The Municipal Securities Rulemaking Board earlier in November issued two long-awaited compliance resources for municipal underwriters and municipal advisors. They were in response to the MSRB’s October 2021 request for comment on draft compliance resources for dealers and municipal advisors on new-issue pricing.
The resources each provide a summary of rules applicable to the pricing of new-issue municipal securities and giving advise re the same. For underwriters, these include MSRB Rule G-17 (basic fair dealing, general fair pricing with commentary around competitive and negotiated underwritings), MSRB Rule G-27 (supervision) and MSRB Rules G-8 and 9 (books and records).
For municipal advisors these include MSRB Rule G-42 (duties of non-solicitor municipal advisors), MSRB Rule G-17 (conduct of municipal securities and municipal advisory activities), MSRB Rule G-44 (supervisory and compliance obligations of municipal advisors) and MSRB Rules G-8 and 9 (books and records).
Importantly the MSRB made clear that the compliance “resources do not create new legal or regulatory requirements or new interpretations of existing requirements but may be useful tools for municipal advisors and underwriters in supporting their continuing compliance efforts and in assessments of their applicable policies and procedures.”
As many of us know, recent Securities and Exchange Commission exams have included questions around new-issue pricing and support for the same consistent with the rules. While the MSRB’s compliance resources are not a rule and it has not been filed with the SEC, one can infer that following the same will be beneficial should the SEC inquire.
The underwriter resource provides for those acting as an underwriter, a resource to enhance their understanding of their fair dealing obligations, on conduct of municipal securities and municipal advisory activities and certain of supervisory obligations.
To start, MSRB Rule G-17 includes an “implied representation that the price an underwriter pays to an issuer is fair and reasonable, taking into consideration all relevant factors, including the best judgment of the underwriter as to the fair market value of the issuance at the time it is priced.”
In negotiated deals (the focus here — please see the UW resource for more on competitive deals), the underwriter has a duty to negotiate in good faith with the issuer and includes the obligation to ensure the accuracy of representations made including those regarding the price negotiated and investor demand. In this regard, there are a number of factors that can be at play and are important as one navigates the landscape.
Let’s start with the purchase price paid by the underwriter — it must be “fair and reasonable” under Rule G-17. This need not be the “best” price. The MSRB rules recognize that underwriting engagements are “arm’s length” and that the interests of the parties can and do differ and that the underwriter can place its own interests ahead of the issuers to ensure the underwriting firm is adequately compensated for its services and by limiting its risk.
Factors relevant when determining “fair and reasonable include the best judgment of the underwriter as to the fair market value of the new issuance when it is priced. While subjective the underwriter’s “best judgment” is informed with market information “reasonably available up to and at the time a new issuance is priced.”
This can and should include the final purchase price, comparable issues of the recent past as well as where those issues are trading in the secondary market and as appropriate, the side of the market and size of trades. Importantly, “the process by which an underwriter arrives at and documents its best judgment of the fair market value of a new issuance can be helpful to affirming compliance with Rule G-17.” In other words, process and documentation matter.
“Facts and circumstances” can also be relevant to determining if the underwriter has met its fair pricing obligation and, per the UW Resource, may include one or more of the following:
- Market dynamics leading up to and at the time of pricing;
- Movements of benchmark curves v. preliminary pricing scales;
- Whether the underwriting is solely managed or managed by a syndicate;
- Complexity of the structure and/or unique or uncommon features;
- Instructions related to pricing from the issuer or the issuer’s municipal advisor;
- Whether the underwriting is for a new and/or unknown credit; or
- The type and nature of investor demand for the issuance.
The UW Resource makes clear that the WSP requirement is not one size fits all and the same can and should be tailored to a firm’s underwriting activities. Further, “while firms do not need to document every aspect of the pricing process, there is an expectation … that a dealer will maintain and preserve material records related to primary offerings” that will help “facilitate inspections and examinations … and assist the examining authorities in evaluating a dealer’s compliance with Section 15B of the Exchange Act, the rules and regulations thereunder, and MSRB rules.” (Emphasis added).
DIVER’s New Issue Pricing and Scales platform can be highly effective in supporting these obligations and “facts and circumstances” referenced in the UW Resource and the referenced MSRB Rules. Using the structural and credit characteristics of the transaction, one can identify all comparable issues and trades to form an objective baseline around a new issue. Moreover, relevant secondary trade activity can be included to allow for consideration of additional market data. Additionally, all of the supporting evidence to justify a pricing yield curve can be stored for retrieval to support proper documentation.
The MA Resource can assist municipal advisors in their assessments of their policies and WSPs when providing advice to their clients with respect to advice on the pricing of a new issue municipal security.
MSRB Rule G-42, which establishes the core standards of conduct and duties of municipal advisors. obligates a municipal advisor to “[a]ct in a manner consistent with its duty of care to its client.” The duty of care is explained in Supplementary Material .01 of Rule G-42 and requires a municipal advisor to, among other things:
1. Possess the degree of knowledge and expertise necessary to provide the client with informed advice;
2. Make a reasonable inquiry as to the facts relevant to a client’s determination as to whether to proceed with a course of action or that form the basis for any advice provided to the client;
3. Undertake a reasonable investigation to determine that it is not basing any recommendation on materially inaccurate or incomplete information; and,
4. Have a reasonable basis for any advice provided to or on behalf of the client.
As it relates to new issue pricing (if “pricing-related services” are not within the scope of the relationship the same must be documented and conduct must not include such services), the municipal advisor must take affirmative steps to ensure it is meetings its G-42 obligations. The municipal advisor should have tools and resources to ensure they have a sense of the market for comparable transactions (market segment, credit, structure and more) and where those transactions are trading post issuance should the market have moved since the time of issue. This allows the municipal advisor to engage in a constructive dialogue on behalf of and with their client to address its G-42 obligations. DIVER’s New Issue Pricing and Scales platform is one tool to help access comprehensive information to support new issue pricing obligations.
Furthermore, if a municipal advisor is providing new issue pricing advice, it is expected to have WSPs. The MA Resource makes clear that the requirement is not one size fits all and can and should be tailored a firm’s activities. It also provides that “…there is an expectation … that a municipal advisor will maintain and preserve documents material to a recommendation or that memorialize the basis for the recommendation.” As many have heard, there has been some focus by examiners on new issue pricing and “[m]aintaining and preserving books and records facilitate inspections and examinations of municipal advisors and assist the examining authorities in evaluating a municipal advisor’s compliance with Section 15B of the Exchange Act, the rules and regulations thereunder, and MSRB rules.”
MSRB Compliance Resources are important and meaningful tools for those operating in the municipal market and, while not creating new requirements or having been filed with the SEC, should be a reminder that there are established legal requirements under existing MSRB rules that municipal advisors are expected to fulfill.