2000 Municipal Market Roundtable (Panel 3)
U.S. Securities & Exchange Commission
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U.S. Securities and Exchange Commission

Panel III: Selected MSRB Issues

2000 Municipal Market Roundtable
October 12, 2000
Washington, D.C.

United States Securities and Exchange Commission
Office of Municipal Securities

Ms. Simpkins  – Welcome to the third and final panel on Selected MSRB Issues.

My name is Mary Simpkins. I'm an attorney in the Office of Municipal Securities. And I will let each of the panelists introduce themselves briefly. But I should say that Diane Klinke, from the MSRB, came in at the last minute, so we owe a special debt of gratitude to her.

Mack, why don't you start.

Mr. Northam  – Hi, my name is Mack Northam. I'm with the National Association of Securities Dealers, Director of Regulation or Fixed-Income Securities. And I want to thank the Office of Municipal Securities for the opportunity to be here.

Ms. Klinke  – Diane Klinke, general counsel of the MSRB.

Ms. Currie  – I'm Phyllis Currie and now an independent consultant but I spent the last 15 years as an issuer with the City of Los Angeles, the L.A. Department of Water and Power. I also had the opportunity to be a member of the Municipal Securities Rulemaking Board, acting as vice chair in the late '90s. And then I did a stint with the California Data Advisory Commission.

Mr. Zehner  – My name is Mark Zehner. I am Regional Municipal Securities Counsel in the Division of Enforcement of the Securities and Exchange Commission. I'm also an ex OMS attorney-fellow, which may explain in part why I'm here. And given the fact that I'm an SEC representative on this panel, I need to give you my official disclaimer. All of the views today I express are going to be my own personal views. Will not necessarily reflect the views of the staff, the Commission, the Commissioners, or anybody else I can think of other than myself.

Mr. Arkuss  – I'm Neil Arkuss. I'm a partner in Palmer & Dodge in Boston. I'm really a tax lawyer, which may raise the question why I'm here at all. And about the only explanation I can come up with is I'm here to catch Leslie's javelins.

Ms. Richards-Yellen  – I hope I can throw some javelins. I'm Leslie Richards-Yellen. I work for Vanguard. I'm a principal and associate general counsel and I primarily service Vanguard Fixed-Income Group.

Mr. Doty  – I'm Robert Doty. I'm a financial advisor for the American Governmental Financial Services in Sacramento. And I'm also a lawyer.

Ms. Simpkins  – Actually one of the reasons for this panel is to just to increase awareness about MSRB rules. Because although these rules have been out there for a long time, we continue to hear reports of some problems. And I know that a lot of bond lawyers are only indirectly aware of them because they're not the dealers. They're not the ones dealing with these rules.

So part of the reason for having this is just to make sure that everyone is aware of them and can understand what dealers are going through in trying to comply with them. And with that in mind, I want to make sure everybody knows just what the MSRB is so I made a few points about it and Diane may want to add to this.

But the MSRB, the Municipal Securities Rulemaking Board, was created by Congress in 1975 by an amendment to the Securities Exchange Act to regulate dealer activities in the municipal market. It's the self-regulatory organization for the state and local government securities markets that is subject to oversight by the SEC.

It is a board. It consists of 15 members with representatives of bank dealers, securities firms, and public members, including at least one issuer and one investor. Violation of any MSRB rule is a violation of law under the Securities Exchange Act. The MSRB does not have enforcement power with respect to its rules. Its rules are enforced by the SEC, the NASD, and bank regulatory agencies. And for a lot of information about the MSRB, including all of its rules, I would refer you to their actual Web site which is WWW.MSRB.org.

So that background and the idea of this panel being we want to increase awareness, I guess the first topic we want to talk about is why aren't other participants more aware of the rules and what can be done about that.

Ms. Currie  – Well, I guess since I'm the issuer of the group.

It's been my experience that larger issuers who are in the marketplace tend to have a better awareness of the MSRB and their rules. So I would say that it's probably not extensive. And then when you get to smaller issuers, and those who are infrequently in the market, they probably don't know much about the MSRB at all.

Now, I know from the time that I was on the board and continuing, the MSRB has tried to do more outreach to try to help with this kind of situation.

But I think it's more a case that of an issuer has a lot of things that are high on their agenda. And the individual who has the responsibility for debt issuance in the organization may be the only person who knows that the MSRB exists. They're getting a lot of their information, however, from their financial advisor and their bond counsel about what the regulations are that the dealers have to adhere to.

And I know from my personal experience, the dealers might come in and behave in a certain manner or be concerned about some particular regulation that they're going to adhere to. They didn't always tell me that it was because that they were required to do something because it was in the MSRB rules. I've heard that over time.

So I think it's very helpful when issuers are aware of MSRB rules and the dealer requirements. It also would raise their sensitivity I think to things like having to get the Official Statements out on time and get them into the hands of the customer.

I also think that it's useful to remember that when you talk about an issuer, you are talking about a collection of people. It's not just the finance director. The issuer is represented by elected officials as well as appointed officials. And they have their own city attorney or other counsel. And you need all of these people collectively to be aware enough about the obligations of disclosure so that they act collectively to get some of these documents done in a timely manner so that rules can be adhered to.

Ms. Simpkins  – And I understand the MSRB is doing some outreach programs. Maybe, Diane, could you tell us about that?

Ms. Klinke  – Sure. Actually we try to do quarterly meetings in various regions of the country in which we usually have a local dealer, generally a board member, trying to get members of the community together. And this is not just dealers. This is investors, issuers, financial advisors, everyone in the community involved in the municipal securities market, to come together and at least get a feel for what the board is doing.

Today the way timing works out, many board members and staff members are up in Boston because we were having a regional meeting today and our hope was to get 50 or 70 people, and we usually are able to do that. And just to give a little more explanation about who the board is and what we're doing.

Because Phyllis was exactly correct when she said many times dealers will come in to an issuer, to an FA, and say, "Okay. We need to get this Official Statement done. We need to do all these things. But possibly before -- some of the recent enforcement actions and other things on G-36, which is our rule about Official Statement delivery requirements to the board, and G-32, which is actually the most important, delivery of Official Statements to the market, to purchasers of bonds.

Sometimes they went in and didn't explain it was a rule requirement, which was their basic reason for pressing to get these documents done.

And so on that level, it's extremely important that issuers and bond counsel, financial advisors, recognize that there are very strict rules and requirements that dealers are supposed to follows. Things that are just the dealers' own duty and obligation to act and comply with this one thing. But when those rules like getting Official Statements out to the customers and to the board, when that is so dependent on issuers and bond counsel and FAs and everyone acting together to get the documents done, it's very important that that message should be provided to all the underwriting participants so that they understand the necessity of getting a document like that out.

We actually did a study when we received additional information on our forms G-36, and it was published in June of '99, that basically said from the information we have received, 20 percent of the time issuers did not provide final Official Statements to underwriters within the seven business-day time frame set forth in the 15C2-12 contract.

That's problematical, because there is a contract that pursuant to the rule, underwriters are required to enter into with issuers to get the Official Statement in a timely fashion, and a very important requirement.

Our Rule G-36 does give underwriters at least three extra days to provide the document to the board, and we did, through this statistical analysis, determine that with those extra three days, 97 percent of the Official Statements were done. But still 3 percent of the time underwriters just did not get the documents from issuers in time to turn it around and provide it.

And, again, as I said, it's not just a question of providing the document to the MSRB, who then we turn it around, put it in electronic form, and turn it around to information vendors for the market. But also vitally important Rule G-32, which requires Official Statements to be provided to customers. That's the main point. That the customers, the purchasers of these securities, receive final Official Statements. As the time frame that the Commission put in place, as a very good time frame, within seven business days from the date of sale, let's get that final Official Statement done.

When that's not being complied with, and, you know, it's the whole -- it's the underwriters, it's the issuers, it's the FA. Everyone is involved, I believe in most instances, in getting the final Official Statement done. When that's delayed, you're holding up the whole process so that it might be problematical for customers to get that final Official Statement by settlement, which is a requirement of the board and a very important rule, as the board has determined.

So if everyone involved in the underwriting process has a little more information about those kinds of rules, I think it can only help the timing. And people -- and many times it's not they're deliberately not getting the document done. There's a lot of things to be done between sale and settlement. It's just a question of everyone in the process recognizing that there's a lot to be done paperwork-wise. Let's give everybody the time to get things accomplished so that vitally important information gets to the customer.

Ms. Simpkins  – We may want to talk about G-32 and G-36 a little bit more later in the program. But actually the first issue we'd like to talk about is the so-called exploding bond counsel opinion and the possible application of Rule G-15 to that problem.

This was something that was brought to our attention by the buy side of the market, so I'm going to let our buy side representative, Leslie, tell us what the problem is from their standpoint.

Ms. Richards-Yellen  – Well, basically the concept of an exploding opinion is carve out in an opinion, and it tells you if after the date that the opinion was delivered, if there is any subsequent act, that the opinion is no longer valid. That's the exploding opinion concept.

And there had been some talk about marrying that concept with the delivery, which is G-15. And basically what the delivery is is that what buyers expect is to get the legal opinion and legal documents. And if we purchase a bond without a legal opinion or legal documents, that that should be notated, that we'd gotten them, a legal opinion.

So those are the two concepts. And although I understand the tendency to want to put it on G-15, I don't think exactly that delivery of a bond issue to a purchaser without a valid opinion falls within G-15. And I'm going to talk about that in a minute.

But let's look at this from the investor's perspective. In the secondary market, we get an offering document. And the offering document has the opinion in it, and the opinion may have an exploding provision which says that it may go away. But that was written, let's say, five years ago, and the bonds are outstanding for 30 years.

So when we see our OS, we see there's an opinion. The opinion is good because we assume the opinion is good unless someone tells us that the opinion isn't good. We go to Bloomberg. Bloomberg says nothing. We go to the NRMSIR. The NRMSIR says nothing.

And maybe the reason for that is because under 15C2-12, the security for which the opinion is attached to is exempted. It could be a variable-rate demand note. Or it could be that under one of the 11 material events under 15C212 that the issuer went to bond counsel and said, "If the fact that your opinion went away, is that material and maybe bond counsel didn't determine that that was material." So that may be a reason why we don't get the notice.

But the issuer is sitting there with a bond, with a bond opinion, and with no notice that the bond opinion is no longer valid. And these opinions are part of the security, a very material important part of the security, and that's why we buy them because they go into tax-exempt bond funds.

If we didn't think that the bond was tax exempt, we would expect a higher coupon on the security, but we're assuming that it's tax exempt because there was an opinion and the opinion was attached to the Official Statement.

So the only people at this point who may know that there's no longer a good opinion on the bond deal would be the issuer because if the bond deal was going to be changed, either the issuer initiated it or the issuer perhaps knew, or perhaps the underwriter that made the structural change.

So those are two parties that may know, but the bondholder, whether they're sophisticated or not, they don't have any idea that the opinion that they're relying on is no longer there.

Where I think the good idea that someone had was that maybe you could tie the idea of good delivery to an exploding bond opinion, I think it's a good idea and I think there's emanations in the MSRB rules that you could use to try to tackle this concept.

For example, there's G-17, which is the fair practice rule. And G-17 has a lot of good language, and some of the hooks that you could try to hang this concept on are that the bondholder should have adequate disclosure, that they should understand what they're buying, and that you should tell bondholders what a reasonable bondholder would want to know.

There's also G-30, and that's fair pricing. And obviously if the market thought that they were not buying a tax-exempt bond, they would not be willing to pay the same price for it.

So there has to be a reason for us to pay that price and I think that's a relevant factor to know that there's no opinion on the bond deal.

I think it's unfortunate that we can live in a world where an investor can buy a bond and not know that the bond opinion is no longer good. And I think in the future maybe it's something that bond counsels can start to think about, because there's ways to structure the deal in a way where the opinions can explode.

For example, you could say there has to be a put on the bonds. If there's ever a time when the bond opinion could explode, that before that happens, you tell the market. The market can put and the put price would have to be some kind of hard put price, because we've spent billions of dollars analyzing the bond. We've spent money every so often looking at the credit again to determine that we should still hold it. And we don't want it taken away from us unless it's painful. So puts could be provided.

Or the subsequent opinion for the second event to happen, that opinion could have to be some kind of a bringdown opinion so that we're not left with a gap period without an opinion.

Or lots of bond documents provide that you go back to the original bond counsel that that's okay. But I just posit the situation in which the original bond counsel goes out of business, and it would be impossible.

But I believe in structuring these bond deals in a more careful way that bondholders won't be left on the hook with the possibility of (a) there's a gap period in the tax opinion; and (b) they have no possibility of getting notice that there isn't an opinion.

Mr. Arkuss  – We feel your pain, Leslie, but there are about a dozen things you mentioned with which I don't agree. So I might as well start listing them.

But before I do, I think maybe we should try to put this exploding bond opinion in context. And also I think I'll just take the time, since I'm one of you and not familiar with all the MSRB rules to explain to you that the issue does arise under G-15 under a clause which says as follows. "Delivery of certificates without legal opinions or other documents legally required to accompany the certificate, shall not constitute good delivery unless you identify it as ex-legal at the time of trade."

I think it is my view, I think it is the view of the organized bond bar that an opinion, an exploding opinion, is good delivery on the time of issue and there is absolutely no MSRB issue under G-15.

Ms. Klinke  – Let me just jump in. Fifteen does not apply to the situation.

Mr. Arkuss  – Thank you.

Ms. Klinke  – At all. And the issue is because the section quoted is, as noted, a good delivery provision. And it only applies to physical delivery, which is only a certain percentage of the market now anyway.

And it was kind of a holdover from the ba-zillion years ago when bonds were not even printed. They were typed up and you would staple a legal opinion to it, so that unless you knew the little printed-up bonds you had for some reason didn't have the bond opinion, you know, you would trade it ex-legal. But that's really the extent of that.

So Leslie's issue, if material, it is a G-17 or something else. Fifteen does not apply.

Mr. Arkuss  – I'd agree with that.

Let me read you some disclosure language of an exploding opinion so you can see exactly what it is.

Certain agreements, requirements, and procedures contained or referred to in the indenture, the loan agreement, the tax agreement, and other relevant documents, may be changed and certain actions may be taken or omitted under the circumstances and subject to the terms and conditions set forth in those documents.

Here it is. "No opinion is expressed herein as to any bond or other interest thereon if any such change occurs, or action is taken or omitted upon the advice or approval of counsel other than ourselves."

Now, you may think that that's a business promotion paragraph and in many ways I think it is. But there are two kinds of exploding opinions. One is where the opinion explodes when an action is taken and it explodes as of the time that action is taken without the approval of the original bond counsel. I would call that the conventional exploding opinion.

Then we have the nuclear exploding opinion in which bond counsel goes to the trouble of saying that the explosion is retroactive to the time of issue.

And if I have enough time, I'll explain to you why those all came into being, but at least with respect to the conventional exploding opinion. It is not in the NABL model opinion form. Many, many bond counsel firms do not use an exploding opinion because they believe that their regular opinion, without this statement, is an exploding opinion. And that the exploding opinion is is no more than putting down on paper what's perfectly obvious to everyone. It's like the study of sociology.


So -- I'm glad someone's listening. So that's one point.

The secondary market issue of whether a poor bondholder is purchasing a bond upon which the opinion has already exploded is one that I'm extremely sensitive to. The problem is bond counsel doesn't know it any more than the bondholder does, who knows it, the issuer who took the deliberate action that caused that bond to fail its tax exemption by failing to pay a rebate or changing the use of the facility. Or perhaps some structuring agent who has remarketed the bonds in such a way as to pull their bonds into question. But, again, without the purview of bond counsel.

The truth is bond counsel's opinion speaks as of the date of issue. And anything that happens beyond the date of issue, not within the control of bond counsel, is, in my judgment, not covered by that opinion.

So that's my view. I think it's harder to defend the retroactive, the nuclear explosion. I think that just for purposes of background, many of the tax transgressions one can commit post-issuance result in taxability, at least theoretically, of an issue. You fail to pay a rebate is a perfectly good example. Your bonds are taxable from the date of issue.

I think that out of a concern for potential liability, whether real or imagined, when the exploding opinion was invented, to make clear what I say is perfectly obvious anyway, people said, "Well, if we don't make it retroactive to the date of issue, we may be in somehow misleading the recipient of this opinion as to the consequence of a bad tax act subsequent to issuance."

But, again, I don't write exploding opinions explicitly in either circumstance. But I do not think they're offensive. I just think they're surplus.

Ms. Richards-Yellen  – I'm glad we agree that bondholders should have noted when they don't have an opinion. And I think that's a fundamental right. If you think you're buying a tax-exempt bond and you're not, you should know that. And I'm glad we found consensus, like Gore and Bush, on something.

However, in addition to the opinion that we're buying, which speaks as of the date of issuance, I believe we're also buying tax compliance into the future for the life of the bond. So we're buying someone's mind and that someone went out, they did diligence at the facility, they asked, let's say, the hospital. They asked the hospital all kinds of relevant questions on which they base their tax analysis. They created a tax certificate. The tax certificate was explained to the hospital. The hospital knew what were bad acts, what were good acts. And they created a procedure to carry the deal into the future. And that's a part of what I believe that we're buying. And when an opinion explodes, the nuclear explosion, it's unclear to me what we have left of that diligence system.

Mr. Arkuss  – Well, my only response to that is I think you're accurate in saying exactly what you have bought, and I don't think whether the opinion explodes or doesn't explode changes that result one iota. We're talking about situations. The backdrop for this back in the '80s was when we did not know the tax consequences of a change in mode. It was prior to the new issuance rules and the Cottage savings regulations. Now we have a set of post-issuance, factual impairments to the bond tax exemption, such as a change in use of a bond finance facility 18 years after the bond is issued, that's the bond counsel's engagement. He has set up all of the tax compliance. He has explained to the issuer that you cannot invest bond proceeds in a villa for the mayor. He's explained that you can't sell that office building, even though real estate prices have gone up, to IBM without paying off your bonds.

But it happens. It happens. Now, his opinion does not run to that change of circumstances, and all you're doing in the exploding opinion in my judgment is telling -- as a matter of fact, it's over-disclosure. It's telling you, the bond purchaser, that because of the perversity of our Congress, there are many things that can occur subsequent to the issuance of the bond that affect its tax exemption.

Mr. Doty  – Well, I agree with what you're saying, Neil, and also agree with Leslie's concern.

Part of the answer may lie, Leslie, at the time of the original transaction. You know, usually the issuer makes a covenant not to take action to cause the bonds to become taxable. You might extend that to say, "Or to result in the withdrawal of the bond opinion." Now, that's a possibility.

I've been sitting here struggling to recall what the 11 deadly sins are. I know there's one that deals with the tax opinion, but it may be that you actually receive another opinion, so perhaps that one doesn't fit. But what about 10b-53? A course of business operating as a fraud. Doesn't the issuer implicitly represent at the time of the transaction that it's not going to cause these bonds to become taxable or cause difficulties in trading?

We can't have this kind of difficulty in liquidity or this uncertainty about bonds. Something needs to be done so that the situation is clarified. And if the issuer wants to use another bond counsel, let them use the other bond counsel. Let the other bond counsel issue an opinion.

Ms. Richards-Yellen  – Bring-down.

Mr. Doty  – Right.

Mr. Arkuss  – And if the opinion explodes, and if some other bond counsel issues that opinion, I think what Leslie's objection would be is she didn't buy the opinion of that bond counsel. She bought the opinion of the original bond counsel for the life of the deal. And I don't know how to fix that in the typical bond transaction.

Ms. Richards-Yellen  – Well, right now I just want to know. I mean right now I don't even know.

Mr. Arkuss  – I understand. And we're on the same side on that issue.

Mr. Zehner  – Let me break in here though for a moment, if you don't mind me putting my enforcement hat on, at least my personal enforcement hat on, because I also want to take this issue and take it one step up the extraction ladder, as I would call it.

To me this is just one more variant on a tension that is still in existence in the municipal marketplace, and that is the clash between this concept of an unqualified legal opinion as to the tax-exempt status for the bonds, on the one hand, and the theory that somehow because you've got that unqualified tax opinion, you don't need more than your standard boilerplate, you know, cut-and-paste tax disclosure in your Official Statement.

And one comment to that got my ears perked, if nothing else, which is that this exploding bond opinion problem is to some degree an example of over-disclosure. I disagree. Particularly given his description of what some product practitioners believe, which that this is built into the opinion anyway. This is nothing new. Everybody should already know it.

Well, clearly from the reaction of some of the institutional investors, that's not the case. In my mind, part of the concern is if you listen to the language he read off, it's very unclear to me what would trigger this. You know, some deals are structured so that you need a second opinion of bond counsel upon the occurrence of certain events, or if you wish to do certain things. Change your mode, sell a piece of the property, whatever.

The question I have is were those items that required receiving an opinion of counsel disclosed so that the institutional investor can go to the list and say, "Okay. I see the issues here. I see the various break points, the various events that might occur that might trigger the need for a second opinion," which would then, in turn, obviously be the trigger for the exploding bond opinion.

But it's not there. Or may not be there. That's one of the questions, whether the summary of the institutional -- --

Similarly, there's ambiguity here as to what the consequences are of an exploding opinion. Is it a situation in which you simply get a replacement, an equally valid opinion, that goes back to the initial issuance so that everybody's still covered. It's just a question if he knew there was a piece of paper. Are you truly left without any opinion? Is there an issue here as the underlying tax status of bonds, or are we simply quibbling over whether or not people are comfortable opining to the tax status of those bonds?

There's a lot of different issues here, a lot of which can be dealt with an extensive disclosure of initial issuance. But --

Ms. Currie  – Let me interrupt just a moment.

You know, I think -- I've been in a lot of these situations where questions come up on whether a facility, for instance, that was financed with tax-exempt bonds can be used for a certain purpose, or leased to somebody or sold to somebody.

And, you know, hopefully speaking for the responsible issuers, you have an administrative obligation, you know, once you issue debt, to sort of oversee how the proceeds are being used to ensure that you don't your taxexempt status.

And typically an issuer would get an opinion if they are contemplating something that even calls into question whether the bonds are going to remain non-taxable. And you typically would go back to the bond counsel that entered the opinion.

Now, I don't know that it's written somewhere that you have to do that, but when you start using, you know, common sense and a little bit of logic, I mean it kind of leads one to think that it would help to go back to the bond counsel who wrote the opinion to ensure that they still would stand behind their opinion if the issuer now uses a facility in a manner that wasn't contemplated. Now, from your standpoint, if, as an issuer, I did something and I did now call into the question the taxability of the bonds, I either have to cure it somehow by taking the financing out and replacing it with some other source of funding, or, you know, under the disclosure rules, give notice that I've now done something.

Ms. Richards-Yellen  – I'm not sure about that. I wish I were sure, Phyllis. You were talking about 15C2-12, the 11 deadly sins.

I think it's the sixth deadly sin for tax, and it says, "Adverse tax opinion or events affecting the tax-exempt status of the security."

If you get a subsequent opinion, you're probably not there, and even if an issuer did have a question of whether or not they had breached this sin, it's a bond counsel's determination, so most issuers, I think, Neil, go to their bond counsel and say, "Here's the facts. Do I have to disclose it? Is this one of the 11 deadly sins?" And it's a case-by-case determination.

Mr. Arkuss  – Well, it's even before that.

Ms. Richards-Yellen  – Yeah, well, that's the second sin.

Mr. Arkuss  – 99 out of 100 cases, Phyllis is absolutely right, if an issuer of bonds is thinking about doing something that they're unsure of under their bond documents, the first person they call is their bond counsel to ask them if it's okay.

This exploding opinion situation deals with the case that that doesn't happen in. And we are as much in the dark as you are. Because they've asked their Uncle Murray whether it's okay if they build a villa for the mayor, and Uncle Murray says "Fine. $40,000 please." And you don't know.

Ms. Currie  – Murray is the mayor's brother, so what else would he say?

Ms. Richards-Yellen  – But Uncle Murray should at least bring it down. I see the possibility of having an exploded opinion and then Uncle Murray opining on subsequent fact and there being a gap period between the original opinion and what Uncle Murray did.

So I see that being a problem, and the second problem is that investors should know that Uncle Murray gave an opinion.

Mr. Zehner  – And I would like to point, and this is perhaps my own perspective, but somehow in enforcement, we always deal with the 1 percent that's bad, not the 99 percent that did the right thing.

I'm not disagreeing with anything that Neil had said here. 99 percent I think will do the right thing, will go back to the original bond counsel. There will be no issue and issuers will march on without any concerns.

Obviously to some degree there is a structural solution here which is to add in your continuing disclosure contract that you will give notice to NRMSIRs of any context in which the original bond counsel opinion explodes, regardless of whether or not in fact you believe the underlying tax status of a security has been threatened.

And I can see the reasonable counsel disagreeing saying "Look, I'm not going to give the opinion, but you are capable of giving the opinion." We have an explosion opinion as a result with respect to the original bond counsel, but as you were saying earlier, the issuer is still comfortable with the underlying tax status of the security has not changed. Nevertheless, I think there's a good practice to include that kind of thing in continuing disclosure agreements if you are also going to have a continuing bond opinion provision. It seems to be simply the obviously logical consequence of that.

As I see from my perspective, the more intriguing question here, and it's the one that I think we're all struggling with, is how to deal with the fact sometimes you have situations like this in which reasonable bond counsel can disagree as to the tax implications of a change.

Now, okay. Now, funding the multi-million dollar villa for the mayor is a relatively easy one. But you can get into a large number of areas in which it's not so obvious. It's not so easy. And it comes back to this question of whether or not the tax opinion is truly drafted such that no court would reasonably come to a contrary conclusion.

We're kind of backing ourselves into the reality that to paraphrase what was said at the first discussion, the first panel today, we're in a very complicated bond world now. The tax aspects of municipal securities generates a lot of very complicated issues. And yet we still have, with respect to disclosure of those very complicated issues, a nice, you know, three-paragraph boilerplate section in the Official Statement.

And there is attention there. There is a challenge there. And I think for those of -- no matter how many people in the industry would like to think that the whole yield burning saga is now ancient history. The door has been closed and locked and we'll never reopen that door. The reality is that so long as that tension still exists between the reality of the likelihood that the court or the IRS would ever hold otherwise on the tax opinion, and that skimpy disclosure, with respect to tax matters, you're going to have trouble. And somehow those two issues have to get going somehow.

Ms. Simpkins  – I guess from my perspective, and I should have given a disclaimer that everything I say is my perspective. It's really a problem from the investors' standpoint. Do they have notice about what's going on later on?

And I don't know, Diane, if you have a view if G-17 or G-30 or any other would cover this situation?

Ms. Klinke  – Yeah. The whole thing with G-17 is the requirement for dealers to disclose material events. You have to determine first whether the fact the issue is material but also it has to be something a dealer could actually find out about.

So that if it is a fact that just an issuer knows, and as Neil says, the bond counsel doesn't know, and if it's not part of the 11 deadly sins, they might not be under an obligation to provide, then I don't think one could even say a dealer under 17, even if it's a material fact, would be responsible for providing the information if it was not public. You know, the material fact requirement is really prefaced on either public information or information the dealer otherwise has. If the only people in the world who knows there was some change in the use of a facility is the issuer, I don't think there's any way to have a dealer liability under even G-17.

Clearly the price is not right. But, again, when the dealer has absolutely no idea about what's going on, it would be a hard case.

Mr. Doty  – But, you know, the more I think about it, Leslie, the more I am coming around to the idea that maybe the original continuing disclosure agreement is a good place and then maybe the support of an organization such as the NFMA to get people to focus on this would make sense. It's been I think reasonably successful. NFMA hasn't got full compliance with everything, but I think on a specific issue, I would bet that you could get some satisfaction.

And the good thing about it is that if later on you get the opinion of Uncle Murray, and Uncle Murray really gives the opinion and you question that opinion, there's always the alternative of jawboning the issuer at that point and being able to step in.

So I mean I don't think that it's a situation in which you would be totally helpless. It doesn't take care of all of the concerns, but I think it gives you a lot more tools than you have now.

Ms. Richards-Yellen  – It does give us more tools but there's a big section of the market that's excluded from 15C2-12 which are money markets, variable-rate demand notes. So that would still leave the inability for those kinds of funds to get this kind of information.

But I do agree with you that it's a good start.

Mr. Doty  – Well, there is always that covenant of the issuer not to take actions that affect taxability, and, you know, you can negotiate on those covenants even in variable-rate obligations.

Ms. Richards-Yellen  – Can I just dispel one thing? Someone else said it in another panel.

Individual buyers -- you know, you're assuming that we would have seen it in the primary market and -- -- the covenant.

Mr. Doty  – No, I understand your problem.

Ms. Richards-Yellen  – And that's not always the case. And even if that were the case, individual buyers have one -- you know, Vanguard has one voice. We can't make an underwriter or issuer change the provisions of a bond. I mean we try but we can't unilaterally change that.

Mr. Arkuss  – Let me just say one final thing about this.

The discussion we've just had over the last 10 minutes, tax compliance and the standard of care in giving a clean tax opinion, tax disclosure, are questions that I wrestle with all the time.

I think my point, if I want to leave you with one, is that whether or not there's an exploding opinion doesn't change that one bit. It is what it is. And the fact is, and it is well disclosed. I do not agree with the characterization by the gentleman on my left that it's skimpy. It is well disclosed in the tax section of every OS that the tax exemption is subject to act and failures to act subsequent to the date of issuance.

Ms. Richards-Yellen  – But exploding opinion takes it away as of the date of issuance.

Ms. Simpkins  – Yeah, once that happens, don't investors have a right to know that?

Mr. Arkuss  – I don't disagree that they have a right to know it. And I absolutely don't disagree with that.

Ms. Simpkins  – Well, this might be a good point to move on to a discussion about Rule G-17, which is a fair dealing rule and which has been described as an omnibus and a very expansion rule. And if you haven't read it recently, it's very short. It says, "In the conduct of its municipal securities business, each broker-dealer and municipal securities dealer shall deal fairly with all persons and shall not engage in any deceptive dishonest or unfair practice.

And in preparation for this panel, I went back through all the cases that our office had compiled in the municipal securities area and I looked under the "Underwriter" section, I was looking through there, and I noticed we had charged G-17 violations in a lot of those cases. So I'd like -- would any of the panelists care to talk about the application of G-17?

Mr. Doty  – I'd like to say some things about it.

I think G-17 is a rule everybody needs to know about. It's a real sleeper in some ways because people have not paid attention to it.

In some ways it's narrower than 15b-5 because it only applies to dealers. But having said that, if you look at the language of the rule, it is far broader than Rule 10b-5 in many, many ways. And the Commission has used it over and over and over and over again. Now, usually the Commission has used it in enforcement actions in conjunction with a lot of other violations. But all that accomplishes is it builds the body of precedent. That such and such an act, among other things, was considered to violate G-17.

G-17 doesn't require scienter. It does apply to deceptive acts but it also applies to dishonest acts and unfair acts. I question whether it even requires negligence. The history of the adoption of G-17 makes it clear that it applies to all of the dealers' municipal finance business, not merely their sales to investors, not merely their underwriting of securities, but also their financial advisory business, investment advisory business. It applies to everything they do in the municipal market.

And so it is extremely broad. And I can give you two examples of enforcement actions based solely on G-17. One I believe is the release on Lazard and Merrill arising from the Mark Ferber situation. That release is around 1995/96. And I believe the only violation cited there is G-17 and the section of the Exchange Act that prohibits violations of the MSRB rules.

There's also another action which technically is still pending because it's on appeal to the Commission. And that's the Wheat First decision last December. In the Lazard/Merrill situation, it was non-disclosure of arrangements between Lazard and Merrill that affected the financial advisory business of Lazard in providing financial advisory services to its clients.

And in the Wheat First, it was violation of a contract between the financial advisor and the issuer, in that case a representation by the financial advisor in the process of getting employed. That it had not used a lobbyist and was not paying anybody any compensation contingent on the representation.

So there it's a contractual violation. And there are many authorities of which it is said that G-17 requires full disclosure. But G-17 is more than a full disclosure rule. I saw an article somewhere where somebody said, "Well, it means you can't do anything naughty." That's a comment for people to think about. G-17 can be applied to a lot of different things, and so I think people need to pay attention to it and look at its sheer breadth as it applies to dealers.

Mr. Zehner  – And I would like to echo that. As an enforcement attorney, I've certainly used G-17 and seen it used, and I think Bob is correct. In most cases, you are dealing with a situation that fairly clearly is fraudulent, very clearly has the requisite scienter of knowing or reckless conduct. But nevertheless, it is useful. And there are certain odd-duck situations in which, for whatever reason, whether they be logistical, jurisdictional, whatever, 10b-5 cannot be used but G-17 can. And it's a tool in the toolbox and a valuable tool. And I think people have to realize it, think it through.

I do think though that G-17 is ultimately simply one more example of an underlying theme to a lot of MSRB rules. Some people mistakenly think of the MSRB rules as mundane procedural rules. Underneath those so-called mundane procedural rules, a lot of substantive issues, a lot of issues that are really of relevance, not just to the brokerdealer, but to the issuer, to the financial advisor, the bondholders and everyone else.

To take what I hope is a blatantly obvious example, if a slick investment banker ever tried to hand an issuer a document asking them to sign it and mumbles under their breath something about this being required under that stupid silly G-23 rule, if the issuer would wake up, think and say, "Umm. I wonder what that rules says. And more importantly, what that rule is intended to do."

Because if you think about it, the G-23 rule, which requires consent of the issuer before someone acting as an FA on a transaction shifts and becomes the underwriter on a negotiated basis on that transaction, is dealing with conflict of interest. And that's a very important issue for the issuer. And although it's a rule on the broker-dealer, ultimately, hopefully, if it works right, you're protecting the issuer as well.

There are other rules of a similar nature on limits on gifts and gratuities, so forth and so on. And which again the benefits to the issuer are relatively obvious I would hope. And then there are some rules that aren't so obvious. You know, who cares whether or not the underwriter files that G-36 form on time with the MSRB. It's an empty document. It's not boilerplate, dot, dot, dot. And everybody can ignore and forget about it and laugh at it, until the issuer starts wondering whether or not they have the ability to call those escrow to maturity bonds. And all of a sudden, an issuer issue, whether or not they can call their bonds, is very much dependent on whether or not the underwriter filed the requisite documentation such as the bond market was put on notice of those call features.

So a lot of this stuff, if you think about it for a bit, has very important substantive issues underlying what I would almost call trip wires. If you follow the MSRB rules, at least you'll avoid some of the most obvious and glaring abilities to get yourself in trouble, it's not a -- -- you can still get yourself in trouble and not violate the MSRB rules. Don't get me wrong. But having said that, I think they need to be perceived by all sides as something that if treated correctly, it can actually help instead of just hurt. But I think the underwriter counsel who advise dealers need to be aware of the breadth of G-17 and also on some of the subtleties of G-23 we'll be talking about. And I think the issuers need to be aware that they have protections they didn't know about as well as investors, both institutional and individuals.

Ms. Klinke  – Yeah. I just want to mention one thing about G-17, that sometimes, yes, it is viewed as the catch-all, and there are some interpretations on the board under 17, but not many. And why is that? Because the board, in adopting 17, made it clear it was obviously to prohibit -and I agree with everything said up until this point -unfair deceptive practices. But it was also a vitally important part of 17 is to have a high ethical standard in the marketplace.

And, yeah, you don't need scienter for that. It could be negligence. It's just kind of -- the board's rules, while sometimes complicated and tough, try to be reasonable, try to be rational, try to be the kinds of rules that dealers are able to comply with. And what G-17 says in the conduct of your municipal securities business, you act fairly. And it does apply, not only to your dealing with customers, or dealing with issuers, you are dealing with other dealers. It all comes in under 17.

So it is a vitally important rule and for many reasons, sometimes it is the only rule the SEC charges and I'm sure Mack will mention too, many times the NASD could charge that rule as well when there is not another more specific rule, more on point.

But the whole basis for 17 was to ensure high ethical standards in the dealer community.

Ms. Simpkins  – Right. I made a note that the board has interpreted the rule to require dealers to disclose at or before sales of state and local government securities all material facts concerning the transaction including a complete description of the security and prohibits omissions of material facts in light of the information provided.

Ms. Klinke  – We talked more about the scope of G-17 in a notice we just did a few weeks ago on E-trading in the municipal securities market, and that's on our Web site. And you may want to review that notice.

Ms. Simpkins  – Well, why don't we move on now to Rule G-20, which restricts gifts and gratuities to personnel of customers, and just to review the rule briefly, G-20A "prohibits municipal securities dealers from giving anything or service worth more than $100 per year directly or indirectly to any person other than an employee or partner of such dealer, if such payment or service is in relation to the municipal securities activities of the employer, or the recipient of the payment or service." And in Rule G-20B, "exempts normal business dealings from the $100 limit. And the rule is intended to prohibit commercial bribery and covers payments to issuer officials.

But I know we all heard a lot about the violations in the '80s. We are still hearing about problems in the gift area, and I'm wondering if other panelists are aware of the gifts being made in a more subtle way. For example, say you have issuer officials going to New York for a rating agency trip, which admittedly rating agency trips can be totally legitimate. But we've heard of situations where a whole lot of people go. They take their spouses. They go for a week. The underwriter pays for everything, and then sends a bill back to the issuer for that trip.

And do people have comments about problems in the gift area or more subtle ways that gifts are being made?

Ms. Currie  – Well, let me comment on that.

I think there are many instances where there are rating agency trips that may be called into question in terms of their legitimacy. Typically, however, I think most issuers are much more focused on their local conflict-ofinterest laws that their state and local government have imposed upon them.

And that has made a lot of issuers very, very careful about how they interact with dealers and all the little goodies that they can, you know, throw your way. You know, if they're trying to make an impression.

The rule itself also provides some caveats in that. It doesn't apply if the payment is for theatrical and sporting events, entertainment or other expenses that can be construed as a deductible business expense by the IRS. So in terms of I think trying to limit gifts and gratuities that are going to influence behavior, I don't know that this rule is as effective for a foreign issuer, as their local conflict-of-interest laws would be.

I know with the City of Los Angeles, there are much more stringent prohibitions that both the city and the state Fair and Local Practices Act impose that would say that if you have taken anything that amounts even to $50 from anyone doing business with the city, that you cannot now act upon something that influences their business dealings.

So that has much more impact and there's much more scrutiny of compliance with those kind of rules.

Ms. Klinke  – I just want to note. Under 20, even though the rule does exempt from that category of gifts, kind of normal business expenses, the rule does go on to say "provided, however, that such gifts shall not be so frequent or so expensive as to raise a suggestion of conduct inconsistent with high standards of professional ethics in the industry."

So every instance regarding G-20 should be reviewed, you know, on a facts-and-circumstances basis, and as Phyllis said, you know, many rating agency trips are obviously perfectly fine and necessary for a transaction. But even if something could be viewed as a legitimate business expense, even in that definition, they say "occasional" with that caveat at the end that they cannot be so frequent or so expensive that raises propriety questions. And that is in the rule. And it would just be a factual determination.

Mr. Zehner  – I would like to point out that although I think you're quite right, responsible issuers do care much more about their local conflict-of-interest rules than any MSRB rule, again, I'm going to have to start dealing with that 1 percent out there that we seem to always have so much fun with. That's not true in every state. And either the rules aren't that strict on a local level or they are winked at more than anything else.

And, indeed, I think to some degree one of the issues this rule raises is what do you do with the issuer who puts the kibosh on the underwriter and says, "You know, we've got the entire board here, and they've been looking forward to a Broadway play for the last, you know, two years. Now this bond issue is coming up, you will, of course, be paying for every board member to go to the rating agency meeting, won't you?" The underwriter is sitting there saying, "Ah, ah, I don't know." I think there are a lot of factual --

Ms. Currie  – I wouldn't go that far.

Mr. Zehner  – There are a lot of factual situations that play out here, and I'm not about to point fingers or name names, but I just think that, again, this is the kind of situation where the rule, if looked at very closely with a lawyerly magnifying glass, normal business dealings, all these exemptions and so forth. Sure, you can kind of wiggle your way out of it. I'm not so sure it's going to cover every situation.

But at the same time, it's a trip wire. It's a "Think about this one, guys." Maybe, you know, frequent gifts and gratuities, even if nominally within that exception, should raise issues for issuers.

Ms. Currie  – Well, I think this rule, as other rules that we've talked about, are really there to try to encourage ethical behavior and raise the standards for the industry. And I think as an issuer I speak for a lot of people when I say that most issuers want to behave responsibly. And I've even met a lot of dealers who want to act responsibly.

But, again, you know, there are people who don't and there are people who will get business any way they can. They will stoop to levels that I think none of us would condone. And we need to always reinforce for everyone that this business will not enjoy the reputation that is beneficial to it. And there won't be confidence in the outcome of the business dealings if there isn't a high ethical standard.

Mr. Northam  – I had one thing. These are my personal opinions and not the opinion of the NASD, by the way.

But one of the things that gifts and gratuities I think you need to be aware of, is institutional investors that might be the recipient of a gift or gratuity in the form of a trip or a due diligence review of something in the south in January, and bring the family to Orlando while you're here over spring vacation, and it doesn't necessarily come from the municipal finance professional group that is offering this. It's done through the marketing group, through hosting a seminar of big issuers and inviting someone to speak, and then extend the stay.

And those things, while they could be fairly legitimate, at the same time, there can be a tendency to curry favor, and it kinds of falls off the radar screen because it's not being done through the sales group and it's not being done through the underwriting group. It's being done through the larger securities firms, marketing their new business development or customer retention budget, and it would be done that way. And so I think you need to pay attention to that.

Ms. Simpkins  – Right. I think from our standpoint, it wouldn't matter if it was another group that was doing it. And, again, these are not new issues. We have evidence that the message is not universally out there, so be careful.

I think we can move on now to Rule G-23, which prohibits financial advisors to an issuer from engaging in underwriting activities with that issuer in the absence of certain disclosures and written consent.

This is another issue where people have been calling us about temporary resignations of FAs to act as underwriters or placement agents. And people perceive that there's some problems out there. Either they're not complying with the rule or maybe they feel the rule as it is is not sufficient.

So I'd like to get a discussion, and I think, Bob, you said you wanted to talk about this issue.

Mr. Doty  – Right. Well, I think that -- I've been doing some research in the last two or three months that it's beginning to put G-23 in a very different light for me.

And I say this as somebody who years ago taught agency and law school, and has begun thinking about fiduciary relationships and so on.

This morning I thought it was very interesting or in the prior two panels that we have institutional investors who just say, "Well, I'm a fiduciary and so I have to do this." And they just accept that and say they are a fiduciary. In the municipal market, people have tended to want to run away from that concept.

And yet I began to realize that there are a number of court decisions in the last few years on this very topic that are quite relevant. And you'll find them all in my Web site, I'll add. The two Cochran decisions, in which in the first case, the criminal case, it was found -- a criminal conviction was overturned based on the evidence.

The second one being a civil case in which a summary judgment against the Commission was overturned and now that is going to trial in the spring, the Debader case in the 11th Circuit. The two Cochrans are in the 10th Circuit. The Debader case in the 11th Circuit.

We've got the Rauscher case, the lower court, in the 9th Circuit. And on top of that, a corporate case, Daisey Systems, in which the investment banking firm advising a corporation on mergers took the position that as a matter of law, an investment banking firm cannot be a fiduciary. And the court said, "That's not true. It's a facts-andcircumstances determination."

And if you look at these decisions, they are very consistent in their analysis. They looked at state laws as a general rule. State common law, fiduciary principles. You get certain things that you look to, the trust and confidence. Is the trust and confidence of the client being placed in the financial professional? Is there reliance, in other words? Is there an agency relationship? That's defined in part as representing the issuer, the client, in its dealings with third parties.

Sometimes in Commission settlements, you'll see references especially to unsophisticated issuers, but I'll point out that not all of these decisions relate to unsophisticated issuers at all, but rather issuers who have employed somebody to carry out a specific task. Managing investments.

In the Debader case, employing an underwriter, where Fulton County, Georgia, made the final determination, and so on, and the court said, "No. The financial advisor had enough influence, enough control or dominance, over that procedure in sending out RFPs, evaluating them, submitting the recommendation, and so on, even though the county made the final recommendation, there's a fiduciary relationship." I'm saying that to lay a very brief basis for what is the notion, what is the nature of a fiduciary relationship? And I think it's becoming more and more clear to me that in my normal practice, it's very difficult for a financial advisor not to be a fiduciary.

I've accepted that for a long time and I approach things that way and I charge accordingly. And if I have clients who don't want to pay it, I don't keep them, because I don't want to put myself in the position of having to do a lot of work for which I can't be compensated.

Ms. Simpkins  – And if I could just interject right here. I could say the Commission has said that in the Lazard Freres release that generally a municipality's financial advisors owes fiduciary obligations to it in connection with bond financings by the municipality.

Mr. Doty  – The Commission has come right out and said it, and then in some later releases has given us some rationale for it. And I'm being very hard pressed at this point to find contradictory precedent. Now, having said that, keep in mind that I'm an independent FA. I am not a dealer, so G-23 doesn't apply to me. But I was around when G-23 was adopted. And Freida Wallison was there, and so on. And I was actually on the issuer's side, the GFOA side. And I had people calling me up and they were saying things like, "Well, you know, my investment banker is the only person who will bid on my bonds." And things like that.

Now, today I am sitting there and having a little more experience under my belt, and I say, you know, "That is the strangest statement I believe I can think of in the municipal bond market, that some issuer is going to tell me that there's only one banker that wants to buy their bonds." I mean I have seen so many people bleeding on the floor, fighting over whether to get a deal, and knocking each other and knocking on doors, and doing everything except committing murder, and they might even do that.

And only one firm is going to be bidding on that deal and why is that? And if this firm has been acting as financial advisor and now they're the underwriter and there's only one bidding, why is that? Why aren't there other firms out there? And the answer seems to me pretty obviously, the financial advisor didn't do the job in soliciting firms to come in and submit proposals or bid, why they structured the transaction in a certain way that favored their firm. But let's look at G-23. And keep in mind some of these principles. G-23 says, "Financial advisory relationships shall be deemed to exist when a dealer renders or enters into an agreement to render."

All right. Let's start there. They don't have to have an agreement to render the financial advisory services. All they have to do is render them. That's (a) or (b). With the expectation of compensation. The compensation expectation might be the underwriting in the end.

I remember being told by a banking firm, a wellrespected regional banking firm, "We always get hired as FA and then switch." Okay? And I've seen it in several states. There are states where this is uniform practice almost, to get hired as FA and then switch. Even keeping your continuing contract in place. Resigning for that one bond issue but keeping the contract there.

Now, how do you -- keep in mind the trust and confidence of the client, if you have a continuing contract, how do you erase -- how do you have trust and confidence over here but do away with trust and confidence over here?

Ms. Richards-Yellen  – Bob, can I ask you a question?

Mr. Doty  – Yes.

Ms. Richards-Yellen  – How is that sort of situation disclosed to the bondholder? Because I know our analysts go to the conflict-of-interest section, and they look at that, and they take that to heart.

Do you expect that an issuer is getting the best advice that they can get, that advice is impartial and that advice is going to lead to good business decisions, which is going to lead to the credit being good?

Mr. Doty  – Well, the whole idea is conflict of interest. And, of course, there are two interests here. There's the investor interest and there's the issuer interest. And the rule actually requires disclosure to both. Everyone thinks -- most of the words in the rule relate to the disclosure to the issuer and procedures for the issuer. The rule also requires disclosure to the investors. And whether it's actually being made, I have not taken a look at that. I have my guess.

But I just want to lay down some of the tension that I see here. If a dealer renders financial advisory services with the expectation of compensation, they have to carry out the steps in the rule involving resignation, delivery of a notice and that sort of thing.

Now, there is a sentence that says, "Notwithstanding the foregoing, a financial advisory relationship shall not be deemed to exist when -- " These are the operative words. "In the course of acting as an underwriter the dealer then provides certain advice to the issuer, and structure terms, and so on."

Now, what does that mean "In the course of acting as an underwriter"? And I really hadn't thought about that before. To me, after hearing for years now that underwriters are principals who deal strictly at arm's length, and I read that into that phrase, "When a dealer is acting as a principal strictly at arm's length," they can provide advice about certain matters.

But a principal dealing with another principal doesn't say, "I'm going to tell you what is your best decision to make." What the principal dealing with another principal says, "Here are market conditions. This is how investors are going to receive this structure. This is how this is going to affect the marketing of your bonds." But they don't say, "Trust me. I'm going to give you the best deal you ever had. I'm going to lead you by the hand and take you from start to finish." Or they don't act as agents. They don't say "We're going to represent you with the bond counsel. We're going to represent you with the rating agencies. We're going to represent you with this party. We're going to represent you with that party."

And to hit another nerve, they don't say, "We're going to help you write your communications to bondholders; i.e., the Official Statement." An agent in these cases is somebody who communicates on behalf of the client to third parties. So now if they are not acting strictly as a principal, they must be acting as an advisor and have a fiduciary role. And if they render those services, they are supposed to put them in writing.

Now, the rule obviously recognizes they might not. And when they put them in writing, when they put in writing the basis for compensation, they are supposed to set forth provisions relating to the utilization of fiduciary or agency services.

Those are all very interesting words that I never thought about any of those words before in any of this context, but now in the last five years, we have a ton of precedent coming out of the Commission in the last few years out of the courts. And I'm not sure about all of the nuances of all of this.

So I'm making some observations here. And to some extent, I've pretended to give you some answers, but I think that there are probably more questions than answers. And so there you are.

Ms. Klinke  – Let me just raise a few issues. I think what you're saying is that a dealer could enter a transaction as an underwriter, but depending on either the extent of the advice given or representations made to the issuer in connection with those underwriting activities, the underwriter may take on an agency or a fiduciary role.

Mr. Doty  – Possibly.

Ms. Klinke  – Yeah. Because in my view, fiduciary status is a state law question. It depends on the facts and circumstances of the arrangement. So even though I believe most underwriters would say in the course of their underwriting activities they are not fiduciaries, anyone could find anyone to be a fiduciary depending on the facts and circumstances, you could have a review.

But I have to say I can't agree that -- I think you are putting two terms together that don't really go together. Financial advisor, as defined in 23, and fiduciary. They are not the same terms. Financial advisor, as defined in 23, may in many cases be a fiduciary, but not necessarily in all cases. Again, a fiduciary finding is a facts-andcircumstances determination. So that my view is in G-23, if an underwriter engages -- if a dealer goes into an issuer and is performing the underwriting function, depending on the facts and circumstances and what they say and do, it may be found later that they were a fiduciary, depending on actions. It could not be found that they have somehow turned into a financial advisor under 23 and therefore financial advisory requirements under 23 kick in. That's just not how it is written.

Mr. Doty  – Are you saying then that the phrase "In the course of acting as underwriter" is broader than acting as a principal strictly at arm's length?

Ms. Klinke  – Acting as an underwriter is acting as an underwriter. Again, we go back to a common sense view of the world. When a dealer goes to an issuer and says, "I am here to be your underwriter," and that's the normal course of human events, in my view, 23 was never intended, through any kind of terminology, to say that depending on how they fulfill their underwriting function, that they somehow would turn into a financial advisor and therefore other sections of 23 would kick in.

What they do may cause them to be a fiduciary given facts and circumstances, most of the time, again, most underwriters would view themselves not as a fiduciary.

Mr. Doty  – Understand.

Ms. Klinke  – But they would never turn into a financial advisor under 23 and have those requirements kick in. That was never how 23 was set up.

And I will go back to, and Bob mentioned, he was general counsel of MFOA --

Mr. Doty  – It was MFOA in those days.

Ms. Klinke  – Before GFOA. And when the board first went out with the 23 rule, it was to prohibit dealers who act as financial advisors from for the same issue becoming the underwriter. Just out and out prohibited because of the conflict of interest.

And many issuers, including the GFOA and other people, said, "You're being a little paternalistic, board. If disclosure of the conflict is provided, issuers should be able to make the determination of whether they still want that dealer FA to be an underwriter."

So even though the board was against it at the beginning, and was going to prohibit the activity, because of the issuer comments back, which said "Board, thank you very much. We can take care of ourselves in this regard," the board changed its view when the final rule was put into place to change it from a prohibition of dealer changing roles to a dealer is allowed to change those role but only if they resign as a financial advisor for that issue, proceed to make very specific disclosures to the issuer about the prima facie conflict of interest in changing those roles. And with issuer written approval, they can go ahead and do that.

Ms. Simpkins  – But I think that's a situation the issuer has to be very careful about because if you have an FA that sets up the whole structure, I think there's a concern that maybe the underwriting arrangement structure that was created would be one that would favor that FA when they put on their underwriter or placement agent hat.

Ms. Klinke  – Sure. That is the conflict of interest that rule was meant to deal with. And the only decision that the board made 20 years ago in the face of a lot of issuer complaints about the paternalistic attitude of the board for their activities, that if an issuer with all that conflict information still decided that was the way to go, who was the board to say they couldn't make that decision.

Mr. Zehner  – I'd like to --

Ms. Klinke  – And the board tries not to be all that paternalistic to issuers.

Mr. Zehner  – I'd like to follow up on the distinction that Diane made, because I think it's a very important one, but it cuts two ways.

And that is you can find yourself in a situation where you do not violate G-23. For example. You are acting as financial advisor for an issuer on one issue and then simultaneously acting as underwriter on a second unrelated issue. Technically that's not a violation of G-23.

Ms. Klinke  – Correct.

Mr. Zehner  – Because it has to be on the same issue.

Ms. Klinke  – Right.

Mr. Zehner  – Well, that's great, that's fine. But guess what? You still have fiduciary duties with respect to the financial advisory role you are playing on the first issue under state law, assuming the facts and circumstances flow that way. And you can very well find yourself in as much trouble, if not more trouble, for doing things as underwriter on that second transaction, even though you never violated Rule G-23. To me it comes back to this concept that these rules frequently are trip wires. If you look at them real closely, sure, you can wiggle out of them, but I'm not sure that's to your best advantage.

And for those of you who aren't aware of it, we currently have a case outstanding against an individual in West Virginia who did just that. He was acting as a financial advisor on one transaction and simultaneously was acting as underwriter on a second advance refunding transaction, and "Oh, by the way, incidently, I picked up over $100,000 from the provider of the escrow securities in advance refunding without telling anybody. But that's not a problem, is it? I don't have any fiduciary duties. I was an underwriter on the advance refunding transaction." "Whoops, well, maybe not."

As I say, that case is still in litigation, so I don't want to --

Ms. Klinke  – Always the finding of fiduciary capacity is the facts and circumstances of the situation.

Mr. Zehner  – Exactly.

Ms. Klinke  – Pursuant to state law.

Ms. Simpkins  – Although I think it's fair to say that the Commission generally thinks that a financial advisor usually is a fiduciary.

Ms. Klinke  – It's just not an absolute, and you have to look at the facts and circumstances.

Mr. Doty  – The last section of G-23 makes it clear that any stricter provisions of state law also govern --

Ms. Klinke  – Of course. That's really why it's in there because 23 was not meant obviously to trump any state fiduciary or other requirements.

Mr. Doty  – And there was, if I remember, one of the reasons for that provision was Miami v. Benson, which is an old Florida case, but which said that a contract by a financial advisor to buy bonds was void as against public policy.

Ms. Klinke  – And there are a number of states that have copied 23 the way it was initially drafted, which is in their state, if a dealer is an FA on the deal, they may not underwrite. And, again, that's perfectly okay too. It was just what the board had heard was that to give the issuer the required disclosure, knowledge and information regarding the prima facie conflict of interest, and let it be the issuer's decision whether to go ahead or not.

Mr. Doty  – So what I want to clarify, Diane, is once a firm has begun to use the term "underwriter" in describing its relationship with the issuer, are you saying that there is nothing that firm can do, short of using the term "financial advisor," to turn itself into a financial advisor regardless of the facts and circumstances?

Ms. Klinke  – I would think so. Because, you know, what is a dealer -- and the definition of an FA is rendering advice with respect to structure, time and terms other than if you're an underwriter rendering advice with respect to structure and timing and terms?

So that if you go in as an underwriter, you're an underwriter. If at some point you turn into the FA, you would think there would be a separate, okay, you know, you turn 180, it really is a different role. And I don't think you could slip into that role.

Mr. Doty  – But so you --

Ms. Klinke  – -- without knowing it.

Mr. Doty  – Now, but you would say that the underwriter may, depending on the facts and circumstances, take on a fiduciary responsibility.

Ms. Klinke  – I think they'd fight mightily not to, but depending on the facts and circumstances, anyone could become a fiduciary for anyone pursuant to state fiduciary requirements. It depends on the actions taken.

Ms. Simpkins  – Why don't we move on to Rule G-32 and G-36 that we talked about a little bit before. As you probably know, G-32 requires just giving disclosures to customers. And G-36 requires filing of OS's with the MSRB.

Maybe Mack can tell us a little bit about whether underwriters are complying with these rules and tell us about his exam modules and I'm sure people would be interested in what the NASD is doing to improve compliance of those and any other rules.

Mr. Northam  – Thanks. You know, really this discussion almost aside, excluding bond counsel's opinion and due diligence review and the OS and publishing the OS, really at the end of the day it doesn't matter until an investor alleges that they've lost yield or principal or interest, because as long as yield is maintained and principal is paid and interest is paid, most investors aren't going to even look at anything that has been produced as part of the OS. Notwithstanding some of the institutional investors. But my mother certainly is not going to.

But in any case, so, you know, Rule G-36 requires that the underwriter or managing underwriter submit within very tight time frames two copies of the OS to the MSRB. And we talked earlier about, you know, who is going to provide the OS, and all the problems getting the OS, and whose fault is it?

Everyone is pointing their finger, but it's the dealer who has got to send it to the MSRB, and that's where I come in because I regulate the dealer. And I'm charged with, with other people here, charged with protecting the interest of investors.

So in 1997, the NASD fined 21 firms $325,000 for their non-compliance with Rule G-36. That is, they did not send the OS into the MISL system within the required time period and there were some firms actually who'd never sent an OS in at all.

And, you know, the argument was, you know, the justification was, "Gosh, oh, gee, it's hard to comply with these new rules." And I think if you go back and look at the rules adopted in 1990. So here we are in 1997, it's still a new rule for the issuer.

So that's why they are interested in complying. That's one of the reasons why they're interested in complying, because they know I'm going to be taking a look to see that they are complying.

And importantly, by not filing the OS with the MSRB or even filing the OS late, the investing public is deprived of access to critical information about the issue and this does not serve investors well.

So overall compliance with the MSRB's Rule G-36 has improved since 1997, and there's a couple of reasons for this, but quarterly the MSRB provides me with statistical information on the form's filings, and what we've done is create a scorecard firm by firm by firm -- there's 2600 plus or minus firms, municipal dealer firms in the country, which would list description, date of the sale, date of closing, date the OS was received from the issuer, date it was sent to the MSRB, and date it was received by the MSRB.

And accordingly what we can do through an access spreadsheet is to do a real quick simple calculation. "Did you send it in on time?" And what we do with that information is compile that information, and by and large, as somebody said, you know, 99 percent of the firms are generally pretty darn good compliances, that 1 percent which we caught causes us to spend a lot of time.

But what we do is make the information about all the firms' underwriting available to the examiner who's going to go in to do the review and the examiner then has a very simple job. They have the schedule in front of them. They see what was done. They see how late, or if the form was filed late or if it was filed within the time frame. And they can simply focus their examination efforts on the ones which appear to be late. And there could be some reasons why they are late or not filed at all.

But all that means that we've got a pretty good audit trail because now we have an evidentiary trail and we don't have to develop the evidence I've already provided to the local examiner to look for compliance patterns.

So we look for those which file late. We look for firms which file routinely late. Some firms have a routine, "You know, okay. It's one day late. What's the harm? Or two days late? What's the harm?

Well, when they're always one day late and always two days late, that would indicate to me that there's some kind of pattern of maybe a failure to supervise within the firm or some kind of supervisory process in the firm. Is it working right?

There's other instances where I think Diane has indicated that sometime the firm simply doesn't get the form from the issuer in time, and obviously then they can't file the form to the MSRB.

Well, since the firms need to tell me when they received the information from the issuer, I can do that quick calculation, are you telling me correct or aren't you telling me correct?

But that brings us to a whole another issue. If you didn't get the Form OS from the issuer, then how can you comply with G-32. And what MSRB Rule 32 says, requires that a dealer not just a managing underwriter, but any dealer during the new issue period, send to the customer purchasing a municipal security at or before settlement, a copy of the final OS, or a POS if a final one is not prepared. And we need to do this within one day, send the final OS within one day of receipt by the dealer.

And Rule G-8 requires that they maintain records. Well, if you can't send the OS to the MISL system within one day of receipt, and we know that settlement, typically regular-way settlement on municipal securities is T plus 3, then how can you send the OS to the customer in time for them to receive it at or before final settlement.

There's the conundrum on the part of the dealer. The dealer says "Gosh, oh, gee. I've got a customer who wants to buy but I don't have the OS from the issuer. What should I do? I guess I could not sell it."

Well, I don't think that's really a viable -- well, I think it might be a viable option. I'm a regulator. But from the business perspective, I see the creative tension there, "What do you mean, don't take the customer's money?" But nevertheless, that's the problem that they're in.

So we might find a parallel between those firms which are late in sending the forms to the MISL system, because they didn't receive it from the issuer. That conjures up problems with G-32. Then how could you comply with the requirement that you send the individual investor or the institutional investor, with the OS at or before final settlement so that they can make an informed decision as to all the material facts which have been properly disclosed in the OS, including the exploding bond counsel's opinion perhaps, whether this is a proper investment?

So importantly, the failure to receive the OS from the issuer doesn't absolve the dealer and so they have me to answer to or examiners to answer to. And that goes back to the '97 enforcement agreement.

Again, compliance is a lot better than it used to be. Still not perfect. We still hear stories that the OS was not received by the issuer in time. That's not borne out by the statistics produced by the MSRB because by and large, the majority of the OS's are received by the issuer in time. So it's a mechanical process in-house. Whether E-trading will make that better or whether that'll make that worse, that's a whole another story. I don't know.

Ms. Klinke  – And I just want to mention again. 32 compliance is very dependent on getting the document from the issuer as soon as possible. And when that happens, if dealers are just sitting on the documents, you know, they will get nailed on 36, on 32. But it's vitally important to provide dealers, not just underwriters but other selling dealers as well, with the final OS as soon as possible.

So everyone in the underwriting process, if they could, redouble their efforts to get the document done early, that just benefits the whole process of getting it through underwriters and other selling dealers to the customer, which is the goal.

Mr. Zehner  – And just for those who aren't aware of it, let me echo Diane's comments.

If you're a broker-dealer who really has systemic problems with getting these things out on time, we can bring cases too, and we did with respect to a prominent Baltimore firm that seemed to have a systemic problem in getting their OS's and ARD's filed on time. The case is actually still in litigation.

Ms. Simpkins  – We've got one question from the floor which I think is probably for Diane. It says "Describe MSRB actions regarding application of MSRB rules to electronic trading." So would you like to say a few remarks about your draft notice

Ms. Klinke  – Our notice on that is on the Web site. We see a number of things. We reviewed the issue of electronic trading and basically want to say, at least for draft interpretative purposes, and everything is open for comment, that we think this electronic trading in municipal securities could well be a wonder. Could hopefully reduce costs to the customers, get more customers involved in the market, all those things are well and good.

The concern we had is that the muni market is not like -- and I'll just use the analogy of the equity market. A lot of these electronic systems are premised on the equity market, where many times you can get on your Web site and you find out you want to invest in IBM. There is plenty of information around about IBM.

The muni market is different. Millions and millions of differing kinds of municipal securities. 80,000 issuers. I mean there's only 10,000 different equity securities in the country I think. My numbers -- I don't want to be like Al Gore. My numbers may not be right. But there's just a multiple of differing kinds of municipal securities in the market. And information about the securities themselves and the issuers are not always readily available to all concerned.

Which is why the history of the muni market is that dealers are a very important part of that market because they are the regulated entity. They have the duties and responsibilities to get the information and to sell securities to customers, to act fairly. If making a recommendation, make sure the recommendation is suitable and always to price the security fairly.

When you have a dealer E-system, what did we say in the notice? The rules still apply. You're a dealer. Just because you're on the Internet doesn't mean for some reason the rules don't apply to you. So that's the main issue. We have done a few things in interpretations, draft interpretations and notice, which I'd like everybody to review. The comment period runs until December 1st.

Basically in the fair practice area, and that is G-17, G-18 and G-19, we've done some draft interpretations so that for what we term "sophisticated market professionals" -and there's a big definition of those people or entities. The requirement to disclose all material information under G-17 does not apply because part of the definition of a "sophisticated market professional" is they already have all the information in the marketplace. They're on kind of the same level as the dealer community.

On suitability. We want to specifically say whether a recommendation is made, which Kate McGuire mentioned before, that's the key. Before you get into G-19, you need a recommendation. It's the facts-and-circumstances determination whether a recommendation is being made. But a sophisticated market professional, even if given a recommendation, the dealer does not have to get any more information about the customer to determine whether their recommendation is suitable, pursuant to the definition of "sophisticated market professional," they are able to review the security. They have the wherewithal to do the research to determine whether that product is suitable for them.

So the customer-specific suitability requirements would not be involved in a trade with a sophisticated market professional. But with a retail customer, if a recommendation is made and maybe a dealer showing a list of their inventory to a customer, depending on the facts and circumstances, may be viewed as a recommendation to the customer. That's something to be determined. But you can't, in the E-trading world, assume you're never making a recommendation.

So you have to be concerned about that, review your facts and circumstances, and if a recommendation is determined to be made, you have suitability obligations in that context. And then we also make a few comments about quotations rules that aren't overly relevant to the retail customer world. And some issues in the new securities trading where there are some systems that assist issuers on the Internet to get their securities to dealers and customers, and we make some comment about 32 and 36.

But the comment period still runs for a month and a half and we look forward to getting some good comments back.

Ms. Richards-Yellen  – Diane, in your proposal, is there a difference between the information you provide institutional investors and Mom and Pops?

Ms. Klinke  – Yes. The requirement, for example, under G-17, to disclose all material information for Mom and Pop, remains, whether you're on the phone with Mom and Pop or you're on an E-system with Mom and Pop.

But for the sophisticated market professional, the definition of which they have research capabilities, they are reviewing the market, kind of the same par level as a dealer, they have the information available, that specific disclosure requirement would not be required. You should read that notice, Leslie.

Ms. Richards-Yellen  – I will.

Ms. Simpkins  – Well, I think we're out of time. I'd like to thank all our panelists and thank you all for staying. I think Steve is going to make a few closing remarks, and then that will conclude our roundtable.


On to closing remarks...


Modified: 03/21/2001