Background
On December
20, 2010, the SEC proposed new rules to (a) clarify what constitutes a
“municipal advisor;” (b) provide a permanent registration process for them; and
(c) impose an express Federal fiduciary duty on municipal advisors in their
dealings with governmental entities.
The SEC
action was taken in response to a provision included in the Dodd-Frank
financial services industry reform bill passed by Congress earlier that
year. This section of the law was
drafted in part as a response to what were perceived as serious abuses
associated with, among other things, swaps deals such as those involving
Jefferson County, Alabama. (In 2011, Jefferson
County became, at the time, the largest municipal bankruptcy in U.S. history
due in part to expensive interest rate swaps connected to a bond sale; bribery
of public officials was alleged.) By
imposing registration requirements on muni advisers as well as a fiduciary duty
to their clients, Congress hoped to guard against these kinds of muni market
scandals and protect certain governmental entities that have what is often
referred to as a lack of “market savvy.”
However,
when the SEC issued its proposed rule for comment, it became clear to even
supporters of Dodd-Frank that the SEC had probably overreached. The suggested rules were very broad, and
created serious problems for some of the very government officials that the law
was intended to protect.
Specifically,
even though Dodd-Frank excluded employees of a “municipal entity” – which term
is defined to include public pension funds, local government investment pools
and other state and local governmental entities or funds, along with
participant-directed investment programs or plans such as 529, 403(b), and 457
plans -- from the definition of “municipal advisor,” the statute did not
explicitly refer to members of a board or other governing body of a municipal
entity who might not technically be employees.
To solve the
problem, the SEC rationalized that elected and ex officio board members are “accountable”
for their performance to the citizens of the municipal entity, as opposed to
appointed members, who, in the SEC’s view, are not. Therefore, the SEC proposed that the former
would be included in the exemption, while the latter would not.
Thus, if the
rule were to be adopted in final form as the SEC proposed, some public pension
trustees might have to register with the SEC, pay the registration fee, and
comply with the Federal fiduciary standard, while their ex officio colleagues
would not.
NCTR Response
NCTR and NASRA
filed joint comments with the SEC on February 22, 2011, objecting to this
approach. Among several other points,
the letter argued that all trustees of state and local government retirement
systems (whether elected or appointed), as members of a governing body of a
governmental pension fund, are, per se, a part of that municipal
entity, and, as such, are therefore expressly excluded from the definition of a
“municipal advisor.”
The letter
also pointed out that public pension trustees are already held to strict
accountability standards, whether elected or appointed. Furthermore, the letter cautioned that creating
“burdensome and costly registration requirements would also serve to discourage
service on public pension boards, which could diminish rather than enhance the
quality of these governing bodies.”
Current Status
The SEC has
received an extraordinary number of responses to its proposed rule – over 1,200
comments. This is not surprising, given
that it deals with the issue of the general definition of “municipal adviser”
and could have major implications for investment advisers, broker-dealers and
others. The SEC has yet to issue a final
rule.
In addition,
the SEC has been the target of increasing Congressional pressure, particularly
from the House, where a letter from a bipartisan group of Members said that the
Commission’s proposed rules “go far beyond the statute’s intent and scope by
capturing, in the ‘municipal advisor’ definition, parties and activities that
were not anticipated by Congress or authorized by the statute,” including
“appointed volunteer public servants.” Finally, in testimony before Congress, SEC
Chair Mary Shapiro has conceded that the agency “may have cast the net too
widely."
As the
September 30, 2012, SEC deadline for action on the rule drew near, the House
Financial Services Committee, in a 60-to-0 vote, unanimously approved HR 2827
on September 12, 2012. Congressman
Barney Frank (D-MA), the ranking Democrat on the Committee, its former
chairman, and the “Frank” of “Dodd-Frank,” voted for the bill, indicating that
the SEC had advised him that it had no objection to the legislation.
HR 2827
would narrow the definition of municipal advisors; retain but restrict the application
of Dodd-Frank’s original fiduciary duty; and exempt certain activities of nine
different categories of professionals, including “any elected or
appointed member of a governing body of a municipal entity or obligated
person, with respect to such member’s role on the governing body.’’ (Emphasis added.)
Shortly
thereafter, on September 19th, the full House approved HR 2827 and
sent it on to the Senate, where it has been referred to the Senate Banking,
Housing and Urban Affairs Committee and has received no further action.
Outlook
On September
21st, the SEC announced that it is giving itself another year to
take final action on its proposed rule.
(Technically it did so by extending the sunset date of rules for
temporary registration of municipal advisors under an interim final temporary rule.) However, SEC Commissioner Elisse Walter was
recently quoted in the press as saying that there is no intention on the part
of the SEC staff to take anywhere near that long. Also, the added pressure of bipartisan House
action on HR 2827 should encourage the SEC to act sooner rather than
later.
In the short
term, the upcoming election and the control of the Senate may prove to be the
key factor. If Republicans take over the
upper house in 2013, it may well be that a lame duck Democratic Senate could
take up the House-passed bill later this year in the belief that this is the
best deal that can be had. After all, a
new Republican Senate might revert to an earlier version of the House bill
that, as introduced, would have stripped out the Federal fiduciary standard for
muni advisers. In any case, as it will
be a new Congress, HR 2827 will “die” if the Senate does not act this year, and
the entire process must start over again in 2013 on both sides of the Hill.
If, on the
other hand, the Senate remains in Democratic control, the SEC may feel that it
has a little more breathing room in which to deal with the problem itself. This is likely to appeal to the SEC, which
would prefer to settle the matter through its own regulatory process than have
a Congressional legislative solution imposed on it.
Furthermore,
a Democratically-controlled Senate may not be as anxious as the House to pass
the bill. Groups such as Americans for
Financial Reform, a coalition of more than 250 national, state and local groups,
strongly opposed passage of HR 2827, saying that the exemptions it would create
“would certainly result in many financial entitie claiming that they do not
owe any fiduciary duty to respect taxpayer interests” and that the bill “weakens
accountability for financial advice to municipalities, harms communities, and
is unnecessary given the authority of the SEC to address any outstanding
issues.” This letter was signed by the American
Federation of State, County & Municipal Employees (AFSCME), the AFL-CIO,
the Consumer Federation of America, the Leadership Conference on Civil and
Human Rights, Public Citizen and the United States Public Interest Research
Group.
However,
given that Congress -- or at least the House -- has now taken steps to address
the SEC’s original quandary over how to treat governing bodies and elected
versus appointed members, it appears that a favorable outcome for pension
trustees is very likely, whether in a final rule or via legislation. This is also supported by the fact that the
SEC purportedly does not object to the legislation.
Finally,
even those opposing the bill agree that the trustee issue needs resolving. In their letter, the Americans for Financial
Reform note that with regard to financial advice provided by elected or
appointed public officials in their capacity as members of public advisory
boards, the SEC “has agreed to fix this
problem in the final rule,” and narrow the definition of financial advisor to
exclude public officials. “Should the
SEC not follow through on this commitment, Congress could legislate once the
final rule is passed,” the letter argues.
- HR 2827
- NCTR/NASRA comment letter on SEC Proposed Rulemaking
- Americans for Financial Reform Opposition Letter
