MSRB Notice 2012-25 – Brutal Honesty In The Municipal World

by Christopher B. Langhart on August 3, 2012

Municipal Securities Rulemaking Board (“MSRB”) Notice 2012-25 (the “Notice”) was approved by the SEC on May 4, 2012 and took effect on August 2, 2012. The Notice sets forth the responsibility of underwriters of municipal securities to make certain disclosures to an issuer, to ensure that they have dealt fairly with that issuer.

Specifically, the Notice states that an underwriter must disclose to the issuer that:

(i) Rule G-17 requires an underwriter to deal fairly at all times with both municipal issuers and investors;

(ii) the underwriter’s primary role is to purchase securities with a view to distribution in an arm’s-length commercial transaction with the issuer and it has financial and other interests that differ from those of the issuer;

(iii) the underwriter does not have a fiduciary duty to the issuer under the federal securities laws and is therefore not required by federal law to act in the best interests of the issuer without regard to its own financial or other interests;

(iv) the underwriter has a duty to purchase securities from the issuer at a fair and reasonable price, but the underwriter must balance that duty with its duty to sell municipal securities to investors at prices that also are fair and reasonable; and

(v) the underwriter will review the official statement for the issuer’s securities in accordance with, and as part of, its responsibilities to investors under the federal securities laws, as applied to the facts and circumstances of the transaction.

The Notice also makes clear that the underwriter must not recommend that an issuer not retain a municipal advisor.

Compensation is addressed in that an underwriter must disclose to the issuer whether underwriting compensation will be contingent on the closing of a transaction. If so, the underwriter must disclose that such compensation presents a conflict of interest, because an underwriter could conceivably recommend a transaction that is unnecessary or larger than necessary. Typically an underwriter does not get paid unless a transaction is completed, so it is likely this disclosure will be necessary in almost every transaction.

The basic intent of the Notice appears to be to emphasize that the underwriter is a party to a business deal and is not always the issuer’s ally. However, the underwriter is acting no differently than in past deals, and this flurry of disclosure requirements has come about solely due to the changes in Rule G-17.

An issuer can expect to receive initial disclosure representations at the beginning of a transaction, but certain additional disclosures may be required at later times within a transaction, especially for more complex transactions. Since the Notice requires that an issuer acknowledge receipt of such disclosures, an issuer can expect to be requested to sign an acknowledgment of receipt of the disclosure representations of an underwriter. However, by acknowledging or signing for such receipt, the issuer is acknowledging only that it has received and read the representations and is not making a contract with the underwriter or in any way binding the issuer to continue the transaction.

The Notice states that all written and oral representations made by an underwriter to an issuer must be truthful and accurate and not misrepresent or omit material facts—which conduct might be expected anyway—and that an underwriter must have a reasonable basis for its statements and any prepared materials. For example, an underwriter cannot represent that it has the requisite knowledge or expertise with respect to a transaction, if the personnel who will work on the transaction don’t have such knowledge or expertise. This is important to think about during the RFP and RFQ processes.

The requirements detailed in the Notice raise potential issues that need to be thought about in every transaction going forward, especially because the Notice appears to be a harbinger of the stricter regulation of municipal securities transactions that seems all but inevitable.

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