Financial Services Reform Webinar Series: Public Finance and the Dodd-Frank Act February 22, 2011
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Moderator: Richard P. Eckman 302.777.6560 eckmanr@pepperlaw.com Partner in the Wilmington office of Pepper Hamilton LLP Finance and transactional lawyer and chairs the firm s Financial Services Practice Group In additional an active transactional practice representing financial institutions, corporations and other entities in a variety of business transactions, has 30 years experience representing clients in the consumer financial services industry including designing new products, dealing with compliance issues including enforcement and litigation matters, and helping clients navigate the increasingly complex web of state and federal laws that regulate the offering of consumer financial products on a national basis. 9
Speaker: Timothy B. Anderson 215.981.4711 andersontb@pepperlaw.com Of Counsel in the Financial Services Practice Group of Pepper Hamilton LLP, resident in the Philadelphia office Advises clients on a variety of public and project finance matters Acted as bond counsel and underwriter s counsel in numerous tax-exempt and taxable bond issues, ranging from school districts, townships and municipal authorities, to manufacturing facilities, private education entities and universities in both public and private placements.. 10
Speaker: Frank A. Mayer, III 215.981.4632 mayerf@pepperlaw.com Partner in the Financial Services Practice Group of Pepper Hamilton LLP, resident in the Philadelphia office Focuses his practice on counseling regulated business enterprises with a special emphasis on financial institutions Well-versed in the areas of bank regulations, international banking, bank insolvency, receiverships and related business disputes Service in the legal divisions of the FDIC and the RTC. 11
Speaker: Gregory J. Nowak 215.981.4893 nowakg@pepperlaw.com Partner in the Philadelphia and New York offices of Pepper Hamilton LLP, where he concentrates his practice in securities law, particularly in representing investment management companies and other clients on matters arising under the Investment Company Act of 1940 and the related Investment Advisers Act of 1940 Represents broker-dealers and CTA s and CPO s with respect to matters under the Securities Exchange Act of 1934 and the Commodity Exchange Act and represents many hedge funds and other alternative investment funds in fund formation, investment and compliance matters, including compliance audits and preparation work. 12
Introduction Change in Composition of Congress. Purpose of the Dodd-Frank Act enacted in response to financial crisis of 2008 and the bail-out of Wall Street firms at taxpayer expense, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act ) represents the most extensive change in the regulation of financial institutions since the Great Depression. 13
Introduction Oversight of implementation of the Dodd-Frank Act The Senate Committee on Financial Services (the Committee ) plans to exercise high levels oversight concerning implementation of the Dodd-Frank Act. 14
Introduction The Committee plans to conduct significant oversight of the Financial Stability Oversight Council ( FSOC ) created by the Dodd-Frank Act which is an interagency body charged with identifying, monitoring and addressing potential threats to U.S. financial stability. The Dodd-Frank Act requires FSOC to report annually to Congress. The Committee will conduct significant oversight over the FSOC, monitoring among other things the extent to which its designation of systemically significant firms may create an expectation among market participants that the government will not permit these firms to fail, as well as the effectiveness of the FSOC in making financial markets more stable and resilient. 15
Introduction The Dodd-Frank Act creates a new Office of Financial Research ( OFR ) housed with the Treasury Department and grants it broad powers to compel the production of information and data from financial market participants. Section 153 of the Dodd- Frank Act requires the OFR to report annually to Congress on the state of the U.S. financial system. The Committee will conduct oversight of the OFR to ensure that the OFR s request for data are not unduly burdensome or costly and that the confidentiality of the data it collects is strictly maintained. The Committee will also assess whether the OFR duplicates data collection efforts already being undertaken b other regulatory bodies. 16
Introduction Issues regarding constitutionality of the Dodd-Frank Act concerns that Act gives the federal government unchecked power to seize financial firms and to legislate through regulation. 17
Effects of the Dodd-Frank Act on Public Finance Municipal Advisors Definitions Municipal Advisor means any person who 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 who undertakes a solicitation of a municipal entity. Municipal Entity means any state, political subdivision of a state, or municipal corporate instrumentality of a state, including agencies and authorities (whether or not they issue municipal bonds). 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. The SEC currently intends to exclude providers of municipal bond insurance, letters of credit, or other liquidity facilities from the definition of obligated persons. 18
Effects of the Dodd-Frank Act on Public Finance Municipal Advisors With certain exceptions, the Dodd-Frank Act makes it unlawful for a municipal advisor to provide 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 to undertake a solicitation of a municipal entity or obligated person unless that municipal advisor is registered in accordance with the Dodd-Frank Act. 19
Effects of the Dodd-Frank Act on Public Finance Municipal Advisors The universe of persons potentially affected is broad and encompasses individuals and entities providing investment advice to state and local governments and their instrumentalities. As proposed, the new implementing regulations could also require financial and other officers of bond obligors (such as hospitals and universities) to register. 20
Effects of the Dodd-Frank Act on Public Finance Municipal Advisors Pursuant to the Dodd-Frank Act, those persons or entities which fall within the definition of municipal advisor are required to file with the SEC and the MSRB. Such filers must first file with the SEC. 21
Effects of the Dodd-Frank Act on Public Finance Municipal Advisors Requirement that municipal advisors register with the MSRB means that such persons or entities must comply with other requirements of MSRB registration, including: Rules on assessments, rulemaking procedures and registration Rules concerning fair dealing Potentially concerning a new "pay-to-play" rule and to make certain conforming changes to existing rules for brokers, dealers, and municipal securities dealers to make such rules applicable to municipal advisors. A municipal advisor that has previously registered with the MSRB as a broker, dealer or municipal securities dealer must register separately with the MSRB as a municipal advisor. 22
Effects of the Dodd-Frank Act on Public Finance Municipal Advisors The Dodd-Frank Act provides that municipal advisors and any person associated therewith are deemed to have a fiduciary duty to any municipal entity for whom such municipal advisor acts as a municipal advisor, and no municipal advisor may engage in any act, practice, or course of business which is not consistent with a municipal advisor s fiduciary duty or that is in contravention of any rule of the MSRB. 23
Effects of the Dodd-Frank Act on Public Finance Municipal Advisors The Dodd-Frank Act requires the MSRB to adopt rules that provide continuing education requirements for municipal advisors and professional standards. The Dodd-Frank Act requires that MSRB rules not impose an inappropriate regulatory burden on small municipal advisors. 24
Effects of the Dodd-Frank Act on Public Finance Changes to the MSRB Board Composition Fifteen-member MSRB Board will include eight independent members unaffiliated with a broker-dealer or municipal advisor. Independent members will include at least one investor, one issuer, and one member of the general public with knowledge of or experience in the municipal industry (referred to as the public representative ) Industry board members will include at least one non-bank dealer, one bank dealer, and at least one municipal advisor (referred to as the regulated representatives ). May expand Board beyond 15 members, so long as public representatives exceed number of regulated representatives and the number of total board members is odd. 25
Effects of the Dodd-Frank Act on Public Finance Changes to Authority of MSRB Dodd-Frank Act authorizes the MSRB to assist the SEC and FINRA in examinations and enforcement actions regarding MSRB rules, and to retain half of any penalties collected by the SEC in such enforcement actions. Dodd-Frank Act authorizes the MSRB to establish information systems and to impose fees for submission of information to these systems. Dodd-Frank Act expands the MSRB s authority to regulate advice provided to or on behalf of municipal entities as well as obligated persons, which includes any person who is committed to support the payment of all or part of the obligations on municipal securities. Dodd Frank Act requires the MSRB to meet with the SEC and FINRA at least twice a year to share information about the interpretation of MSRB rules and examination and enforcement of compliance with such rules. 26
Effects of the Dodd-Frank Act on Public Finance Creation of SEC Office of Municipal Securities Dodd-Frank Act creates an Office of Municipal Securities within the SEC, which shall administer the rules related to municipal securities brokers and dealers, municipal securities advisors, municipal securities investors, and municipal securities issuers and coordinate with the MSRB with regard to rulemaking and enforcement actions as required by law. Dodd-Frank Act requires that the Office be staffed sufficiently to carry out such purposes. The head of the Office of Municipal Securities will be the Director, who will report directly to the Chairman of the SEC. 27
Effects of the Dodd-Frank Act on Public Finance Effect of Dodd-Frank Act on Credit Rating Agencies New Requirements The Dodd-Frank Act creates an Office of Credit Ratings within the SEC with its own compliance staff and the authority to fine agencies. The SEC is required to examine Nationally Recognized Statistical Ratings Organizations ( NRSROs ) at least once a year and make key findings public. The head of the Office will be the Director, who will report directly to the Chairman of the SEC. The Dodd-Frank Act requires disclosure of NRSROs methodologies, reliance on third parties for due diligence efforts, and ratings track record. 28
Effects of the Dodd-Frank Act on Public Finance Effect of Dodd-Frank Act on Credit Rating Agencies The Dodd-Frank Act requires issuers and underwriters of assetbacked securities to disclose the findings and conclusions of any third party due diligence report. Third party provider must provide a certification to the NRSRO which then must be disclosed by the NRSRO. Provides that enforcement and penalty provisions of the Securities Exchange Act of 1934 (the Exchange Act ) apply to statements made by a credit rating agency in the same manner and to the same extent as such provisions apply to statements made by a registered public accounting firm or a securities analyst. Statements are not deemed forward-looking for purposes of the safe harbor for forwardlooking statement under Section 21E of the Exchange Act. 29
Effects of the Dodd-Frank Act on Public Finance Effect of Dodd-Frank Act on Credit Rating Agencies Requires that NRSROs consider information about an issuer that the NRSRO has, or receives from a source other than the issuer or underwriter, that the NRSRO finds credible and potentially significant in its rating decision. 30
Effects of the Dodd-Frank Act on Public Finance Effect of Dodd-Frank Act on Credit Rating Agencies Dodd-Frank Act requires NRSROs to address conflicts of interest. The Dodd-Frank Act requires NRSROs to conduct a one year lookback review when an NRSRO employee goes to work for an obligor or underwriter of a security or money market instrument subject to a rating by that NRSRO. The Dodd-Frank Act requires NRSROs to report to the SEC when certain employees leave to work for an entity that the NRSRO has rated in the previous twelve months. The Dodd-Frank Act directs the SEC to create a new mechanism to prevent issuers of asset-backed securities from picking the NRSRO they think will give the highest rating, after conducting a study and reporting to Congress. 31
Effects of the Dodd-Frank Act on Public Finance Effect of Dodd-Frank Act on Credit Rating Agencies Provisions of the Dodd-Frank Act provide for enhanced oversight of NRSROs. The Dodd-Frank Act creates a private right of action against NRSROs for knowingly or recklessly failing to conduct a reasonable investigation of the facts or to obtain analysis from an independent source. The Dodd-Frank Act authorizes the SEC to deregister an NRSRO for providing bad ratings over time. The Dodd-Frank Act requires ratings analysts to pass qualifying exams and requires continuing education. The Dodd-Frank Act eliminates many statutory and regulatory requirements to use NRSRO ratings. Pursuant to the Dodd-Frank Act, NRSROs are now subject to liability as experts under Section 11 of the Securities Act and registrants under the Securities Act must file the consent of the NRSRO with their registration statement pursuant to Section 7 of the Securities Act. Municipal securities remain exempt from registration under the Securities Act. 32
Effects of the Dodd-Frank Act on Public Finance Effects on Securitizations Section 941 of the Dodd-Frank Act defines an assetbacked security as a fixed-income or other security collateralized by any type of self-liquidating financial asset (including a loan, a lease, a mortgage, or a secured or unsecured receivable) that allows the holder of the security to receive payments that depend primarily on cash flow from the asset. 33
Effects of the Dodd-Frank Act on Public Finance Effects on Securitizations The Dodd-Frank Act specifically includes within the definition of asset-backed securities: collateralized mortgage obligations; collateralized debt obligations; collateralized bond obligations; collateralized debt obligation of asset-backed securities; collateralized debt obligation of collateralized debt obligations; and a security that the SEC, by rule, determines to be an asset-backed security. 34
Effects of the Dodd-Frank Act on Public Finance Effects on Securitizations The Dodd-Frank Act requires issuers of asset-backed securities ( securitizers ) to: Refrain from directly or indirectly hedging or otherwise transferring the credit risk that the securitizer is required to retain with respect to an asset. Retain not less than 5% of the credit risk for any asset, subject to certain exceptions related to qualified residential mortgages. 35
Effects of the Dodd-Frank Act on Public Finance Effects on Securitizations The Dodd-Frank Act directs the SEC to provide a total or partial exemption for any asset-backed security that is a security issued or guaranteed by any State of the United States, or by any political subdivision of a State or territory, or by any public instrumentality of a State or territory that is exempt from the registration requirements of the Securities Act by reason of section 3(a)(2) of that Act, or a security defined as a qualified scholarship funding bond in section 150(d)(2) of the Internal Revenue Code of 1986, as may be appropriate in the public interest and for the protection of investors. 36
Effects of the Dodd-Frank Act on Public Finance Effects on Securitizations The Dodd-Frank Act requires the SEC to adopt regulations requiring each issuer of an asset-backed security to disclose more information about the underlying assets, including asset-level or loan-level data if such data is necessary for investors to independently perform due diligence. 37
Effects of the Dodd-Frank Act on Public Finance Effects on Derivatives and Swaps The Dodd-Frank Act divides jurisdiction over derivatives and rulemaking into three categories: security based swaps regulated by the SEC, swaps regulated by the CFTC, and mixed swaps subject to joint regulation by both the SEC and CFTC. Although the existing exemption for State and municipal obligations contained in the Commodity Exchange Act are expected to continue to be applicable to State and municipal swaps, the new provisions requiring reporting of municipal swap transactions will apply, as will the new rules regarding the business conduct standards for swap providers and swaps advisors providing services to municipal entities. 38
Effects of the Dodd-Frank Act on Public Finance Effects on Derivatives and Swaps The Dodd-Frank Act provides that swaps are generally not required to be cleared if one of the counterparties is not a financial entity, is using swaps to hedge commercial risk, and notifies the SEC or CFTC, as applicable, how it generally meets its financial obligations relative to entering into noncleared swaps. 39
Effects of the Dodd-Frank Act on Public Finance Effects on Derivatives and Swaps Swap dealers are subject to new business conduct and risk and other disclosure requirements, and, when dealing with governmental parties: if acting as an advisor, must comply with special rules against fraud, deception or manipulation; and if acting as a swap provider, must have a reasonable basis to believe that the governmental entity has an independent representative meeting certain qualifications and other requirements pursuant to Section 731 of the Dodd-Frank Act. 40
Effects of the Dodd-Frank Act on Public Finance Effects on Derivatives and Swaps The Dodd-Frank Act defines special entity to include a State, State agency, city, county, municipality, or other political subdivision of a state. The Dodd-Frank Act defined swap dealer as any person that is required to be registered as a swap dealer under this section shall register with the CFTC regardless of whether the person also is a depository institution or is registered with the SEC as a securitybased swap dealer. 41
Effects of the Dodd-Frank Act on Public Finance Effects on Derivatives and Swaps The Dodd Frank Act defines major swap participant as Any person that is required to be registered as a major swap participant under this section shall register with the CFTC regardless of whether the person also is a depository institution or is registered with the SEC as a major security based swap participant. 42
Effects of the Dodd-Frank Act on Public Finance Effects on Derivatives and Swaps The Dodd-Frank Act imposes certain business conduct requirements on swap dealers and major swap participants in dealing with special entities, including: Prohibition on fraud, deception or manipulation involving swaps (including swaps that are offered but not entered into); Requiring swap dealers (but not major swap participants) to act in the best interest of the special entity; and Requiring swap dealers to disclose to the special entity in writing the capacity in which the swap dealer is acting before the initiation of the transaction. 43
Outstanding Issues concerning Dodd-Frank Deal Risk for Municipal Issuers Title II of Dodd-Frank Act provides for Orderly Liquidation Authority ( OLA ) for Covered Financial Companies. 44
Outstanding Issues concerning Dodd-Frank Deal Risk for Municipal Issuers Entities deemed to be Covered Financial Companies and therefore subject to OLA: Failing financial companies that pose significant risk to the financial stability of the United States. Federal regulatory authorities must make recommendation to the Secretary of the Treasury. Secretary of the Treasury consults with President of the United States and determines that grounds exist to appoint Federal Deposit Insurance Corporation ( FDIC ) as receiver for entity subject to OLA. Dodd-Frank Act allows for immediate judicial review of the Secretary s determination based on an arbitrary and capricious standard. 45
Outstanding Issues concerning Dodd-Frank Deal Risk for Municipal Issuers Pursuant to OLA: FDIC succeeds to all rights, titles, powers, and privileges of the covered financial company and its assets, and of any stockholder, member, officer, or director of such company. Sale and disposition of assets Anti-Trust Issues Bridge Financial Companies Resolution of Claims Disposition of existing contracts and similar obligations Creditors guaranteed to receive no less than what they would receive under Chapter 7 of the Bankruptcy Code 46
Outstanding Issues concerning Dodd-Frank Deal Risk for Municipal Issuers For issuers of municipal securities, swap counterparties, providers of letters of credit, other liquidity facilities, bond insurance or swap insurance may be subject to OLA under Dodd-Frank whereby FDIC succeeds provider as a receiver. 47
Outstanding Issues concerning Dodd-Frank Deal Risk for Municipal Issuers Possible outcomes? Prophylactic responses Terms allowing issuer to immediately terminate swap agreement, insurance policy, liquidity agreement or reimbursement agreement. Terms permitting lower LOC or liquidity fees pursuant to a ratings schedule provider gets downgraded and issuer pays a lower fee and gets partial reimbursement of any fees already paid. Terms under which Bond Insurer of Letter of Credit Bank Consent is no longer required for changes to documents. 48
Outstanding Issues concerning Dodd-Frank Municipal Advisors Revisited The SEC has specifically noted that [o]bligated persons can include entities acting as conduit borrowers such as private universities, non-profit hospitals, and private corporations. Comments are outstanding concerning the breadth of the municipal advisor definition as proposed by the SEC in its Release No. 34-63576. 49
Outstanding Issues concerning Dodd-Frank Municipal Advisors Revisited As currently proposed, the definition of municipal advisor could conceivably include: Appointed (other than ex-officio) board members of municipal entities. The SEC s rationale for this is that appointed members of board are not sufficiently subject to the public. May be difficult for boards to get qualified people to serve on boards of municipal entities. May also raise issues of federalism; and Attorneys acting as counsel to municipal entities. The current proposed definition of municipal advisor exempts attorneys from registering with the SEC and MSRB only when they give advice which is of a traditional legal nature. This is very nebulous and if it is allowed to stand will force attorneys to behave in ways which may be at odds with state rules of professional conduct. 50
Outstanding Issues concerning Dodd-Frank MSRB Proposed Changes The MSRB recently filed proposed amendments to its Rule G-23 with the SEC which would prohibit dealerfinancial advisers from switching roles and becoming underwriters in the same transaction, should that transaction involve the issuance of municipal securities. 51
Outstanding Issues concerning Dodd-Frank MSRB Proposed Changes The proposed amendments would, subject to the exceptions prohibit a dealer financial advisor with respect to the issuance of municipal securities from acquiring all or any portion of such issue directly or indirectly, from the issuer as principal, or acting as agent for the issuer in arranging the placement of such issue, either alone or as a participant in a syndicate or other similar account formed for that purpose; apply the same prohibition to any dealer controlling, controlled by, or under common control with the dealer financial advisor; and prohibit a dealer financial advisor from acting as the remarketing agent for such issue. 52
Outstanding Issues concerning Dodd-Frank MSRB Proposed Changes The proposed amendments would not prohibit: a dealer financial advisor from placing an issuer s entire issue with another governmental entity, such as a bond bank, as part of a plan of financing by such entity for or on behalf of the dealer financial advisor s issuer client; a dealer financial advisor from serving as successor remarketing agent to an issuer for the same issue with respect to which it provided financial advisory services if the financial advisory relationship with the issuer had been terminated for at least one year; or a dealer financial advisor from purchasing such securities from an underwriter, either for its own trading account or for the account of its customers, except to the extent that such purchase was made to contravene the purpose and intent of the rule. 53
Conclusion Final Thoughts and takeaways. 54
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