "consistent with" the definition of that term in the Treasury Department's arbitrage regulations. Proceeds also include funds with which proceeds are commingled, except for short-term operating funds that are treated as spent for tax purposes when commingled. The FAQs clarify that proceeds of pension obligation bonds cease to be proceeds when contributed to and commingled with other funds in a public pension plan, if the issuer may not use them for other purposes. Municipal Derivatives: Advice with respect to derivatives is regulated under the Rule (a) if provided to a municipal entity in any event (not just when it is hedging municipal securities), but (b) if provided to an obligated person, only when it is acting "in its capacity as an obligated person." The Release clarifies that this would occur if a derivative transaction is entered into in connection with or anticipation of, or pledged as security for, municipal securities issued for the obligated person. D. Due Diligence Duties. Determining Whether Investments are of Proceeds: To determine whether advice is being given with respect to the proceeds of municipal securities, the Rule states that 3

4 a person may rely on representations of a knowledgeable official as to whether amounts to be invested are "proceeds," if the person has a "reasonable basis" for reliance. The Release clarifies that, although a person "generally need not independently verify all of the information underlying the representation," a person must perform "reasonable diligence" to have a reasonable basis for reliance on a representation by reviewing both the representation and other reasonably available relevant information, including information in the person's possession. The Release states that similar diligence is required before giving derivatives advice to or soliciting a company, if it could be an obligated person. Transitional Relief: The FAQs provide transitional relief for post-effective date investment advice with respect to funds on deposit in accounts as of July 1, 2014, and investments then held, if the advisor does not know that they are proceeds of municipal securities after reasonable diligence, which could include (a) a review of the account name (to assure that it does not refer to a municipal entity or a bond issue) and (b) reliance on the account holder s failure to respond to a request to notify the advisor if the account includes proceeds of municipal securities (i.e., a negative consent process). The FAQs state that the reasonableness of pre-effective date account diligence could be affected by administrative burdens and costs and the likelihood that the account holder would use proceeds of municipal securities, given the nature of its business. This transitional relief is inapplicable to advice regarding investments of newly-arising proceeds of municipal securities that are issued on or after July 1, E. Solicitations. Solicitation: Under Dodd-Frank and the Rule, a person may not engage in a "solicitation of a municipal entity or obligated person," i.e., seek to obtain an engagement with respect to municipal financial products or the issuance of municipal securities for an unrelated person for compensation, unless the solicitor is an employee of the person for whom the engagement is solicited or an affiliate or the person qualifies as a municipal advisor. The Release clarifies that the endorsement of a broker-dealer or financial advisor by an association could be considered a solicitation, if compensated, except possibly if it is communicated only by the endorsed entity as part of its general advertising. Compensation: The Release clarifies that any economic benefit qualifies as compensation, but not whether a quid pro quo is required, or whether the recommendation of a broker-dealer by an attorney, for example, would be for compensation if by course of dealing the attorney could expect to be engaged as underwriters counsel in another transaction. 4

5 III. EXEMPTIONS. A. Advice by Attorneys. Legal Services Exemption: The Rule excludes attorneys who provide legal advice or services of a traditional legal nature to a client, unless the attorney "represents himself or herself as a financial adviser or financial expert." 5

6 Primarily Financial Advice: The Release recognizes that services of a traditional legal nature "inherently involve a financial advice component," but states that an attorney would be representing himself or herself as a financial adviser or expert (and therefore not be eligible for the exception) if he or she "provides advice that is primarily financial in nature," including advice with respect to project feasibility, estimating or comparing cost to maturity of an issue, or recommending a structure (or competitive versus negotiated sale) based on its financial advantages. The Release clarifies that, without qualifying as a municipal advisor, an attorney may compare the structure, terms, and (presumably issuance) costs of possible financing alternatives, explain the tax consequences, recommend a particular financing structure due to legal considerations, and provide arbitrage compliance services. Advice to Client: The Release clarifies that an attorney's advice to his or her client in a working group meeting is excluded even if a non-client municipal entity or obligated person hears and relies on the advice, and that advice is "to a client" even if given before (and in anticipation of) being engaged or after the formal attorney-client relationship has terminated. The FAQs state that an attorney may disclose to a nonclient advice that the attorney would give to its client, if asked, even if the client is not present. The FAQs also clarify that bond counsel may give advice to an obligated person within the scope of the attorney exemption. On the other hand, even purely legal advice given to a municipal entity or obligated person under other circumstances would require registration, if not given to a client. B. Advice in Responding to an RFP or RFQ. RFP/RFQ Exception: The Rule exempts advice (oral or written) given in response to an RFP or RFQ, if the person giving the advice is not separately compensated for it (directly or indirectly). Qualification for Exception: The Release clarifies that the exemption extends to responses to "mini-rfps" sent to "pre-screened or pre-qualified" persons. The FAQs clarify that the exemption would be available if the RFP or RFQ identifies a particular objective or question, is open for a reasonable amount of time (generally, six months), and is sent to at least three reasonably competitive market participants (unless sent to a smaller pre-qualified pool), even if it does not comply with the issuer s procurement policies. Compensation: The RFP/RFQ exception is not available to a person separately compensated for his or her advice. C. Advice as an Underwriter. Underwriting Exemption: The Rule contains an exclusion for advice provided by a broker, dealer, or municipal securities dealer acting as an underwriter, if the advice is within the scope of the underwriting. 6

7 4. Engagement: The Release states that the exclusion becomes effective only when the underwriter is engaged by the advisee for a specific securities issue and ends at the end of the underwriting period, and that appointment as part of a pool from which underwriters will be selected for specific offerings in the future is not sufficient. The FAQs clarify that a sufficient engagement would exist if (a) the underwriter receives a letter of intent or expectation for a particular issue that is approved or acknowledged by a duly authorized official of the issuer, even if it is preliminary, non-exclusive, non-binding, terminable, and/or conditioned on governing body approval or financial structuring, if the issuer reasonably expects to engage the underwriter, or (b) the underwriter is informed by a duly authorized official orally or by that it has been engaged, if in either case the underwriter makes all of the disclosures required by MSRB G-17 at or before the time of engagement. Scope of Underwriting: The Release clarifies that advice is within the scope of an underwriting if it is integral to purchase and distribution of the municipal securities being offered or to compliance with law, or is given with respect to terms, timing, structure, ratings, roadshows, marketing, disclosure, closing, obtaining CUSIPs, DTC eligibility, post-sale reports, or escrow cash flow requirements. The Release states that activities are outside the scope of an underwriting if they concern investments or derivatives, the method of sale (negotiated or competitive), whether to issue, bond election campaigns, matters not specific to the securities issue (e.g., the impact of capital projects, debt capacity, or overall rating strategy), competitive sales, financial feasibility analyses, budget planning or analyses, preparation or evaluation of RFPs or RFQs, and post-offering services. Placement/Remarketing Agents: The Release states that the underwriting exclusion extends to service as a placement agent, but the FAQs clarify that it does not extend to service as a remarketing agent (unless the remarketing is a primary offering). The FAQs also clarify that a remarketing agent may provide (presumably particularized) factual information about how rates would differ between daily and weekly rate modes or a change in the liquidity provider, without registering as a municipal advisor, if it expresses no recommendation, opinion, or view as to what action the issuer should take. D. Advice to a Person Represented by an Independent Registered Municipal Advisor (IRMA). IRMA Exemption: Under an exemption in the Rule, a person may provide advice to a municipal entity or obligated person that is represented by an independent registered municipal advisor on the same aspects of the issuance of municipal securities or municipal products transaction, if (a) the IRMA is independent, (b) the person receives (and has a reasonable basis for relying on) a written representation from the advisee that it is represented by and will rely on the advice of the IRMA, (c) the person advises the advisee (and its IRMA) in writing that the person is not a 7

8 municipal advisor and (in the case of a municipal entity) owes no federal statutory fiduciary duty to it, and (d) the timing and manner of the disclosure allows the advisee to assess the person s material incentives and conflicts of interest. The Release states that the level and timing of disclosures will vary with the advisee's knowledge and experience. The FAQs clarify that a general financial advisory engagement (i.e., that is not issue-specific) will qualify, if it covers the same aspects as the exempted advice; that an issuer may make its representation in any reasonable manner, including by posting a general representation to prospective advisors on its website; and that the IRMA need not be present at or receive a copy of the exempted advice. The FAQs also clarify that rely on means only that the municipal entity or obligated person will seek and consider the advice, analysis, and perspective of the independent registered municipal advisor (not that the municipal entity must follow such advice). Independence: The Rule provides in relevant part that, to be independent from a market participant seeking to use the IRMA exemption, an SEC-registered municipal advisor must not be, and cannot have been within at least the past two years, associated (as defined in Section 15B(e)(7) of the Exchange Act) with the market participant. The FAQs interpret independence to require both a dealer and its employees engaged in providing exempted advice to an issuer to be independent of the issuer s registered municipal advisor, and both the registered municipal advisor and its employees engaged in advising the issuer to be independent of the dealer. Consequently, the dealer and registered municipal advisor must not have been affiliated in the past two years. In addition, no partner, officer, director, branch manager, or other employee of the registered municipal advisor who is engaged in the management, direction, supervision, or performance of advice to the municipal entity or obligated person may have been employed by the dealer in such a capacity in the past two years. The FAQs provide that this same test also applies conversely when individuals employed by the registered municipal advisor within the past two years are employed by the dealer, but they are unclear whether independence is defeated even if they did not participate in advice to the issuer while at the registered municipal advisor. E. Commercial Bank Exemption. Banking Exemption: The Rule exempts advice rendered by a bank (as defined in the Exchange Act, including a savings association or trust company) with respect to deposit and sweep accounts with the bank, investments made by it as a trustee or escrow agent, and extensions of bank credit, including through letters of credit, direct loans, and the purchase of municipal securities by the bank for its own account. The FAQs state that dual employees (who are employed by a bank but also associated with a bank s broker-dealer affiliate) may provide advice under both the banking exemption and underwriter exemption, if the capacities are disclosed appropriately and the requirements of those exemptions are met. 8

9 Extent of Direct Purchase Exemption: The banking exemption expressly covers, among other identified banking activities, advice on the making of a direct loan or the purchase of a municipal security by the bank for its own account. The Release states that the exemption does not apply to advice on the issuance of municipal securities, which is ambiguous unless read in conjunction with the referenced activities expressly covered by the banking exemption. The FAQs clarify that a bank may provide advice regarding the structure, timing, and terms of municipal securities that that the bank will purchase for its own account, but not regarding other municipal securities. F. Other Exemptions. Public Official Exemption: The Rule includes a broad exemption for advice by elected or appointed officials and employees of municipal entities and obligated persons acting within the scope of their official capacity. The Release states that advice provided at a public comment session in a public meeting or other public forum is intended to be exempted, in order not to unduly "impede the deliberative process that municipal entities engage in with their citizens." The FAQs give other examples of exempted comments from the public, at least if made publicly. The FAQs also clarify that the public official exemption covers advice between employees of different municipal entities (e.g., a state government agency and a municipality) if the employees provide advice within the scope of their employment. Swap Dealers: To reduce duplication of effort, the Rule exempts derivatives advice by swap dealers who are registered under the Commodities Exchange Act and would not be acting as an "advisor" to the municipal entity or obligated person for purposes of that Act, even if the entity or person were a "special entity" within the meaning of the Act. To qualify for this exemption, the dealer must not make a specific recommendation, the advisee must be represented by a registered independent swap adviser, and certain representations and disclaimers must be exchanged. The exemption does not extend to "securities-based swaps," such as matched rate swaps or swaps based on a very small index of securities. Registered Investment Advisors: The Rule excludes investment advice and ancillary services by an investment advisor registered under the Investment Advisers Act of 1940 and its associated persons (employees), but not advice by it concerning the issuance of municipal securities or municipal derivatives or the "solicitation" of a municipal entity or obligated person. The FAQs clarify that only advice with respect to derivatives that are related to an issue of municipal securities is excluded from the exemption. No exemption is afforded to state-registered investment advisers. The Release clarifies that a registered investment adviser may give advice concerning the selection of investment managers, if it is not compensated by the managers to do so. Brokers and dealers are exempt from registration under the 1940 Act, but not from 9

10 registering as a municipal advisor, if they provide only advice that is incidental to their activities as a broker or dealer or certain ancillary advice Accountants: The Rule exempts advice from accountants that consists of audit or other attest services (audit opinions), preparing financial statements, or giving letters to underwriters for or on behalf of a municipal entity or obligated person. Other services, if covered "advice," are not exempt. Consequently, an accountant could perform attest services with respect to third-party feasibility services without qualifying as a municipal advisor, but likely could not perform the feasibility study without qualifying. Engineers: The Rule exempts engineers providing engineering advice. The Release states that exempt engineering advice may include feasibility reports, capital outlay schedules, and cash flow analyses, including projections of demand and project revenues, but only if "based on considerations involving engineering aspects" and not involving advice concerning municipal financial products or the issuance of municipal securities. The Release states that revenue projections "to support the structure of an issue" are not exempt. The Release states that an engineer's feasibility report attached to an offering document "may" indicate non-exempt advice if it includes revenue projections and debt service coverage, and that a rate consultant may be a municipal advisor, depending on the facts and circumstances. The Release states that whether a rate consultant to a municipal utility would qualify for the exclusion will depend on facts and circumstances. The FAQs clarify that rate advice required for an issuer to comply with its bond covenants would be exempt, implying that advice to set rates higher might not be. The FAQs also provide further examples of activities within the scope of the engineering exemption in connection with new projects to be financed with issuances of municipal securities and existing projects that were financed with outstanding issuances of municipal securities. IV. CONSEQUENCES OF BEING A MUNICIPAL ADVISOR. A. Registration. SEC: Municipal advisors must register with the SEC, temporarily before July 1, and by the advisor s permanent registration deadline thereafter, but their employees are exempt from registration if listed in the employer s registration. MSRB: Municipal advisors must also register with the MSRB after registering with the SEC. B. Fiduciary Duties of Municipal Advisors to Municipal Entities. Fiduciary Duty: Dodd-Frank states that a municipal advisor and its associated persons shall be deemed to have a fiduciary duty to a municipal entity for which it acts as a municipal advisor, and it authorizes the MSRB to adopt rules to prevent 10

11 business conduct that is inconsistent with a municipal advisor s fiduciary duty. The FAQs state that a municipal advisor to a municipal entity in the early phases of a financing may not switch roles and underwrite municipal securities in the financing. There could be other statutory fiduciary duties, even if not promulgated by the MSRB or SEC. Cf. SEC v. Chenery Corp., 318 U.S. 80 (1943) ( To say that a man is a fiduciary only begins the analysis... What obligations does he owe as a fiduciary? ) with SEC v. Chenery Corp., 332 U.S. 194 (1947)(upholding public utility holding company decision on alternate grounds based on SEC s novel application of fair and equitable standard). MSRB Proposed Fiduciary Rule: Under Rule G-42 as proposed, a municipal advisor to a municipal entity would owe a fiduciary duty that includes duties of loyalty and care. C. Business Conduct Rules. MSRB Authority: Dodd-Frank authorizes the MSRB to adopt professional standards for municipal advisors. Fair Dealing: Under existing Rule G-17, a municipal advisor must deal fairly with all persons and may not engage in any deceptive, dishonest, or unfair practice. Business Conduct Rules: Under Rule G-42 as proposed, a municipal advisor would owe duties of care, to disclose or avoid conflicts, not to recommend unsuitable actions, to refrain from principal transactions with the advisee, not to accept excessive compensation or split fees with certain principals, not to pay unregistered solicitors, and to document arrangements and keep records. D. Minimum Qualifications. SEC Approval: To be qualified as a municipal advisor, the Rule requires (1) the submission of registration and various other forms through the SEC's public online filing system (EDGAR), including Form MA to register as a municipal advisor and Form MA-I for each individual associated with the firm who engages in municipal advisory activities, and (2) compliance with various record retention requirements. The SEC may reject applications for registration. MSRB Requirements: Dodd-Frank authorizes the MSRB to adopt professional standards and continuing education rules for municipal advisors, including employees. The MSRB plans to propose qualifications in future releases. Prepared by: Fredric A. (Rick) Weber Norton Rose Fulbright 11

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