The MSRB on July 18, 2012, released guidance regarding an interpretive notice on the application of Rule G-17. The interpretive notice takes effect on August 2, 2012. The guidance comes in the form of “practical considerations” provided by the MSRB to help explain and clarify certain provisions of the notice.
The MSRB guidance organizes the guidance into categories, and within each of these categories gives a number of “statements of principle” that reflect key policies from Rule G-17. Then for each of these statements, the MSRB provides applicable information from the interpretive notice (if any), along with the “practical considerations.” Since the “practical considerations” are new, but also require context, this alert will focus on them, organized by associated “statement of principle.” For insight into changes caused by the interpretive notice, see this prior exam alert or the MSRB guidance. Categories are italicized below, summarized statements of principle are underlined.
Statements and Representations
An underwriter must not misrepresent material information.
-Underwriters must have a reasonable basis for any assumptions underlying provided information.
-The less certain an underwriter is of its underlying assumptions, the more important it is to disclose its uncertainty.
-A request for proposal is subject to the rule, and “should not be treated as merely a sales pitch.”
-If an underwriter would be uncomfortable with an issuer relying on provided information, the underwriter should either refrain from providing the information or provide additional disclosures as to the reliability of the information.
-Underwriters must clearly distinguish opinion from fact.
An underwriter in a negotiated underwriting must not recommend against using a municipal adviser.
-An underwriter may not imply that the underwriter can provide that same services as a municipal adviser.
Fairness of Financial Aspects of an Underwriting
The underwriter’s compensation must be reasonable.
The price the underwriter pays to the issuer must be fair.
Profit-sharing arrangements with investors that purchase IPO shares may not be allowed, particularly if the investor resells the shares shortly after they purchase them.
-An arrangement can be inferred to exist based on a pattern of transactions, even without a written agreement.
-An underwriter should consider whether any such arrangement would result in an unfair price for the issuer.
An underwriter should not seek to be reimbursed for lavish expenditures made for the personal benefit of issuer personnel.
Required Disclosures to Issuers
An underwriter in a negotiated underwriting must disclose information about its role to the issuer.
-If the underwriter is operating in agency capacity (by working as a placement agent) rather than principal capacity, the underwriter does not need to state that the underwriter’s financial interests are independent of the issuer’s.
-If the underwriter is operating in agency capacity rather than principal capacity, the underwriter does not need to state that the underwriter lacks a fiduciary duty to the issuer.
-In offerings with no official statements, the underwriter does not need to disclose a duty to review the official statement.
An underwriter in a negotiated underwriting must disclose its actual and potential material conflicts of interest.
-An underwriter in a negotiated underwriting must disclose payments, values, credits, and other material conflicts of interest regardless of the complexity of the issue.
-Payments to third parties only need to be disclosed when they would cause a conflict of interest; routine business payments would not generally trigger the requirement.
-An underwriter should focus on giving a complete picture of conflicts of interest, rather than trying to organize their disclosure based on the categories provided by the notice.
If an underwriter in a negotiated underwriting recommends a complex form of financing to the issuer, the underwriter must disclose the material characteristics and risks of the financing.
-Not all negotiated underwritings involve a recommendation by the underwriter (i.e. when the issuer or a financial advisor has already decided on the form of financing and the underwriter merely executes the transaction).
-An underwriter must make the judgment of whether a form of financing is complex. A relatively common financing structure or product may still be complex.
-As an issuer becomes more experienced with a complex financing structure or product, less disclosure may be necessary. If an experienced employee of the issuer (in a relevant position) is replaced with a relatively inexperienced one, more disclosure may be necessary.
-The underwriter must tailor its disclosures to the specific issuer and the specific complex financing structure/product, rather than handing out a general form with various types of complex financing structures/products described.
-The underwriter may have a set of standardized descriptions of complex structures/products that it selects from and modifies as necessary to form the disclosure document provided to the issuer.
If an underwriter reasonably believes that an employee of the issuer is unfamiliar with a financing structure that it recommends, the underwriter must provide material information on that structure (regardless of whether a typical municipal securities professional would be familiar with the structure).
Manner and Timing of Providing Disclosures to Issuers
-Disclosures for a complex financing must not consist of “page after page of complex legal jargon in small print.”
-For complex financing involving a swap, the swap dealer must have reasonable basis to believe that a municipal client has an independent representative that can evaluate the transaction (including its risks, pricing, and appropriateness).
-The agreement among underwriters should designate a syndicate manager to give disclosures to the issuer (besides firm-specific conflict of interest disclosures).
-It may not always be feasible to strictly adhere to the timelines provided for disclosure. The important thing is that the issuer is kept informed throughout the process. The notice is not intended to cause technical violations as long as the underwriters act “in substantial compliance” with the timeframes and meet the “key objectives” for providing the disclosure.
Sources:
MSRB Provides Guidance to Underwriters on Implementation of New Obligations to State and Local Governments
Guidance on Implementation of Interpretive Notice Concerning the Application of MSRB Rule G-17 to Underwriters of Municipal Securities
This alert applies to the Series 7.
