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 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.”
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.
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