Dodd-Frank Act Expands Authority of the Municipal
Securities Rulemaking Board
On July 15, 2010, The Senate passed the Dodd-Frank Wall
Street Reform and Consumer Protection Act, which had
previously been passed by the House. It has been reported that
the President will sign the bill next week.
The Reform Act contains a substantial expansion of the
rulemaking authority of the Municipal Securities Rulemaking
Board (MSRB). The MSRB was established by Congress under the
1975 amendments to the Securities Exchange Act of 1934 as a
self-regulatory organization in connection with broker-dealer
transactions in municipal securities and related municipal
securities business activities of broker-dealers. Unlike FINRA
and the stock exchange self-regulatory organizations, the MSRB
was created directly by Congress in section 15B of the 1934
Act, and section 15B(c)(1) specifically provides that any
violation of a rule of the MSRB is a violation of law. The
provisions expanding MSRB jurisdiction are primarily in
Subtitle H, section 975 of the Reform Act and will appear as
amendments to section 15B of the 1934 Act.
Prior to the Reform Act, MSRB jurisdiction extended only to
broker-dealers and to their transactions in municipal
securities. The Reform Act broadened the class of persons
covered by MSRB jurisdiction, and rulemaking authority is no
longer limited to activities related to municipal securities,
but includes transactions in an array of financial products
(notably, municipal derivatives and investment contracts)
involving "municipal entities" or "obligated
persons."
Municipal Advisors
The Reform Act requires that municipal advisors be
registered with the SEC, similarly to the registration
requirement for broker-dealers. A municipal advisor is defined
as a person that, (i) provides advice to a municipal entity or
obligated person with respect to municipal financial products
or the issuance of municipal securities, or (ii) undertakes a
solicitation of a municipal entity. The definition
specifically includes financial advisors, guaranteed
investment contract brokers, third-party marketers, placement
agents, solicitors, finders and swap providers. The definition
excludes broker-dealers acting as underwriters and investment
advisers registered under the Investment Advisers Act of 1940.
The definition also excludes attorneys offering legal advice
or providing services that are of a traditional legal nature,
and engineers providing engineering advice.
The Reform Act authorizes the MSRB to adopt rules that
provide professional standards for municipal advisors (e.g.
testing of personnel and supervisory rules), and that
prescribe means reasonably designed to prevent acts,
practices, and courses of business conduct as are not
consistent with a municipal advisor's fiduciary duty to its
clients. A municipal advisor is deemed to have a fiduciary
duty to any municipal entity for whom such municipal advisor
acts as a municipal advisor.
There is an antifraud rule specifically applicable to
municipal advisors with respect to: advice to a municipal
entity or obligated person, financial products, the issuance
of municipal securities or in the solicitation of a municipal
entity or obligated person. The Reform Act further provides
that no municipal advisor may engage in any act, practice or
course of business that is not consistent with the municipal
advisor's fiduciary duty or that is in contravention of any
rule of the MSRB.
Municipal Financial Products
The Reform Act extends MSRB rulemaking jurisdiction
to regulate transactions by broker-dealers and advice by
broker-dealers or municipal advisors concerning municipal
financial products, in addition to the MSRB's
traditional rulemaking authority with respect to broker-dealer
transactions in municipal securities. A municipal financial
product is defined as municipal derivatives, guaranteed
investment contracts and investment strategies.
An investment strategy is defined to include plans or
programs for the investment of municipal securities, and the
recommendation of and brokerage of municipal escrow
investments.
A guaranteed investment contract is defined to include any
investment that has specified withdrawal or reinvestment
provisions and a specifically negotiated or bid interest rate,
and also includes any agreement to supply investments on two
or more future dates, such as a forward supply contract.
The bill that was reported out by the conference committee
deleted the definition of municipal derivatives that had been
in the Senate bill. Under S.3217, a municipal derivative had
been defined by the Senate in section 975 as "any financial
instrument or contract designed to hedge a risk (including
interest rate swaps, basis swaps, credit default swaps, caps,
floors, and collars)". It is not clear
whether the definition will be reinserted when Congress adopts
technical amendments to the bill.
Regardless of the definition of municipal derivatives that
is finally applied to MSRB rulemaking authority, the
jurisdiction of the MSRB in respect of derivatives is likely
to overlap with the new rulemaking authority of the CFTC and
the SEC to regulate derivatives. The agencies will have to
reach an accommodation with the MSRB on the issues to be
covered by MSRB rules.
Solicitation of Municipal Entities and Obligated
Persons
The Reform Act grants jurisdiction to the MSRB to adopt
rules regulating the use of outside consultants by
broker-dealers and municipal advisors who, for compensation,
solicit municipal entities or obligated persons for the
purpose of obtaining an engagement of a broker-dealer or
municipal advisor for municipal financial products, the
issuance of municipal securities, or of an investment adviser
to provide investment advisory services to or on behalf of a
municipal entity.
Municipal Entities and Obligated Persons
A municipal entity is broadly defined to mean any State,
political subdivision of a State, or municipal corporate
instrumentality of a State, including: (i) any agency,
authority, or instrumentality of the State, political
subdivision, or municipal corporate instrumentality, (ii) any
plan, program, or pool of assets sponsored or established by
the State, political subdivision, or municipal corporate
instrumentality or any agency, authority, or instrumentality
thereof, and (iii) any other issuer of municipal
securities.
The definition of an obligated person is derived from SEC
Rule 15c2-12 and is defined in the Reform Act to mean any
person, including an issuer of municipal securities, who is
either generally or through an enterprise, fund, or account of
such person, committed by contract or other arrangement to
support the payment of all or part of the obligations on the
municipal securities to be sold in an offering of municipal
securities. The obligated person definition in the Reform Act
does not have the Rule 15c2-12 exclusion for credit providers
and liquidity facilities because obligated persons are not
regulated under the Reform Act; they, along with municipal
entities, are beneficiaries of certain rules regulating
broker-dealers and municipal advisors.
The purpose of the definitions of municipal entities and
obligated persons is to make clear the beneficiaries of
certain of the MSRB rules. For example, section 15B(b)(2)
provides that the MSRB is to make rules governing advice to
municipal entities or obligated persons by broker-dealers and
municipal advisors regarding municipal financial products and
the issuance of municipal securities, whereas section
15B(c)(1) makes a municipal advisor a fiduciary to a municipal
entity, but not to an obligated person.
Enforcement of MSRB Rules
Prior to the Reform Act, the MSRB was limited to
rulemaking, and enforcement of MSRB rules was by FINRA, the
SEC, and appropriate bank regulators. The Reform Act extends
authority to the MSRB to "provide guidance and assistance in
the enforcement of, and examination for, compliance with" MSRB
rules to the SEC, FINRA or the appropriate bank regulators.
Related sections of the Reform Act require FINRA to adopt
rules to request guidance from the MSRB in the interpretation
of MSRB rules. Section 979 of the Reform Act, which formalizes
the office of municipal securities within the SEC , directs
the office to coordinate with the MSRB for rulemaking
and enforcement actions.
MSRB Board Composition
The MSRB Board is composed of 15 persons with three-year
staggered terms. Previously, the board was composed of five
persons representing broker-dealers, five persons representing
commercial banks having municipal finance departments, and
five persons representing the public. In the future, the board
is to consist of eight public members, at least one of whom is
to represent institutional investors and at least one of whom
is to represent municipal entities. Of the seven members
associated with a broker-dealer and a bank municipal
department, or a municipal advisor (regulated
representatives), at least one is to represent broker-dealers
that are not banks, at least one is to represent municipal
securities dealers that are commercial banks,
departments of banks or subsidiaries of banks, and at least
one is to represent municipal
advisors. | 
