MSRB Rule G-17:
Interpretive Notice on Duties of
Underwriters to Issuers
June 27, 2012
Webinar
About the MSRB
• A self-regulatory organization that oversees the
municipal securities market
• Mission is to protect investors, state and local
governments, other municipal entities and the public
interest by promoting a fair and efficient market through:
– Establishment of rules for dealers and municipal advisors
– Collection and dissemination of market information
– Market leadership, outreach and education
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Background on Rule G-17 Interpretive
Notice
• Dodd-Frank Wall Street Reform and Consumer Protection
Act of 2010 expanded MSRB’s jurisdiction to protect state
and local governments
• In light of this, the MSRB prioritized a reassessment of
existing duties of underwriters to state and local
governments
• Determined that expanded requirements were necessary
• Developed new interpretive notice on MSRB Rule G-17 to
ensure state and local governments are properly protected
in securities transactions
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Rule G-17 Interpretive Notice
• MSRB Notice 2012-25 on Rule G-17, on fair dealing, was
approved by the Securities and Exchange Commission on
May 4, 2012
• SEC-approved interpretive notice carries the force of
federal law
• Notice is effective August 2, 2012
Note: Slides regarding this interpretive notice provide only a brief
overview. Refer to www.msrb.org for the full interpretive notice.
3
Rule G-17 Interpretive Notice
• Goals of the notice:
– Clarifies the relationship of an underwriter to its
clients
– Creates affirmative obligations for underwriters
– Requires an underwriter to disclose important
information to an issuer to help the issuer assess
proposed financial transactions
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Duties of Underwriters to Issuers
• Fair practice duties outlined in the notice fall into three
broad areas:
– Statements and representations to issuers
– Disclosures to issuers
– Financial aspects of underwriting transactions
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Rule G-17 Interpretive Notice
Statements and Representations
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Statements and Representations
• All provisions in the interpretive notice arise from the same
fundamental duty of fairness to an issuer already required
under MSRB Rule G-17
• However, the interpretive notice more clearly articulates the
specific nature of an underwriter’s fair dealing obligations in
order to:
– Assist an underwriter with conforming to the expectation of
fairness, and
– Assist enforcement agencies in assessing an underwriter’s
compliance with this expectation
7
Statements and Representations
• All representations made in writing or orally by underwriters to
issuers must:
– Be truthful and accurate
– Not misrepresent or omit material facts
– Not be misleading
– Have a reasonable basis
– Not misrepresent knowledge or expertise
• Requirements apply to representations made in documents
such as responses to requests for proposals, issue price
certificates and materials used in official statements
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Statements and Representations
• Notice provides more detailed direction on an underwriter’s
obligation to honor an issuer’s retail order period
– An underwriter that agrees to conduct retail order periods
must take reasonable measures to ensure that retail clients
are bona fide
– An underwriter would violate its fair dealing duty if it
knowingly accepts an order framed as a retail order but
which does not meet the issuer’s requirements for retail
– Dealer placing a false retail order also would be in violation
of MSRB Rule G-17
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Statements and Representations
• The notice also requires that an underwriter:
– Must act consistently with its representations to issuers
of the level of effort it will put toward new issue pricing
and not misrepresent the nature of investor demand
– Cannot recommend that an issuer not retain a financial
advisor
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Rule G-17 Interpretive Notice
Required Disclosures
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Required Underwriter Disclosures
to Issuers
• Under the interpretive notice to Rule G-17,
underwriters have new, defined disclosure
requirements that are effective August 2, 2012
• Disclosure requirements set out types of
information an underwriter must provide to the
issuer, and include the manner and timing of
providing such disclosures
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Required Underwriter Disclosures
to Issuers
• As of August 2, 2012, an underwriter must make
specific disclosures to an issuer regarding:
– Nature of the underwriter’s legal obligations and
relationship with an issuer;
– Existence of any conflicting interests that, without
disclosure, could leave issuers with inaccurate
impression of an underwriter’s impartiality in dealings
with issuers; and
– Material financial terms and risks of underwriting
transactions recommended by an underwriter
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Required Underwriter Disclosures
to Issuers
• An underwriter may acquire securities either by
negotiation with an issuer or by competitive bidding
process
• Much, but not all, of the notice is limited to negotiated
offerings rather than competitive bids
• An underwriter in a negotiated offering must disclose
its role and legal obligations to the issuer to clarify the
differing roles of underwriters and municipal advisors
for state and local governments
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Required Disclosure of Underwriter’s
Role and Related Obligations
• Required disclosures include that:
– Rule G-17 requires an underwriter to deal fairly at all
times with both municipal issuers and investors;
– An underwriter’s primary role is to purchase securities
with a view to the distribution of those securities in an
arm’s-length commercial transaction
– Unlike municipal advisors, an underwriter does not have a
federal fiduciary duty to issuers and is not required to act
in the issuer’s best interests without regard to its own
financial or other interests
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Required Disclosure of Underwriter’s
Role and Related Obligations
– An underwriter has a duty to purchase securities from an
issuer at a fair and reasonable price but must balance that
duty with a duty to sell municipal securities to investors at
fair and reasonable prices
– An underwriter reviews official statements in accordance
with, and as part of, its responsibilities to investors under
federal securities laws
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Required Disclosure of Underwriter’s
Conflicts of Interest
• An underwriter is required to disclose all actual or
potential conflicts of interest to allow an issuer to
evaluate the impartiality of the underwriter and its
recommendations
• Regarding compensation, an underwriter in a
negotiated offering must disclose:
– Whether its underwriting compensation will be contingent on closing
of transaction, and
– That compensation contingent on closing or size of transaction
presents conflict of interest because it may cause underwriter to
recommend unnecessary, or larger than necessary, transactions
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Required Disclosure of Underwriter’s
Conflicts of Interest
• Some scenarios that can give rise to actual or potential
conflicts of interest that underwriters must disclose
include:
– Third-party payments
– Profit-sharing arrangements with investors
– Issuer-related credit default swap activity
– Other transaction-specific incentives
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Required Disclosure of Third-Party
Payments
• An underwriter must disclose all potential or actual
conflicts of interest related to the existence, but not the
value, of any third-party payments made or received in
connection with underwriting of new issues
– Disclosure also required for payments in connection with
collateral transactions such as swaps or reinvestment of
bond proceeds
– Disclosure also required for third-party marketing
arrangements
19
Required Disclosure of Profit-Sharing
Arrangements
• An underwriter must disclose any profit-sharing
arrangements with investors
– Such arrangements include any agreement to directly or
indirectly split or share profits from resale by the investor
of securities sold to it by an underwriter
– Formal written agreement not necessary for such
arrangement to be inferred
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Required Disclosure of Credit Default
Swap Activity
• An underwriter for a new issue must disclose whether it
issues, purchases or otherwise trades credit default
swaps (CDS) for which the issuer or its securities is a
reference
– Trading in CDS related to a state or local government or one
of its specific issues of securities can affect pricing of such
issuer’s securities
– Disclosure about value or specifics of such CDS activities is
not required
– Disclosure about CDS based on baskets or indexes is
limited
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Required Disclosure of Deal-Related
Incentives
• An underwriter must disclose transaction-specific
conflicts, such as existence of incentive for underwriter
to recommend complex municipal securities financing
– Example: An underwriter provides a swap used by an
issuer to hedge an offering or an underwriter receives
compensation from a swap provider for recommending
that swap provider to an issuer
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Rule G-17 Interpretive Notice
Required Disclosures for
Complex Financings
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Required Disclosures for Complex
Financings
• The notice requires an underwriter in a negotiated
offering making a recommendation about a financing to
provide disclosures on certain key features of the
financing
• An underwriter in a negotiated offering must make
reasonable determination about whether recommended
financing is “complex”
• Complex municipal securities financings are structured
in a unique, atypical or otherwise complex manner
– Examples: VRDOs, swaps or other derivatives
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Required Disclosures for Complex
Financings
• If a recommended transaction in a negotiated offering is
a complex financing, the underwriter must disclose:
– Material financial characteristics of the financing
– Material financial risks of the financing that are known or
foreseeable
• Information about the risks and characteristics of a
complex financing is crucial for issuers to evaluate
whether this type of financing is appropriate for them
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Required Disclosures for Complex
Financings
• Example: An underwriter recommending VRDOs should
disclose:
– Risk of interest rate fluctuations, material risk of potential inability to
replace liquidity facility upon expiration and material risk of potential
shortening of maturity schedule if bonds not remarketed but instead
held as bank bonds, among other disclosures
• Example: An underwriter recommending a swap should
disclose:
– Material market risk, credit risk, operational risk and liquidity risk;
material economic terms, operational terms and parties’ material
rights; and possibility of accounting and legal risks, among others
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Required Disclosures for Complex
Financings
• Tailoring disclosures to issuer personnel for complex
financings is permitted based on:
− Issuer’s knowledge or experience with proposed financing
structure or similar structures;
− Issuer’s capability of evaluating risks of recommended
financing; and
− Issuer’s financial ability to bear risks of recommended
financing
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Required Disclosures for Complex
Financings
• Determination of an issuer’s level of expertise and
ability to bear financial risk will dictate whether
disclosures may be abbreviated or must be more
fulsome
• The level of disclosure should be re-evaluated
over time as the issuer:
− Gains experience with a complex financing over the
course of multiple new issues utilizing that structure
− Undergoes personnel changes since new employees
may have differing levels of expertise
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Required Disclosures for Routine
Financings
• Underwriters may also need to disclose information
about more routine financings depending upon the
expertise of the issuer
– If issuer personnel charged with executing the transaction
lack knowledge or experience with the structure, material
aspects of the structure must be disclosed
– If an otherwise routine financing incorporates a less
understood element, that element and its impact on the
financing is subject to the same disclosure requirements
as complex financings
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Required Disclosures to Issuers
• If an underwriter does not reasonably believe issuer
personnel are capable of independently evaluating
disclosures, the underwriter must make additional
efforts to inform the official or its employees or agent of
risks
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Specificity of Required Disclosures for
Complex Financings
• Disclosures concerning a complex financing must address
specific elements of the financing
• Requirement not satisfied by:
– Broad overview of generic characteristics and risks not addressing
specific features of complex financing, or
– Document covering broad range of financing options without
prominent and specific reference to features of particular complex
financing
• Underwriter may prepare, in advance, standardized
disclosures for each type/variety of complex structure it
offers, to be tailored to unique features and risks of specific
complex financing
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Rule G-17 Interpretive Notice
Manner and Timing of Disclosures
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Required Manner of Disclosures
• Disclosures required by interpretive notice to MSRB
Rule G-17 are to be made to issuers:
– In writing
– In a manner that makes the subject and implications
clear to the issuer
– To an official with appropriate authority to bind issuer
by contract
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Required Manner of Disclosures
• Conflicts of interest disclosures cannot be made to an
official who is party to such conflicts
• An underwriter must request written acknowledgment of
receipt of disclosures from issuer and document any
failure to receive such acknowledgement
• Syndicate managers may provide disclosure on behalf
of other syndicate members except in the case of
conflicts disclosures, which must be made by the
particular underwriters subject to such conflicts
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Required Timing of Disclosures
• Timing requirements for disclosures ensure issuers
have information they need when they need it to make
informed decisions
• Disclosure of arm’s-length nature of underwriting
transaction must be made at earliest stage of the
underwriter’s relationship with the issuer
– Corresponds with MSRB Rule G-23 requirements that issuer
understands a firm is seeking to serve as an underwriter, not
financial advisor
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Required Timing of Disclosures
• Disclosures concerning role of underwriter,
compensation and conflicts of interests must be
made when underwriter is formally brought into
transaction
• Such disclosures may not be made later in process,
such as at the signing of a bond purchase
agreement
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Required Timing of Disclosures
• Disclosures concerning material financial
characteristics and risks of complex financings and
applicable routine financings, and newly identified
conflicts of interest, must be made prior to execution
of bond purchase agreement
– Issuers must have sufficient time to evaluate
recommendation
• Underwriters should view timeframes in light of fair
dealing goals of Rule G-17
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Rule G-17 Interpretive Notice
Financial Aspects of
Underwriting Transactions
38
Financial Aspects of Underwriting
Transactions
• MSRB does not establish specific compensation
standards for underwriters
• However, an underwriter’s compensation for a new
issue must not be so disproportionate as to constitute
unfair practice under Rule G-17
• Compensation includes both direct compensation paid
by issuer and separate payments from issuers or third
parties in connection with underwriting
39
Underwriter Compensation
• Factors to consider when evaluating whether
underwriter’s compensation is disproportionate:
– Credit quality of the issue
– Size of the issue
– Market conditions
– Length of time spent structuring the issue
– Whether underwriter is paying fee of underwriter’s
counsel and other relevant costs
40
Pricing of New Issues of Municipal
Securities
• Pricing of a new issue is one factor in determining
whether an underwriter has treated the issuer fairly
– Price paid by underwriter must be fair and reasonable,
considering all relevant factors
– Competitive bids must be bona fide based on dealer’s
best judgment of fair market value
– In negotiated offering, underwriter has duty to negotiate in
good faith with issuer
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Conclusion
• Note: Slides regarding this interpretive notice provide
only a brief overview. Refer to www.msrb.org for the
full interpretive notice.
• For more information on Rule G-17 and other MSRB
regulatory initiatives, please visit www.msrb.org.
• Contact the MSRB at (703) 797-6668.
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MSRB Rule G-17:
New Interpretive Notice on Duties of
Underwriters to Issuers
June 27, 2012
Webinar