Fulbright & Jaworski l.l.p.
A Registered Limited Liability Partnership
Fulbright Tower
1301 McKinney, Suite 5100
Houston, Texas 77010-3095
www.fulbright.com
fweber@fulbright.com
direct dial: (713) 651-3628
telephone:
facsimile:
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September 30, 2010
BY E-MAIL TO LCAREY@MSRB.ORG AND U.S. MAIL
Municipal Securities Rulemaking Board
1900 Duke Street Suite 600
Alexandria, VA 22314
Attention: Leslie Carey
Associate General Counsel
Re:
MSRB Notice 2010 - 27
Ladies and Gentlemen:
This letter responds to your request for comments on draft amendments to MSRB Rule
G-23. The amendments would effectively prevent dealer financial advisers from bidding on and
underwriting offerings of municipal securities by the issuers whom they advise or have recently
advised. Currently, the Rule merely proscribes negotiated underwritings by a dealer
simultaneously engaged as financial adviser, but permits dealer financial advisers to bid on
competitively sold issues (with issuer consent) and to underwrite negotiated offerings after
resigning as financial adviser on terms that assure that issuers are fully aware of and consent to
any conflicts of interest that could result.
In your Notice, you asked for comments concerning relevant aspects of existing market
practice as well as the potential impact of adopting the draft rule change. We represent a large
number of small municipal utility districts and similar special districts that are created to finance,
develop, and operate public infrastructure to serve developing areas of the State of Texas. I write
on the behalf of these districts. If the Rule change is adopted as drafted, I believe the ability of
these districts (as well as many other issuers) to efficiently and reliably raise capital to finance
needed public infrastructure would be adversely affected.
Market Practice. In their development phases, these districts are unrated credits that
have not previously accessed the capital markets. They depend on future land development
activities for their ability to repay debt offerings. Consequently, they issue small amounts of
bonds at a time to manage development risks. The districts are required by state law to sell their
new money bonds competitively. To raise necessary capital in these circumstances, the districts
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Municipal Securities Rulemaking Board
September 30, 2010
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typically engage a dealer as financial advisor on a contingent fee basis to help structure,
schedule, and prepare disclosure documents for their bond issues. In doing so, the districts not
only authorize the financial advisor to bid for their bonds, they also encourage it to do so. Since
the financial adviser’s compensation for services in connection with the creation, organization,
and start-up of the districts is contingent, the financial adviser has an additional incentive to
submit a bid to make sure that the offering will be successful. In addition, because the financial
adviser watches the credit as it develops, it can more efficiently and reliably put together an
underwriting syndicate than other dealers. Due to the small size of the initial public bond
offerings and the unrated nature of the credits, it is not uncommon for only one bid to be
submitted and for that bid to be submitted by the dealer financial advisor. In many instances,
only two bids are submitted, including one by the financial adviser’s syndicate.
When these districts are presented with an opportunity to refund their bonds for interest
savings or other reasons, many districts also ask their financial advisors to underwrite the
refunding bond issue and accept their resignation as financial advisor, after full disclosure of
consequences in accordance with the existing Rule. They typically do so for several reasons.
First, refunding bonds may be sold on a negotiated basis and, given the interplay between the
yield at which the bonds are sold and the investment and structuring of the refunding escrow,
small refunding issues can be most efficiently sold on a negotiated basis. Second, the districts
have developed a level of confidence in their financial advisor’s ability to structure and prepare
disclosure documents for their bond issues, a function that is typically performed by the
underwriter in a negotiated sale. Third, the districts want to keep their financial advisor involved
in the offering to make sure that the offering is successful and can be completed efficiently, and
to prepare the financial adviser to provide financial advice in future new money competitive
sales. Fourth, the districts do not want to incur duplicative expenses by engaging both an
underwriter and a financial advisor, which in turn would be required to undertake due diligence
from scratch, for a small refunding issue.
Impact on Investors. Although others can speak to this issue more knowledgeably than
I, the practices described above do not appear to be antithetical to the interests of investors. If
dealer financial advisors are able to be involved in each competitive and negotiated offering,
then they can better keep abreast of the issuer’s affairs and serve as a resource to investors who
have (or may acquire) an interest in the issuer’s bonds. If, due to changes in your rules, dealer
financial advisors are not able to take part in competitive or negotiated offerings, it may be more
difficult for investors to stay abreast with small issuer developments.
Impact on Issuers. If, as I believe, it is the issuers’ interests that are primarily at stake,
then the current Rule appears to strike an appropriate balance: It requires disclosure to issuers to
assure that issuers are not misled in choosing whether to permit financial advisors to bid on
competitive issues or participate in negotiated ones, yet leaves the issuers with the ability to
permit bidders in competitive sales, and contract with the underwriters in negotiated sales, that
the issuers believe to be in their best interests in their own circumstances. To adopt a rule
change that narrows the free choice of state and local governments, even if with the intent to
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Municipal Securities Rulemaking Board
September 30, 2010
Page 3
protect their interests, would appear to be inconsistent with fundamental principles of federalism.
Moreover, it is difficult to understand how an issuer would be disadvantaged by allowing an
additional dealer to bid on its bonds. If the financial adviser could not participate in a bidding
syndicate, there would be a substantially greater risk that any other (often the sole) bid would be
less competitive. If financial advisors were not permitted to submit a bid for bonds, the ability of
small unrated or start-up issuers to raise capital would be adversely affected. Similarly, if
financial advisors were not permitted to underwrite negotiated bond issues for recent small
unrated or start-up financial advisory clients, then the net yield or efficiency of their offerings
could be expected to suffer in many cases. In addition, if these issuers were to forced to engage
another dealer as the underwriter for a negotiated offering, they might choose to forego a
separate financial advisor in the offering and rely instead on the financial advice of the
underwriter in structuring the offering (as many established issuers do). It is difficult to see how
issuers (or investors) would be better off by preventing issuers from relying on the advice of a
knowledgeable dealer (with whom it has had a relationship) when it acts as principal in an
offering, while permitting it to rely on the advice of a dealer that is new to its affairs.
Consequently, if you do choose to adopt the draft Rule change in some form, I urge you to
exempt competitive offerings and, for negotiated offerings, to establish a small issuer exemption.
Impact on Dealers and Advisers. The current Rule may advantage dealer financial
advisors in securing financial advisory engagements from small, start-up issuers, but only by
enabling them to utilize a competitive advantage that they possess: an ability to bring securities
to market. Given the clear advantage to issuers and investors, it seems to me that you should not
change the Rule to prevent dealer financial advisers from utilizing their natural advantage in
serving these types of issuers, thereby creating an artificially level playing field. The current
Rule may also advantage dealer financial advisers in bidding on competitive offerings by issuers
whom they advise and in securing negotiated underwritings. However, the advantage results
from their ability to assess the credit and perform the work more efficiently than other dealers
who have not worked with the issuer. This advantage benefits small start-up issuers and should
not be banned. If you have any concern that financial advisors may truncate the bidding period
to unduly advantage themselves, then you could add a minimum bidding period as an additional
condition to financial advisor bids.
In sum, the draft Rule changes, if adopted, could be expected to substantially
disadvantage small start-up issuers. If you choose to entertain any changes to the Rule, I urge
you not to interfere with the ability of small unrated issuers to sell bonds to the dealers whom
they believe can best serve their interests.
Very truly yours,
Fredric A. Weber
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