By Cyril Tuohy
Financial advisors arguing over whether retail clients are better off with advice that meets a “suitability” as opposed to a “fiduciary” standard of care have it easy. Over yonder, in the relatively lawless world of municipal bond issuance, regulators are having a devil of a time deciding who or what constitutes an advisor in the first place.
Until the passage of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, which imposed new rules on the municipal bond market, the kind of advice peddled to issuers -- never mind investors -- often has been pie in the sky and occasionally out of this world. That's not an exaggeration, either.
Remember Robert Citron, former treasurer of Orange County in California? He’s the fellow who lost $1.7 billion of taxpayer funds on derivative investments in the early 1990s. Court documents later revealed Citron had consulted an Indianapolis astrologer for help in guiding the county’s $20 billion investment pool, according to news reports.
Citron’s follies eventually squeezed Orange Country into bankruptcy in 1994. Since then, other municipalities have gone belly-up: Stockton, Vallejo and San Bernardino, all in California; Central Falls, R.I.; Jefferson Country, Ala., and Harrisburg, Pa. Detroit is coping with financial ruin; Illinois faces a massive pension deficit.
In some cases, municipalities’ financial foibles involve old-fashioned incompetence and corruption. In other cases, transactions renowned for their opacity played a role. Jefferson County, for instance, filed for bankruptcy protection after costs spiraled out of control on auction-rate securities and derivatives debt connected to a sewer system.
Advisors aren’t necessarily to blame for municipal bankruptcies, of course, but America’s $3.7 trillion municipal bond market is huge, with an average of about $450 billion in state and municipal debt obligations issued annually, according to the Municipal Securities Rulemaking Board (MSRB).
Would the financial affairs of Jefferson County, for instance, have turned out differently had local officials received counsel from advisors charged with delivering a fiduciary standard of care and regulated by a state, federal or independent overseer? Perhaps.
Section 975 of the Dodd-Frank Act takes no chances, and attempts to do exactly that: amend Section 15B of the Securities Exchange Act of 1934 by requiring municipal advisors to submit to a “registration regime” of the Securities and Exchange Commission (SEC).
It is a laudable goal: raise the standard of the financial responsibilities intermediaries owed to their ultimate bosses, the taxpayer. But because the 1934 law never defined the term “advisor,” Congress left it to the SEC to come up with a definition.
When it did, the howling began in earnest with opponents assailing the SEC for overreaching its authority. The deluge came from on high, as leaders from both parties, Sen. Orrin Hatch, R-Utah, and former Montana Gov. Brian Schweitzer, a Democrat, signaled their displeasure with the proposal to register the municipal advisors.
Hatch called “preposterous” the notion of regulating municipal advisors serving on the 19-member Utah Board of Regents, for example, that guide Utah’s higher education system. One of the members is required to be a student and three other members are nonvoting ex officio members.
William J. Caraway, president of Chancellor Financial Associates, a municipal advisor to Texas school districts, said he had “with horror read daily e-mails from the MSRB as to many different statutes, rules and regulations pertaining ostensibly to my business.”
Forcing “municipal advisors,” many of whom volunteer their time or serve for a small stipend or nothing at all, risks alienating many citizens from public service, the groups warned. Thus, the exasperation of R.E.L. Breedlove Jr., executive director of the Natchitoches Parish Port in Louisiana, who wrote that a “heightened fiduciary obligation,” would discourage the participation of “citizen volunteers.”
Opponents came from even further afield, too. From the Fresno, Calif., Fire and Police Retirement Board to the Oregon Finance Authority; from the Nebraska Municipal Power Pool to the Dormitory Authority of the State of New York; from the Lavaca Navidad River Authority, a conservation district in Texas, to the Mackinac Bridge Authority in Michigan, the public authorities let their opinions be known in no uncertain terms: scale back the proposed oversight of municipal advisors.
Even a coalition of more than 30 life and annuity carriers felt compelled to weigh in: “The Committee remains concerned that the commission intends to extend the municipal advisor regulatory scheme beyond that which was intended by Congress and beyond the harms the Dodd-Frank Act was designed to cure,” wrote the Committee of Annuity Insurers.
The outcry prompted lawmakers to act once again, this time in the form of the Municipal Advisor Oversight Improvement Act of 2013, which was introduced in the House in February with bipartisan support.
The bill, sponsored by Rep. Steve Stivers, R-Ohio, seeks to amend the Securities Exchange Act by clarifying the definition of financial advisor and exempting a host of duties conducted by appointed officials in the name of public service.
Do exemptions pertain to palm readers? Federal officials have yet to hear from astrologers and card readers, but there’s still time for them to have their say.
Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at [email protected].
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