Enhancing Oversight of Municipal Advisors to Prevent Further Abuses in the Municipal Finance Market and Protect Investors
Commissioner Luis A. Aguilar
SEC Open Meeting, Washington, D.C.
Sept. 18, 2013
There is much that has been said about the need to increase the investor protections in the $3 trillion municipal securities market. It is well established that the municipal securities market is subject to less supervision than corporate securities markets, and that market participants are at a disadvantage because they generally have less information upon which to base investment decisions. In addition to this increased investor vulnerability due to the scarcity of reliable information, the financial crisis revealed numerous examples of municipal advisors engaging in egregious conduct including:
- Pay to Play practices;
- Undisclosed Conflicts of Interest;
- The Rendering of Advice Without Adequate Training or Qualifications; and
- Failing to Place their Duty of Loyalty to Their Clients Above their Own Interests.
As a result, many municipalities, their citizens, and retail investors suffered significant harm.
Perhaps, one of the most notorious examples involved J.P. Morgan paying bribes to firms and individuals connected to public officials of Jefferson County, Alabama, in order to win $5 billion in bond underwriting and derivatives business from the county. In addition to the bribes, J.P. Morgan then sold the county more than $3 billion worth of interest rate swaps that purported to hedge the county’s risk on the bonds, but instead caused the county to go hundreds of millions of dollars deeper in debt. As a result of these transactions, Jefferson County filed for bankruptcy in November 2011, the largest municipal bankruptcy in history at that time that still has not reached resolution.
Today, the Commission is adopting rules, required by the Dodd-Frank Act, that are designed to prevent these types of abuses by identifying and bringing municipal advisors into the regulatory framework. Moreover, these rules are meant to enhance the SEC’s oversight of those who advise and solicit municipal entities regarding municipal financial products, including derivatives, and the issuance of municipal securities.
Accordingly, these rules will, first and foremost, define who is as a “municipal advisor.” Why does this matter? It matters because municipal advisors and their associated persons will now have to put their client’s interests above their own. Specifically, the Dodd-Frank Act requires that municipal advisors owe a fiduciary duty to the municipal entities they advise.
Under today’s rules, the following persons and entities, among others, are deemed to be municipal advisors:
- Persons providing advice to a municipal entity regarding the issuance of municipal securities, including the structure, timing, and terms of transactions;
- Persons providing advice to a municipal entity regarding derivatives to which the municipal entity is a counterparty; and
- Persons providing advice to municipal entity regarding investment strategies for the investment of bond proceeds.
In addition, the rules require municipal advisors to register with the Commission and disclose certain information. The information to be provided will enable municipal entities to better evaluate whether to hire a particular municipal advisor and will provide investors with needed disclosure regarding the persons and entities that may be influencing municipalities’ investments. The required disclosures include information regarding:
- Their municipal advisory business;
- The firms and individuals who solicit clients on their behalf;
- Any other business activities in which they are engaged; and
- Their participation and interest in the transactions of their municipal clients.
Importantly, municipal advisors must also disclose information about their associated persons, including their employment history, other business activities, and disciplinary history.
It has been close to three years since the Commission took its first step toward adopting an appropriate definition of municipal advisors and establishing a permanent registration regime to oversee them. I am pleased that now that municipal advisor has been defined, the Municipal Securities Rulemaking Board (“MSRB”), who has been in limbo for all of this time, will be able to move forward on its rules governing municipal advisors. Although I share the views of many that the Commission should have acted sooner, I am glad that the Commission is today taking action to adopt final rules to regulate municipal advisors. Accordingly, I support the adoption of the rules.
These rules will not only serve to better protect municipalities and their citizens, but also retail investors. In fact, the vast majority of investors who own municipal securities are retail investors. These hard-working Americans are the backbone of our economy and deserve a regulatory structure that works to protect their interest.
Finally, I commend the staff for their hard work on the rules before us today.
 Report of the Senate Committee on Banking, Housing, and Urban Affairs regarding The Restoring American Financial Stability Act of 2010, S. Rep. No. 111-176 (2010).
 The Commission has brought numerous enforcement actions in this area. For example, the Commission brought an action against Stifel Nicolaus and one of its officers for recommending and selling highly leveraged and risky derivatives to five Wisconsin school districts, who relied heavily on borrowed money to enter the swaps. SEC v. Stifel, Nicolaus & Co., Inc. and David W. Noack, Civil Action No. 2:11-cv-00755-AEG (E.D. Wisc. Aug. 10, 2011). The Commission also brought actions against five large financial institutions in connection with bid-rigging schemes involving investment of municipal bond proceeds in guaranteed investment contracts and other reinvestment products. Collectively, the five financial institutions, Banc of America Securities LLC, UBS Financial Services Inc., J.P. Morgan Securities LLC, Wachovia Bank, N.A., and GE Funding Capital Market Services, Inc., paid $205 million to settle the Commission actions. See, In the Matter of Banc of America Securities, now known as Merrill Lynch, Pierce, Fenner & Smith Incorporated, successor by merger, AP File No. 3-14153, Securities Exchange Act Release No. 63451 (December 7, 2010); SEC v. UBS Financial Services Inc., Civil Action No. 11-CV-2885 (D.N.J. May 4, 2011); SEC v. J.P. Morgan Securities LLC, Civil Action No. 11-CV-3877 (D.N.J. July 7, 2011); SEC v. Wachovia Bank N.A, now known as Wells Fargo bank, N.A., successor by merger., Civil Action No. 2:11-cv-07135-WJM-MF (D.N.J. December 8, 2011); and SEC v. GE Funding Capital Market Services, Inc., Civil Action No. 2:11-cv-07465-WJM-MF (D.N.J. December 23, 2011).
 For example, according to press reports, investors holding defaulted municipal bonds sold by Jefferson County, Alabama will recover less than 80 cents on the dollar for the bonds they purchased. See, Moody’s Sees Smaller Recovery Rates in Muni Defaults, Bloomberg, Sept. 12, 2013, available at http://www.cnbc.com/id/101030020. According to the SEC’s 2012 Report on the Municipal Securities Market, retail investors directly or indirectly hold more than 75% of the outstanding principal amount of municipal securities. U.S. Securities and Exchange Commission Report on the Municipal Securities Market (July 31, 2012), available at http://www.sec.gov/news/studies/2012/munireport073112.pdf.
 See, In the Matter of J.P. Morgan Securities, Inc., Securities Exchange Act Release No. 60928 (Nov. 4, 2009). J.P. Morgan was censured, paid a $25 million civil penalty, made a $50 million payment to Jackson County, and was ordered to forfeit more than $647 million in claimed termination fees under the swaps. See also SEC v. Larry P. Langford, et al., Litigation Release No. 20545 (Apr. 30, 2008) and SEC v. Charles E. LeCroy and Douglas W. MacFaddin, Litigation Release No. 21280 (Nov. 4, 2009) (charging an Alabama local government official, a bond dealer and J.P. Morgan Securities employees with conducting undisclosed payment schemes in connection with awarding Jefferson County municipal bond and swap agreement business).
 See, e.g.¸ High Finance Backfires on Alabama County, N.Y. Times, March 12, 2008, available at http://www.nytimes.com/2008/03/12/business/12bama.html?pagewanted=all; J.P. Morgan Swap Deals Spur Probe as Default Stalks Alabama County, Bloomberg, May 22, 2008, available at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aF_f8gLLNvn0; Eileen Norcross, Op-Ed, Interest Rate Swaps Gamble U.S. Taxpayer Dollars, U.S. News & world Report, August 14, 2012, available at http://www.usnews.com/opinion/blogs/economic-intelligence/2012/08/14/governments-gamble-away-taxpayer-dollars-into-bankrupcy.
 In re Jefferson County, Alabama, Case No. 11-bk-05736 (TBB), U.S. Bankruptcy Court, Northern District of Alabama (Nov. 9, 2011).
 Registration of Municipal Advisors, Exchange Act Release No. 34-[XXXX] (Sept. 18, 2013). I note that many municipal advisors have registered with the Commission under the temporary registration regime adopted by the Commission in September 2010. See Exchange Act Release No. 34-62824 (Sept. 1, 2010). Today’s rules establish a permanent registration regime for municipal advisors and provide greater clarity regarding the definition of municipal advisor and the exemptions from that definition. In addition, the disclosures required when municipal advisors register with the Commission under the permanent regime are significantly more fulsome than those required under the temporary regime.
 Today’s rules would have helped prevent the type of misconduct that occurred in the J.P. Morgan case involving Jefferson County, Alabama. J.P. Morgan would have owed a fiduciary duty to the county when selling the county interest rate swaps, which it claimed were a way for the county to hedge the risk on its bonds but ultimately caused the country to go even deeper into debt. J.P. Morgan would also have been required to publicly identify the individuals and firms that it paid to solicit the county on its behalf, and those individuals and firms would also have been deemed municipal advisors required to register with the Commission.
 Registration of Municipal Advisors, Exchange Act Release No. 34-[XXXX] (Sept. 18, 2013).
 Id. The rules also define municipal advisor to include persons who, for direct or indirect compensation, solicit municipal entities on behalf of a broker, dealer, municipal securities dealer, municipal advisor, or investment adviser for the purpose of obtaining an engagement for municipal financial products, the issuance of municipal securities, or to provide investment advisory services to or on behalf of a municipal entity.
 Id. Registered municipal advisors will also be subject to regular examination by the Commission. It is essential that the Commission be given the resources necessary to effectively oversee and examine this new class of registrants.
 Registration of Municipal Advisors, Exchange Act Release No. 34-63576 (Dec. 20, 2010), available at http://www.sec.gov/rules/proposed/2010/34-63576.pdf. To enable municipal advisors to temporarily satisfy the registration requirement imposed by Dodd-Frank, on September 1, 2010 the Commission adopted an interim final temporary rule, Exchange Act Rule 15Ba2-6T, establishing a temporary registration regime for municipal advisors. Exchange Act Release No. 34-62824 (Sept. 1, 2010). To facilitate the transition from the temporary regime to the permanent registration regime established under today’s rules, the Commission is extending Rule 15Ba2-6T in a separate release to December 31, 2014. Extension of Temporary Registration of Municipal Advisors, Exchange Act Release No. 34-[XXXX] (Sept. 18, 2013).
 U.S. Securities and Exchange Commission Report on the Municipal Securities Market (July 31, 2012), available at http://www.sec.gov/news/studies/2012/munireport073112.pdf.