Public Finance Alert | October.28.2019
In response to the proliferation of direct placements of municipal securities with financial institutions over the past decade, the Securities and Exchange Commission (SEC) has proposed a regulatory change to clarify the role that non-dealer municipal advisers can play in arranging such direct placements. This action was in response to a perceived gap in regulatory oversight that some parties in the municipal industry asserted created confusion for such advisers.
Under long-standing law, municipal brokers and dealers (which includes underwriters) are required to register with the SEC and are subject to extensive regulation by the SEC and the Municipal Securities Rulemaking Board (MSRB). Historically, financial advisers who did not underwrite securities were not regulated, but this changed with enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) in 2010. Dodd-Frank required the SEC to create a regime for the registration of these advisers, who are now called "municipal advisers" or "MAs." MAs now are required to register with the SEC and are subject to MSRB Rules, in many cases the same as apply to dealers. One significant difference in the respective regulations is that dealers do not have a fiduciary duty to their issuer clients, but are treated as having interests adverse to the issuers, while MAs do have a fiduciary duty to their clients.
Of course, many registered municipal dealers also act as municipal advisers, in cases where they do not choose to try to underwrite the securities of a client (see MSRB Rule G-32). Hence, Dodd-Frank and the applicable MSRB Rules created an exemption for registered dealers from having to also register as a municipal adviser. There was no corresponding exemption, until now, for registered municipal advisers.
This regulatory gap has become more noticeable in the context of direct placements, which are typically made between a bank or other financial institution or group of institutions and an issuer (including obligors in conduit financings). The administrative and advisory functions to arrange such a transaction are handled by a professional serving as a placement agent. There is no formal definition of what exactly makes an entity a placement agent, rather than a pure adviser, but for regulatory purposes, absent an exemption, an entity acting as a placement agent has to comply with rules applicable to dealers, including registration with the SEC.
In an effort to bridge this regulatory gap, the SEC has now proposed to allow non-dealer municipal advisers to carry out certain activities to assist issuers consummate a direct placement without having to register as municipal dealers – in effect to act as a placement agent. However, the SEC has proposed limits on the scope of this potential exemption.
First, the exemption will only be available for the purchase from an issuer of 100% of an issue of securities by a single purchaser.
Second, the exemption will only be available if the purchaser of the securities fits within a new definition of a "Qualified Purchaser." Qualified Purchaser (QP) must be one of the following:
(a) a bank, savings and loan association, insurance company or registered investment company;
(b) an investment adviser registered with the SEC or any state; or
(c) any other institution (but not a natural person) with total assets of at least $50 million.
This definition is expressly designed to exclude any kind of retail distribution of securities pursuant to the proposed exemption.
The proposed exemption also requires the municipal adviser to comply with these additional conditions:
First, the MA must make a written disclosure to the QP stating that the MA does not represent the QP, but only the issuer, and the MA must obtain a written acknowledgment from the QP of receipt of these disclosures.
Second, the MA must obtain a letter from the QP that the QP is capable of independently evaluating the investment risk of the proposed transaction. This "big boy" letter is already standard in direct placements but now would have to be addressed to the MA in addition to the issuer.
Third, the exemption is only available if the MA adheres strictly to the limitations and conditions described above. Further, the MA must comply with any other applicable SEC and MSRB regulations.
If an MA follows all these conditions and qualifies for an exemption from dealer registration, it can carry out certain activities that would otherwise be problematic for an unregistered entity. Most prominent would be the ability for the MA to solicit potential buyers for the issuer's securities and to be paid for its services from proceeds of the issue.
The SEC is soliciting comments on this proposed exemption through December 9, 2019. In that regard, the October 9 release listed 17 specific questions to which it is soliciting responses. These particular questions can be viewed in the release.
 Exchange Act Release No. 34-87204, published in the Federal Register on October 9, 2019.
 This entire issue becomes moot if the transaction is treated as purchase of a loan rather than a security, since the SEC only regulates securities transactions. The distinction between these two categories is, however, quite unclear and always depends on the facts of a particular case, so few, if any, firms would risk violating securities laws over this distinction.
 This is analogous to disclosures that an underwriter has to make to an issuer under Rule G-17 that the underwriter has interests adverse to the issuer and disclosing any potential conflicts of interest by the underwriter.