Structured Project and Energy Advisory Practice

Dodd-Frank Wall Street Reform and Consumer Protection Act

Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, MSRB Notice 2012-25 clarifies the MSRB Rule G-17 regarding the relationship of underwriters to clients, creates affirmative obligations for underwriters and requires underwriters to disclose important information to help issuers assess proposed financial transactions.

An underwriter must disclose information about its role, including that its primary role is to purchase securities with a view toward distribution in an arm’s length commercial transaction, and that unlike financial advisors, does not have a fiduciary duty to issuers and is not required to act in issuers best interests. In fact, an underwriter’s duty to purchase securities at fair prices is balanced with its duty to sell municipal securities to investors at fair prices. An underwriter is also required to disclose all actual or potential conflicts of interest. Where a firm and its affiliates serve in multiple roles in a transaction, or where a firm has a lending or underwriting relationship with one or more of the parties to a transaction, a conflict of interest may exist.

The revised regulations also require certain additional disclosures for “complex” transactions. A transaction is complex if structured in a unique, atypical or otherwise complex manner including, but not limited to, variable rate demand obligations or involving derivatives. It is safe to assume that most, if not all, structured and project financings are complex transactions. Indeed, one of the best ways that an entity can level the playing field and reduce risks when dealing with sophisticated, and often conflicted, underwriters in complex transactions, is to engage a qualified financial advisor with a fiduciary responsibility to represent the issuer’s best interests.

The complex transaction disclosures must be specific rather than general in nature. Dodd-Frank puts the burden of assuring that an issuer understands the risks in a complex transaction on the underwriter: If the underwriter does not reasonably believe issuer personnel are capable of independently evaluating disclosures, the underwriter must make additional efforts to inform of characteristics and risks. Under Dodd-Frank underwriters of complex transactions are protected by assuring that issuers have competent financial advice.

Final rules governing financial advisors have not yet been finalized. However, Dodd-Frank amended Section 15(B) (1) of the SEC Act of 1934. 15B(2)(L)(i) directs the MSRB to establish rules for municipal advisors and to “prescribe means reasonably designed to prevent acts, practices, and courses of business as are not consistent with a municipal advisor’s fiduciary duty to its clients”. The financial advisory industry has been characterized by a lack of regulations, oversight and qualifications which have in many cases led to poor or unqualified representation, conflicts of interest from advisors that change to underwriting roles during the course of a transaction, and resulting issuer difficulties, defaults, bankruptcies and law suits. Dodd-Frank attempts to clearly define and distinguish the role of underwriters from that of advisors and to more closely regulate the activities of advisors.

Though not final, a draft of MSRB Rule G-36 has been circulated and comments received. There are certain things that can be reasonably deduced as follows:

Advisors shall be subject to a fiduciary duty, which shall include a duty of loyalty and a duty of care. A duty of loyalty requires advisors to deal honestly and in good faith; act in a client’s best interests without regard to financial or other interests of the advisor; make clear written disclosure of all material conflicts of interest that might impair the duty of loyalty; and receive only fair and reasonable compensation based on experience and the nature of the financing.

A duty of care requires an advisor to undertake advisory engagements for which it possesses the degree of knowledge and expertise needed; to make reasonable inquiry into counterparties representations; to investigate alternatives to the proposed financing structure or product; to make reasonable inquiry into facts relevant to a determination to proceed; to make reasonable inquiry for certificates to be relied upon by issuer or investors; and to exercise due diligence as to facts in preparation of official statements.