September 30, 2010
Leslie Carey, Associate General Counsel
Ronald W. Smith, Senior Legal Associate
Municipal Securities Rulemaking Board
1900 Duke Street
Suite 600
Alexandria, VA 22314
Re:
MSRB Notice 2010-27 Request for Comment on RuleG-23 on the
Underwriting Activities of Financial Advisors
Dear Ms. Carey and Mr. Smith:
Members of and participants in the municipal bond industry sincerely
appreciate the opportunity to provide comments, as requested, on proposals and draft
proposals established by the Municipal Securities Rulemaking Board (“MSRB”),
especially knowing that our input is valued and given weight before final decisions are
made by the Board.
As a member of the Municipal Executive Committee of the Securities Industry
and Financial Markets Association (“SIFMA”) I have taken part in SIFMA’s response
to the MSRB concerning the above referenced Notice. J.J.B. Hilliard, W.L. Lyons, LLC
(“Hilliard Lyons”) concurs with the content of SIFMA’s response in all matters
contained therein.
The balance of this letter will deal with the specific impact the proposed
guidance will have upon Hilliard Lyons and other small to mid sized regional retail
broker dealers.
We are opposed to the proposed amendments to MSRB’s Rule G-23. The
changes paint the municipal bond industry with too broad a brush, assuming that one
size fits all. This is simply not the case.
The consideration and thought used to develop the proposed amendments may
seem logical from sixty thousand feet or when viewed through the eyes of independent
financial advisors. Down in the weeds where underwriting desks and municipal
financial advisors operate, the proposals, if implemented, would have negative effects
on borrower’s costs and possibly on the future of regional firms’ municipal bond desks.
The latter would imperil the liquidity provided by such firms to retail investors.
Different states have different laws regarding the activities of financial advisors
and underwriting. For instance, in Indiana a financial advisor may not act as
underwriter on a municipal bond deal it has advised. In Kentucky, where most of our
firm’s municipal financial advisory business is originated, a financial advisor may bid
on an issuer’s bonds with written permission from the issuer and disclosure of the same
in the preliminary official statement.
Why is it important for this process to continue? In some cases the financial
advisor is the only bid on an issue, especially in the case of issues not only small in par
value but with an issuer of very small size in population and/or assessed valuation.
The current Rule G-23 gives issuers complete control over whether to allow a
dealer serving as an advisor to also underwrite or participate in a syndicate bidding for
the issuer’s bonds. Issuers must receive credit for being intelligent and aware of
perceived “conflicts” relevant to the issuance of their debt securities. This, however,
has seemed to have been overlooked when developing the proposed amendments. In
any case, the current Rule G-23 provides the issuer the flexibility needed to determine
for itself what is most advantageous.
It has been suggested that a municipal advisor may structure transactions in a
manner that benefits them at the auction. In Kentucky, however, most schools and
utilities are structured with ascending coupon requirements so as close to level debt
service as possible can be achieved. This virtually eliminates the possibility of subtle
nuances in the bidding and structuring process from favoring one bidder over another.
In addition, the Dodd Frank Consumer Protection Act imposes fiduciary standards on
municipal advisors with respect to their issuer clients.
We now would like to address the enumerated questions in your request for
comments.
1.
Should a dealer be precluded for a specific timeframe from entering
into a financial advisory relationship with an issuer after serving as an
underwriter on one of the issuer’s prior offerings of securities?
We do not believe there is any need for a specific timeframe to be instituted for
a period following the underwriting services provided as no conflicts can exist
after the role of underwriter has ended. To effectively place firms in a “time
out” chair would decrease the pool of underwriters from which an issuer has to
choose, decreasing competition and possible leading to increased costs of
issuance and long term debt service payments.
2. If the MSRB were to amend Rule G-23 to prohibit dealers from serving
as underwriter on transactions for which they have served as financial
advisor to the issuer, should there be an exception for competitively bid
transactions? Would it matter if the notice of sale was made available
5-7 business days before a competitively bid transaction to allow
additional time for other competing firms to conduct due diligence?
Should a financial advisor be allowed to bid in a competitively bid
transaction in which a failed bid had occurred? How would the situation
be handled in which there is a failed bid and the financial advisor
cannot step in to buy the bonds because of the prohibition? Is this a
common occurrence?
We strongly urge the exemption for competitively bid transactions be
continued regardless of the size of the issue. The competitive bidding
process is efficient and, in many cases, provides the lowest borrowing cost
to the issuer. This is not to imply that negotiated transactions should be
eliminated. Extremely large or overly complex transactions are best served
by a negotiated sale where the flexibility to modify structure, couponing, cal
features and other conditions are necessary to efficiently place the bonds
with investors.
When we are hired as municipal advisor we pledge to the issuer that, if
permitted, we will submit a bid for their bonds. In some instances we are the
only bid. By excluding the advisor from the bidding process there may be a
failed sale. However, in the case a bid does fail because a non broker dealer
acted as financial advisor or the financial advisor was precluded by Rule
from bidding, the ability to negotiate the transaction sometime takes place
where law allows.
We agree that sufficient advance posting of preliminary documents provides
the best opportunity for potential bidders to conclude due diligence
activities. Five business days should be adequate as this is about the time of
forward focus for underwriters. Anything longer will not be beneficial.
3. Are there small and/or infrequent issuers that will be negatively affected
by the proposed prohibition? What are the alternatives and costs for
such issuers should the MSRB adopt the proposed draft rule
amendment?
Small and infrequent borrowers in the municipal bond market face
difficulties getting bids for their bonds even when deal flow is low. The
economies of scale aren’t there for underwriters who opt to look for other
opportunities. As previously mentioned, Hilliard Lyons bids on every issue
for which it acts as financial advisor, guaranteeing that a failed bid will not
occur. If, for example, an independent financial advisor structures a small
issue or an issue for a very infrequent and virtually unknown issuer, other
firms would most likely pass on bidding. Since the independent advisor has
no capital or distribution network to back up a bid, the sale would fail.
Quantifying the costs to an issuer in this example is difficult to do since it
has effectively been barred from the marketplace and access to the funds
necessary for its projects.
Since we are opposed to the amendments to Rule G-23 we cannot suggest
that a de minimus size of a municipal bond issue be considered for
exemption from the Rule.
4.
Is it appropriate for a dealer to serve as financial advisor to an issuer
at the same time that it serves as underwriter on a separate issue for the
same issuer?
Barring broker dealers from participating in different capacities on different
issues would clearly limit the available options for issuers. By limiting the
number of syndicate participants, such a restriction could adversely affect
issuers’ ability to efficiently market their securities. Accordingly, we do not
believe such a restriction would be useful or appropriate.
5. As it relates to current practices, are there instances in competitively bid
transactions in which a financial advisor should resign in order to
“officially” bid on a competitive new issue transaction as an
underwriter? Is there ever a time when the financial advisor does not
conduct the bid process for the issuer, such as the use of electronic
bidding platforms where the process of collecting bids is done by a third
party on behalf of the issuer? Is it an uncommon practice for the bid
process to be handled internally by the issuer?
There are no instances in our firm’s experience where we, as financial
advisor, should have had to resign in order to submit a bid as an underwriter
on a competitive sale.
Today’s technology allows for the calculation and processing of bids to be
handled by a disinterested third party, mostly BidComp and Parity in our
experience. As financial advisor we facilitate the setting up of the bid
process but the access to Parity is handled by the issuer. At the request of
some issuers we do provide in the bidding terms and conditions for a
physical bid to be submitted in case a local bank wishes to submit a bid, not
having access to an electronic bidding platform. Such instances are limited
in number and the sealed bids are opened by the issuer. It is not uncommon
for issuers, especially larger more sophisticated cities, counties and school
districts, to handle the biding process internally. Utilizing the services of an
additional financial advisor to oversee the bidding process is a waste of
taxpayer’s dollars and absolutely unnecessary.
6. In the context of a primary offering, should the exception found in Rule
G-23(d)(iii) be limited to situations in which a financial advisor
purchases bonds from underwriters who won a competitive bid for the
bonds in which multiple bids were received?
The exception noted in G-23(d)(iii) is already restrictive. Should a broker
dealer acting as financial advisor be prohibited from giving orders to a
winning account member for what time period would this cover? The order
period? The underwriting period? The effect of such a prohibition will put
the representatives at the advisory firms in a competitive disadvantage by
not being able to fill customer orders. It will also not be fair to clients loyal
to the representative. This represents an untended consequence of such a
prohibition. Once again, we are opposed to any amendments to the Rule so
this point should be rendered moot.
7. In competitively bid transactions, are there situations where the issuer
may hire a financial advisor to serve on a specific issue and then, at
some point, hire a second financial advisor to oversee the competitive
bid process in order to allow the original financial advisor to bid on the
issue?
We have previously commented on this topic in our response to Question 5
above. Utilizing the services of an additional financial advisor to oversee
the bidding process is a waste of taxpayer’s dollars and is absolutely
unnecessary.
Additional Comments:
The Rules promulgated by the MSRB since its inception have stood the test of
time. There has been some necessary tweaking along the way but the general premises
of conduct are well defined.
The reality of a major implosion such as was experienced in 2008 is a knee jerk
reaction from politicians eager to make their mark. The intent is honest but the outcome
is usually overkill.
In a September 13th, 2010 Bloomberg article written by Nina Mehta, SEC
Chairman Mary Schapiro was discussing the elimination of traditional stock, market
makers that provided liquidity when no one else would. This was especially apparent in
the over-the-counter market where spreads were narrowed to pennies from eighths,
quarters and halves. The result? Firms exited the business as did Hilliard Lyons in
October of 2008. The operation was no longer profitable or a good risk of precious
capital. Technology had taken over with quotations changing in milliseconds.
Then came the flash crash on May 10, 2010. The article states that “Now the
SEC is concerned the revolution has gone too far, leaving markets vulnerable when
selling starts to snowball.” When market makers are eliminated through regulatory
consequences and the high frequency traders pull out there is no liquidity.
Unfortunately, this creates calls for more regulation. Sometimes more regulations
destroy businesses rather than fix the problem.
The preceding discussion applies to the equity markets but parallels can be
drawn to the fixed income and municipal advisory business. Things are not broken.
Good rules exist, they just need enforcement. With the SEC ramping up a new
municipal bond division and the MSRB staffing to be able to handle new directives,
monitoring existing Rules does not seem to be a problem.
The registration of municipal financial advisors was necessary. It was intended
to create a level playing field between broker dealers and independent financial
advisors. The latter were not subject to such ethical restrictions as those covered by
Rule G-37. It has been difficult for a broker dealer to compete when a non regulated
competitor is able to buy business rather than earn it. But now proposed amendments to
G-23 seem to be a trade off, further placing broker dealers in a non competitive
situation.
Hilliard Lyons remains opposed to the amendments covered by this Request For
Comments. We strongly encourage the Board not to further fragment or destroy the
broker dealer municipal bond business by not adopting the proposed amendments to G23. The very retail investors you are trying to protect will be harmed immeasurably.
Sincerely,
/s/ Ronald J. Dieckman
Ronald J. Dieckman, SVP
Director Public Finance and Municipal Bonds
J.J.B. Hilliard, W.L. Lyons, LLC