U.S. SEC Grants Muni Advisors a Temporary, Limited Exemption from Broker-Dealer Registration

On June 16, 2020, the U.S. Securities and Exchange Commission (SEC) granted registered municipal advisors (MAs) a temporary, limited exemption (Exemption) from broker-dealer registration to the extent that they solicit banks and other “Qualified Providers” in "Direct Placements" of securities and receive transaction-based compensation. The Exemption, which is intended to address the financial stresses on municipal issuers caused by the COVID-19 pandemic, is valid through December 31, 2020.

Before describing the Exemption, here are several takeaways worth considering:

1. The Exemption may provide municipal issuers with greater flexibility in selecting service providers to assist with financing.

2. As a result, municipal underwriters could see smaller deals go to MAs, whereas without the Exemption issuers likely would need to engage a broker-dealer.

3. Issuers may realize improved economics from these deals. But that likely will only happen if MAs execute the engagement at a lower price point than a broker-dealer. The exemption does not limit the amount MAs may charge or prevent them from charging more than they otherwise would for an offering in which a broker-dealer is involved.

4. The SEC seems to have crafted the conditions and limitations on the expanded activity to prevent risk to the retail segment of the market (e.g., minimum denominations of $100,000 or more and secondary sale restrictions). However, MAs are not subject to many of the same standards with which broker-dealers must comply, including the continuing disclosure requirements under Exchange Act Rule 15c2-12. This disparity could have effects beyond concerns for retail investors.

5. The Municipal Securities Rulemaking Board (MSRB) updated its FAQ related to COVID-19 to address the Exemption, specifically with respect to MSRB Rule G-23, which prohibits “role switching.” Rule G-23 establishes “ethical standards and disclosure requirements for brokers, dealers, and municipal securities dealers who act as financial advisors to issuers with respect to the issuance of municipal securities.” Specifically, the rule prohibits a firm from acting as MA for an issuer and then “switching” roles to serve as underwriter for the transaction.  MSRB clarified that “[a] firm that is registered as both [an MA] and a dealer may rely on, and engage in, the activities contemplated by the [] Exemption in its role as [MA] without role switching for purposes of MSRB Rule G-23, so long as the firm complies with the conditions set forth in the [] Exemption.”

6. The SEC Exemption does not exempt MAs from state broker-dealer registration requirements. However, we note that most states have an exemption for brokers that do not have a place of business in the state and do business solely with institutional investors in the state. MAs will need to consider the laws of the states in which they solicit Qualified Providers, particularly in the states where the MA has a place of business.

Background

As the SEC noted,  generally speaking, registered MAs assist municipal entities and obligated person clients in: (i) developing a financing plan; (ii) assisting in evaluating different financing options and structures; (iii) assisting in selecting other parties to the financing, such as bond counsel; (iv) coordinating the rating process, if applicable; (v) ensuring adequate disclosure; and (vi) evaluating and negotiating the financing terms with other parties to the financing.[1] But MA activity that goes beyond this to include solicitation of prospective investors in municipal securities and receipt of transaction-based compensation could be considered broker-dealer activity.

The Exemption permits registered MAs to directly solicit “Qualified Providers” (banks, wholly owned subsidiaries of banks that are engaged in commercial lending and financing activities, and federally or state-chartered credit unions) in connection with “Direct Placements”[2] of municipal securities, subject to several requirements and limitations (see below). The Exemption also permits MAs to receive transaction-based compensation for services provided in connection with the Direct Placement.

In issuing the Exemption, the SEC pointed to the disruption in the municipal securities markets as a result of the COVID-19 pandemic, specifically highlighting challenges cities and towns have faced in meeting their unexpected financing needs. According the to the SEC, the Exemption “will provide additional flexibility for registered [MAs] to assist their municipal issuer clients in more efficiently obtaining financing during this market disruption in a way that remains consistent with investor protection.”

The Exemption is similar in some respects to an October 2019 proposed SEC exemption from the broker registration requirements for registered MAs engaging in specified activities with respect to direct placements of municipal securities.[3] That proposal sparked fierce debate within the muni industry, especially from the municipal broker-dealer community. In what might be viewed as a small victory for the municipal broker-dealer community, the SEC noted in the Exemption order that it “is not moving forward with the [proposed 2019] exemption at this time.” The SEC did, however, invite market participants to submit information or views to the comment file for the 2019 proposed exemption, “including in light of actions taken pursuant to the Exemption,” suggesting that the 2019 proposed exemption may still be under consideration.

The following requirements and conditions apply to the Exemption:

Required Representations

The registered MA must obtain written representations from each Qualified Provider that the Qualified Provider:

• Is a Qualified Provider as defined in the Exemption;
• Is capable of independently evaluating the investment risks of the transaction;
• Is not purchasing with a view to distributing the securities; and
• Will not transfer any portion of the Direct Placement within one year of the date of issuance of the securities, except to one or more other Qualified Providers.

The registered MA must also make a written representation to, and obtain a written acknowledgment of receipt from, the Qualified Provider that the registered MA:

• Represents solely the interests of the municipal issuer and not the Qualified Provider;
• Is soliciting the Qualified Provider in connection with the Direct Placement pursuant to the Exemption;
• Has not conducted due diligence on behalf of the Qualified Provider;
• Has not, as of the date of the written representation, engaged, nor has the municipal issuer engaged, a broker-dealer as a placement agent in connection with the Direct Placement;[4] and
• Acknowledges that the Qualified Provider nonetheless may choose to engage the services of a broker-dealer to represent the Qualified Provider’s interests.

Other Required Terms and Conditions

• Restricted Scope of Temporary Conditional Exemption: A registered MA cannot rely on this Exemption to engage in broker activity relating to municipal securities offerings beyond the scope of the Exemption. For example, the Exemption does not apply with respect to public offerings of municipal securities or the sale of securities to a retail investor. Additionally, a registered MA seeking to rely on this Exemption cannot bind the municipal issuer, or handle funds or securities, in connection with the Direct Placement.
• Size Limit: The aggregate principal amount of the Direct Placement may not exceed $20 million.
• Authorized Denomination Requirement: The Direct Placement must be issued in authorized denominations of $100,000 or more.
• Restriction on Transferability: If a Qualified Provider transfers all or any portion of the Direct Placement within one year of the date of issuance of the Direct Placement, the Qualified Provider may transfer the securities only to one or more other Qualified Providers.
• Recordkeeping: A registered MA seeking to rely on the Exemption must make and keep the records required by Exchange Act Rule 15Ba1-8(a)(1).
• Notification Requirement: A registered MA seeking to rely on the Exemption must notify staff in the SEC Division of Trading and Markets no later than 30 calendar days after the sale of securities in the Direct Placement. The notification must identify: 1) the municipal issuer; 2) the date of the Direct Placement; 3) the principal amount of the Direct Placement; 4) each Qualified Provider; and 5) the CUSIP, if available.

[1] See Registration of Municipal Advisors, Exchange Act Rel. No. 70462 (Sept. 30, 2013), 78 FR 67468, 67472.

[2] Direct Placement means a direct purchase from a municipal issuer of municipal securities by one or more Qualified Providers.

[3] See Proposed Exemptive Order Granting a Conditional Exemption From the Broker Registration Requirements of Section 15(a) of the Securities Exchange Act of 1934 for Certain Activities of Registered Municipal Advisors, Release No. 34-87204 (Oct. 2, 2019), 84 FR 54062 (Oct. 9, 2019).

[4] Our understanding is that the Exemption only applies in circumstances contemplated by the text of the Exemption. As such, a registered MA may not rely on the Exemption if the municipal issuer or registered MA has engaged a placement agent because that circumstance is not one that is contemplated in the text of the Exemption. We also understand that the representation must be accurate during the period when the MA is engaged in soliciting Qualified Providers.

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