Bank Loans, Placement Agents, and Financial Advisors

In Chapter Two we discussed bank loans and their role in the municipal market. Many municipalities use bank loans to avoid the difficult process of issuing public debt. The increase in popularity of such loans has raised a number of important questions with which municipal advisors must be familiar in order to operate within the law.

In the context of the municipal market, a “bank loan” can sometimes be considered a security. If it is considered to be a security, it may affect the credit rating of an issuer, as well as the rights of current bondholders.

Essentially, if the bank loan is a true loan, also called a direct loan, then a loan agreement has been established, and it will most likely not be considered a security. In contrast, if the loan is a direct purchase, meaning the bank has bought bonds directly from the issuer, then it will most likely be considered a security, even if it is referred to as a “bank loan.”

As of this writing, there is not a clear legal line that distinguishes direct loans and direct purchases. Instead, the courts decide on a case by case basis.

If a financial advisor becomes involved in a bank loan that is determined to be a security, that financial advisor might be required to register as a broker-dealer with the SEC because the financial advisor may be considered a placement agent. This could, in turn, trigger MSRB Rule G-23, which prohibits financial advisors from acting as placement agents.

Rule G-23 defines a financial advisory relationship as an agreement to advise or consult with a municipal issuer on the timing of an issuance, the structure of the bonds, or other such matters regarding the issuance of bonds. Financial advisors who have entered such an agreement with an issuer have a fiduciary duty to the issuer and are prohibited from acting as underwriters or as placement agents for that issuer because this would introduce a conflict of interes