MUNISTAT SERVICES, INC
Municipal Finance Advisory Service
12 Roosevelt Avenue
Port Jefferson Station, NY 11776
(631) 331-8888
www.munistat.com
September 30, 2010
Leslie Carey
Associate General Counsel
Municipal Securities Rulemaking Board
1900 Duke Street, Suite 600
Alexandria, VA 22314
Re: MSRB Notice 2010-27 (August 17, 2010), Request for Comment on Rule G-23
Dear Ms. Carey:
I am writing as President of Munistat Services, Inc., an independent financial advisory service to
small and medium sized local governments and school districts in New York State. I began my
career as a financial advisor over 40 years ago, working for a dealer bank in its municipal
consulting department; in 1977 I established Munistat Services, Inc. as an independent firm and
have acted as financial advisor on literally thousands of new issue municipal securities offerings,
both competitive and negotiated transactions. When working for the dealer bank, I became
aware of the potential conflicts of interest that our department was subject to, even though the
vast majority of our sales were competitive offerings. That is one of the primary reasons that I
left to establish an independent firm. It should also be noted that my firm has been a member
firm of the National Association of Independent Financial Advisors (NAIPFA) since its
inception and I served on NAIPFA’s Board of Directors from 1995 to 1996 and as its President
from 1996 to 1998.
In my opinion, the roles and objectives of issuers and underwriters are so clearly diametrically
opposed that the conflict of interest in an underwriter acting as financial advisor to an issuer can
never be overcome. Underwriters and broker-dealers are for-profit entities that generate the
majority of their revenues and profits from the sale of securities - thus it is their objective to
purchase such securities at the lowest possible cost from issuers and then sell the securities to
their customers at the highest possible cost. It should be self-evident that underwriters and
broker-dealers have more control over the terms and conditions they are willing to pay for the
securities they are purchasing from issuers than the yields their customers are willing to accept
when they sell such securities. Every employee of an underwriter or broker-dealer (including its
financial advisory staff) therefor has a vested interest in maximizing this “spread” on every
transaction in which the underwriter or broker-dealer is engaged. Moreover, most small and
medium-sized issuers lack the expertise to determine whether they are receiving a fair deal;
unless they have a separate, independent financial advisor, they are at the mercy of the
underwriter or broker-dealer with respect to timing, structure, rates and yields and many other
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specific terms of the transaction. There is no way this could not be a conflict of interest for an
employee of an underwriter or broker-dealer who is ostensibly serving as an issuer’s financial
advisor, even if the transaction was a competitive sale. Such employee knows where his or her
paycheck and benefits come from, and it’s not from the issuer. In short, to allow broker-dealers
or underwriters to act as financial advisors to states or local governments on offerings of
municipal securities is absolutely and clearly against the public interest. It should be
discouraged as strongly as possible.
First, while there currently are no proposed changes to section (b) of Rule G-23, I respectfully
suggest that the Board reconsider that position. The section includes the following statement:
“...a financial advisory relationship shall not be deemed to exist when, in the course of
acting as an underwriter, a broker, dealer of municipal securities dealer renders advice to
an issuer, including advice with respect to the structure, timing, terms and other similar
matters concerning a new issue of municipal securities.” This essentially allows underwriters
to provide the same “advice” as a financial advisor and thus conflicts with the changes set forth
in the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Board could delete
this section or revise it so that the underwriter could only offer suggestions or information to an
issuer with respect to structure, timing, terms or other matters related to a new issue of municipal
securities. The Board could also consider modifying the language to affirm that such “advice” is
now a function reserved for financial advisors and that providing such advice on a particular
transaction places the underwriter in the role financial advisor thus precluding it from acting as
underwriter on such transaction. In addition, if the underwriter does provide such “advice”, it
must be understood that it is assuming the role of financial advisor and thus is assuming the
concomitant fiduciary responsibility attendant thereto and must be required to register as a
Municipal Advisor and enter into a contract to serve as financial advisor.
In response to MSRB’s questions, I offer the following comments:
Question 1: Should a dealer be precluded for a specific time frame from entering into a
financial advisory relationship with an issuer after serving as underwriter on one of the
issuer’s prior offerings of securities?
Comment: A broker-dealer financial advisor should be precluded from serving as
underwriter for any transaction of an issuer for a period of two years following the
termination of its financial advisory relationship with such issuer.
Although I would prefer a longer ban for reasons cited above, I am in agreement with this
restriction as the MSRB has established precedent for imposing two-year time bans for other
violations, such as set forth in Rule G-37. Failure to impose a specific time ban would make the
rule meaningless, and a ban that is shorter than two years would be ineffective.
Question 2: If the MSRB were to amend Rule G-23 to prohibit dealers from serving as
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underwriter on transactions for which they have served as financial advisor, should there
be an exception for competitively bid transactions?
Comment: There should be no exceptions for competitive sales.
Underwriters that serve as financial advisors and then switch roles in order to bid on a
competitive offering can easily take advantage of their unique relationship with an issuer to
influence the timing and structure of an offering in a way that enhances the underwriter’s ability
to win the bid, thus actually reducing the competitiveness of the competitive sale. This is clearly
a disadvantage to the issuer (and against the public interest). There should, therefor, be no
exception for competitive sales.
Question 3: Are there small and/or infrequent issuers that will be negatively affected by the
proposed prohibition?
Comment: There should be no exception for small issuers.
Small and infrequent issuers are the most potentially vulnerable to the conflict of interest
violations addressed in Rule G-23 as they are most likely to lack the market expertise necessary
to defend their own interests. My experience of over 40 years assisting such issuers bears this
out - our clients are fully dependent upon us to represent them and their interests and to guide
them through the issuing process, whether a competitive or a negotiated offering. In addition, it
should be noted that we have never had an investment-grade rated issuer, regardless of its size or
the frequency of its issues, denied access to the markets, and even with distressed credits we
have not experienced a failed bid. There should be no exceptions for small or infrequent issuers.
Question 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 issue?
Comment: There should be no exceptions that allow financial advisors to simultaneously
serve as underwriter on separate issues for the same issuer.
As stated above, I believe there should be a two year ban that prohibits a financial advisor from
serving as underwriter for any transactions of an issuer from the date the financial advisory
relationship has expired. An underwriter or broker-dealer that is serving as financial advisor on
one offering of an issuer while acting as underwriter on a second offering of the same issuer is,
in my opinion, explicitly violating its fiduciary responsibility to the issuer as there is no way I
can see that the underwriter or broker-dealer can differentiate the roles. The issuer has no way to
tell
when communicating with the underwriter whether the underwriter is addressing it in a fiduciary
capacity as its financial advisor or a non-fiduciary capacity as its underwriter. Will the issuer be
able to retain the services of a different financial advisor for the transaction being underwritten?
Perhaps the issuer should be required to retain the services of a separate financial advisor in such
instances, but the MSRB has no jurisdiction over issuers and thus can not implement this
suggestion. This practice should be banned, as it would put underwriters in an impossible
position and be extremely disadvantageous to issuers, especially small and infrequent issuers,
and thus not in the best interest of the public.
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Question 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...where the process of
collecting the 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?
Comment: These instances do not constitute sufficient reason to waive the prohibition - the
conflicts of interest cited above still exist.
In our experience, the financial advisor conducts the competitive bid process on behalf of the
issuer in virtually all transactions.
Question 6: In the context of a primary offering, should the exception found in Rule G23(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?
Comment: This instance does not constitute sufficient cause to waive the prohibition - the
conflicts of interest still exist.
Question 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?
Comment: This situation also does not constitute sufficient cause to waive the prohibition conflict of interest still exists
With respect Questions 5, 6 and 7, it seems that these “situations” are being presented in order to
weaken the rule rather than strengthen it. This would be particularly harmful to small and
infrequent issuers and neither these “situations” nor any others that may be proposed should be
considered in any light other than what would be in the best interests of such small issuers and
the public they represent.
Thank you for the opportunity to express my views with respect to the proposed changes to Rule
G-23. Please feel free to contact me if you wish to discuss this matter further.
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Sincerely,
Robert F. Sikora
President