MSRB Proposes Interpretation of Rule G-17 to Restrict an Underwriter's Ability to Consent as a Bondholder to Certain Changes in Authorizing Documents

February 15, 2012

On Feb. 7, 2012, the Municipal Securities Rulemaking Board (MSRB) released a draft of an interpretive notice concerning the application of MSRB Rule G-17 to an underwriter's ability to consent as a bondholder to certain changes to a trust indenture or a resolution under which municipal securities were issued ("Authorizing Documents").

General Requirements of Rule G-17

Rule G-17 requires brokers and dealers conducting municipal securities activities to "deal fairly with all persons" and "not engage in any deceptive, dishonest, or unfair practice." Rule G-17 is most often applied in the context of interactions between the dealers and the purchasers of municipal securities. For example, it requires a dealer in municipal securities to disclose to the prospective purchasers all material information about the transaction prior to the dealer's sale of the securities. However, MSRB has stated that underwriters' responsibilities under Rule G-17 are broader than merely to their purchasers, but also require underwriters "to deal fairly with all persons" in the conduct of their "municipal securities activities."

How the Proposed Interpretive Notice Would Affect Underwriters

The notice states that the MSRB is concerned with consents by underwriters, as the holders of bonds they are underwriting at initial sale, to amendments to Authorizing Documents that may negatively affect the existing parity bondholders. Most Authorizing Documents allow for the holders of the majority of the bonds issued under those documents to consent to such amendments. However, such Authorizing Documents typically do not expressly grant to the underwriters such consent rights during the brief time in which the underwriters hold bonds for resale. The MSRB believes that, absent specific disclosure, such practice violates the fair dealing standard of Rule G-17.

Consequently, the MSRB's proposed interpretive notice disallows underwriters from consenting to any amendment to an Authorizing Document that would "reduce the security of existing bondholders" unless (1) the Authorizing Document expressly states that an underwriter could provide bondholder consent and (2) the offering documents for the existing securities expressly disclose that bondholder consent could be provided by underwriters of other subsequent issues of securities under the Authorizing Document.

In the release, the MSRB does not define the term "reduction in security." However the following were cited as examples of changes that would reduce the security of existing bondholders: elimination or reduction of a reserve fund as well as the substitution of a surety policy for a cash-funded reserve; a reduction in priority of debt service on existing securities in relation to other expenditures; a reduction in a minimum debt service coverage ratio that is a condition of the issuance of parity securities; and the elimination or reduction in the amount of collateral for existing securities.

The proposed interpretive notice would not apply to consents by a dealer who purchases municipal securities for its own account without view to distribution. In that case the MSRB would consider the dealer to be acting as an investor and not as a dealer in municipal securities. The proposed notice also excludes any amendments to the Authorizing Documents that do not affect other existing bondholders, such as when all bonds of the other bondholders have been defeased.

The MSRB has requested all interested parties to submit comments on this draft of an interpretive notice by March 6, 2012. The MSRB further indicated that, if it decides to seek the Securities and Exchange Commission's approval of its draft as a final interpretive notice, the MSRB will only ask for its prospective application.

In the coming months we will continue to monitor rules and notices promulgated by MSRB. If you have any questions regarding the application of the Rule or other laws governing the municipal securities regulatory framework, please contact the authors.

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