Investment Strategies and Proceeds of
Municipal Securities
Presenter: Maria Altomare, Managing Director
PFM Asset Management, LLC
Discussion Topics
• The Municipal Advisor Rule –What are the key areas to
understand when investing bond proceeds
• Bond Proceeds – How are they defined?
• Bond Proceeds – Risks and procedures when Investing?
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The Municipal Advisor Rule –
What are the key areas to understand
when investing bond proceeds?
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New MA Rule
• Implemented on July 1, 2014 by the Securities and Exchange
Commission (SEC).
• The MA Rule requirements were originally developed as part of the
2010 Dodd-Frank Wall Street Reform and Consumer Protection Act
in order to establish a high standard of care for those who provide
financial and investment advice to municipal entities.
• Before the 2010 Dodd-Frank Act, the activities of municipal
advisors were largely unregulated and the 2008-2009 credit crisis
showed that many municipal entities were engaged in complex
derivative products that caused significant losses.
• This caused the enactment of the 2010 Dodd-Frank Act as well as
the SEC’s MA Rule. The goal of the two are to protect municipal
entities from unscrupulous activities.
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What is a Municipal Advisor?
• “Municipal Advisor” defined to include a person (who is not a municipal
entity or an employee of a municipal entity) who provides advice to a
municipal entity or obligated person with respect to municipal financial
products or the issuance of municipal securities
• Municipal Advisors are required to register with the SEC and the MSRB
• Every Municipal Advisor has a Statutory Fiduciary Duty
– For municipal entity clients, not obligated person clients
• Each Municipal Advisor is subject to MSRB rules (e.g., record-keeping,
professional qualifications)
– MSRB G-42 as proposed would have prohibited a municipal advisor and its
affiliates from doing principal trades if municipal entity or obligated person were the
counterparty
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Who is excluded or exempt from registering as a
Municipal Advisor?
• Underwriter Exclusion
– Only applies for underwriting activities, and SEC has stated that “advice on
investment strategies” is outside the scope of the underwriter exclusion
• Investment Adviser Exclusion – for “any investment adviser registered
under the Investment Advisers Act of 1940” (RIA)
• Banks are exempt, if providing advice with respect to:
– “any investments that are held in a deposit account, savings account, certificate of
deposit, or other deposit instrument issued by a bank”
– “any extension of credit . . . including the issuance of a letter of credit, the making
of a direct loan, or the purchase of a municipal security by the bank for its own
account”
– “any funds held in a sweep account”
– “any investment made by a bank acting in the capacity of an indenture trustee or
similar capacity”
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Who is excluded or exempt from registering as a
Municipal Advisor?
• Independent Registered Municipal Advisor (“IRMA”)
– Commonly used in context of the “issuance of municipal securities” part of the
municipal advisor definition
• Rules establish elements to qualify for IRMA exemption
– Independent – measured at firm and individual level
– Person seeking to use IRMA exemption “receives a representation in writing that it
is represented by, and will rely on the advice of, an independent registered
municipal advisor”
• RFP/RFQ
– Exemption for any person “providing a response in writing or orally to a request for
proposals or qualifications from a municipal entity or obligated person for services
in connection with a municipal financial product or the issuance of municipal
securities.”
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What defines “Advice”?
• “Advice” is generally described as a specific recommendation
related to a security or financial product
• SEC Rules provide that “advice excludes . . . the provision of
general information that does not involve a
recommendation regarding municipal financial products.”
• Brokerage distinguished: “purchase and sale of escrow
investments upon the direction of an obligated person or its
financial advisor without rendering advice is merely a
provision of brokerage services and does not render such
person a municipal advisor.” [SEC Rule Release]
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What information is NOT considered “Advice”?
• Examples of the General Information Exclusion from Advice…
(c) information regarding a financial institution’s currentlyavailable investments (e.g., the terms, maturities, and
interest rates at which the financial institution offers these
investments) or price quotes for investments available for
purchase or sale in the market that meet criteria specified by a
municipal entity or obligated person; (SEC FAQ page 3)
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Bond Proceeds –
How are they defined?
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How does the SEC define bond proceeds?
• “monies derived by a municipal entity from the sale of municipal
securities”
• “investment income derived from the investment or reinvestment of
such monies”
• “monies of a municipal entity or obligated person held in funds
under legal documents for the municipal securities that are
reasonably expected to be used as security or a source of payment
of the debt service”
• “investment income derived from the investment or reinvestment of
monies in such funds”
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When are funds considered “proceeds”?
• SEC did not agree that once proceeds of a municipal offering
are commingled with other funds, they lose their character as
proceeds
• But did provide that once the proceeds “are spent to carry out
the authorized purposes of municipal securities, they cease to
be proceeds of municipal securities.”
• Pension Bonds – “proceeds of pension obligation bonds lose
their character as proceeds of municipal securities . . . upon
their contribution to the public pension plan.”
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Bond proceed tracking
• Municipal entitles should develop policies and procedures to help
determine whether or not the advice they receive involves their
bond proceeds investments
• This means tracking all bond proceeds going forward
• Establish different rules depending on whether proceeds held in
existing accounts or investments are from before July 1, 2014
• “unless a market participant actually knows or reasonably should
have known that an existing account or existing investment
contains proceeds of municipal securities, a market participant may
determine that such existing accounts or existing investments do
not contain proceeds of municipal securities” FAQ 11.1
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Post July 1, 2014 bond proceed tracking
• Municipal entities might consider segregating bond proceeds
from other funds so that the other funds are not
“contaminated” by the bond proceeds for purposes of aiding
compliance with the MA Rule.
• Municipal investors may consider working with an SECregistered investment advisor (RIA) that can provide a full
range of bond proceeds investment strategies.
• Hiring an RIA to professionally manage bond proceeds
investments essentially eliminates the municipal investor’s
additional administrative responsibilities related to the MA
Rule, since the responsibility of investment management
shifts to the RIA.
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What is an IRMA?
• Some broker/dealers are now requiring certification that
public entities have an established Independent Registered
Municipal Advisor (IRMA)
• There have been instances where broker/dealer refuse to
further communicate with public entities until an IRMA has
been designated.
• After certification that an entity has an IRMA, a broker/dealer
is free to continue to provide the public entity with advice via
unsolicited proposals.
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What can a municipal entity do?
•
Entities can choose not to sign certification, and instead state they will not rely on
broker for advice
•
Entities can choose not to sign certification, and instead state they will not rely on
broker for advice as they have an RIA (however the RIA does not have a statutory
safe harbor) - this relies upon the instruction to the broker not to provide direct
advice
•
Entities can choose to sign the certification, and instruct that they have an IRMA
(the IRMA must have competency with bond proceed investing within scope of
services)
•
On a daily basis (or whenever seeking to trade), issue a mini-RFP by means of
circulating a bid/offer sheet for brokers to respond to by providing information for
entities to consider/execute
•
Do nothing - there is no regulatory driver behind brokers not being able to do
business after July 1st – the service provider’s corporate policy (compliance &
legal) may still say otherwise but do not carry weight beyond their walls
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What should a municipal entity do?
• It may depend upon the size of the entity, staffing,
investment portfolio, and volume of trading
• Be aware that broker/deals cannot provide unsolicited
proposals to public entitles unless they register as a
Municipal Advisor or otherwise meet an exemption
• What if an entity is accustomed to taking broker
‘recommendations’ for trades?
• What role can a service provider play
– as a broker / dealer?
– as a registered investment adviser?
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Bond Proceeds –
Risks and Investing?
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Understanding the risks of investing bond proceeds
• Credit (Safety)
– The risk of investing in instruments that may degrade in credit quality
or default
• Market (Liquidity)
– The risk of selling an investment prior to maturity at less than book
value
• Opportunity (yield/return)
– The risk of investing long-term and having interest rates rise or
investing short-term and having interest rates fall and needing to
reinvest the bond proceeds
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How to reduce Risk of investing bond proceeds?
Commitment to principles of Safety, Liquidity and Yield (in that
order)
• Credit Risk (Safety)
– Understanding State Statutes for permitted investments and
Developing good cash flow estimates
• Market Risk (Liquidity)
– Periodically updating those cash flow estimates to reduce credit risk
• Opportunity Risk (Yield/Return)
– Integrating knowledge of expected future market conditions with cash
flow requirements to reduce opportunity risk.
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Developing Policies and Procedures for Investing
Bond Proceeds
• Ensure that you have policies and procedures for:
– Legal and regulatory – State Statutes, IRS, other
– Investment Policy – Does your school follow MSBA’s or do you have your
own written investment policy?
•
•
•
•
Introduction and statement of purpose
Duties, responsibilities and procedures
Investment objectives, constraints and guidelines
Evaluation and review
– Ensure your objectives for various uses of bond proceeds are identified
– Procedures of when you will engage the use of an Investment Advisor
(RIA) or Municipal Advisor (IRMA)
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Considerations when Investing Bond Proceeds
• Official statement should include investment of bond proceeds or
describes a referral to other documents that outline the parameters
for investing bond proceeds
• Coordinate debt management and investment of bond proceeds
activities with different offices or staff
• Be aware that different types of bond proceeds may have varied
investment goals and procedures
–
–
–
–
–
Construction fund
Debt service fund
Capitalized interest fund
Debt service reserve
Escrow fund (in case of a refunding)
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Considerations when Investing Bond Proceeds
• Understand interactions with broker-dealers regarding the
investment of bond proceeds and escrow as a result of the
new MA Rule
– Some broker-dealers may not want to provide advice as it may subject
them to a fiduciary duty
– Some broker-deals may clarify that they will not provide advice absent
in exception from MA Rule but will show full inventory, quote prices
and respond to RFP
– Some broker-dealers may refuse to accept accounts with bond
proceeds or escrows.
• If the investments are longer than one year, mark to market
accounting requirements should be in place and verified by
auditors.
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Considerations when Investing Bond Proceeds
• Require that Registered Investment Advisor (RIA) and
Independent Registered Municipal Advisor (IRMA) report
finder’s fees or fee-sharing arrangements in advance
• Seek a minimum of 3 competitive bids and request fee
arrangements be fully disclosed
• If you want a broker/dealer to bid that has no fiduciary duty to
your school, consider issuing an RFP and records should be
kept to show:
– Investment issuer purchased at fair market price
– Bids are date stamped and arrive at the same time
– Minimum of 3 bids
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Questions ?
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Disclaimer
This presentation is only intended to provide you with an overview of the Municipal Advisor Rule at this
particular time. As the Rule evolves, so will the corresponding regulatory interpretation and guidance relating to
the Rule.
This material is based on information obtained from sources generally believed to be reliable and available to
the public, however PFM Asset Management LLC (“PFMAM”) cannot guarantee the accuracy, completeness or
suitability of this content. This material is for general information purposes only and is not intended to provide
specific advice or a specific recommendation regarding the application of the SEC Municipal Advisor Rule. All
statements as to what may happen under certain circumstances are based on assumptions, some but not all of
which are noted in this presentation. Assumptions may or may not be proven correct as actual events occur,
and results may depend on events outside of your or our control. Changes in assumptions may have a material
effect on the outcome.
Please note that the information provided herein does not constitute legal advice and you must be sure to
consult your attorney regarding your institution's specific circumstances.
Any investment advice in this document is provided solely by PFMAM. PFMAM is an investment advisor
registered under the Investment Advisers Act of 1940.
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