• The MSRB Proposes an Interpretive Notice on the Application of MSRB’s “Fair Dealing” Rule to Bondholder Consents Issued by Municipal Securities Underwriters
  • March 20, 2012 | Authors: Henryka W. Gryc Craig; John R. Devine
  • Law Firm: Miles & Stockbridge P.C. - Baltimore Office
  • The Municipal Securities Rulemaking Board (the “MSRB”) issued a draft interpretive notice providing guidance on the application of MSRB Rule G-17 (i.e., the “fair dealing” rule) to grants by underwriters of bondholder consents to bond document amendments (the “Draft Interpretive Notice”).  Under Rule G-17, brokers, dealers, and municipal securities dealers must deal fairly with all persons in the conduct of their municipal securities activities.  The fair dealing principles of Rule G-17 most often are applied to duties owed by dealers to investors with which the dealers engage in municipal securities transactions.  However, as the MSRB points out in the Draft Interpretive Notice, Rule G-17 is broad in scope and establishes a general duty of a dealer to deal fairly with all persons in the conduct of its municipal securities activities.  As described in the Draft Interpretive Notice, the MSRB is concerned about a current market practice in which underwriters, at the request of issuers, consent, during the period they hold municipal securities with a view to distribution, to bond document amendments affecting other parity holders of such securities.  The Draft Interpretive Notice is intended to provide guidance regarding those circumstances in which a grant of a bondholder consent by an underwriter would violate the fair dealing principles of Rule G-17.

    The MSRB recognizes in the Draft Interpretive Notice that issuers and obligated persons may perceive a grant of a bondholder consent by an underwriter as a more cost-effective way of obtaining required bondholder consents than, for instance, the defeasance of existing securities or solicitation of existing bondholders.  The MSRB cautions dealers, however, to consider carefully before providing such consents whether, depending upon the facts and circumstances, such consent may violate Rule G-17.  Under the Draft Interpretive Notice, it would be a violation of Rule G-17 for an underwriter to consent to amendments that would reduce the security for existing bondholders unless (i) such document expressly provided that an underwriter could provide bondholder consent and (ii) the offering documents for the existing securities expressly disclosed that the consent could be provided by underwriters of other securities issued under such documents.  Examples of what the MSRB would consider a “reduction in security” are  (i) an elimination or a reduction of a reserve fund or the substitution of a surety policy for a cash-funded reserve, (ii) a reduction in the priority of debt service on existing securities in relation to other expenditures, (iii) a reduction in a minimum debt service coverage ratio that is a condition of the issuance of additional securities, or (iv) the elimination or reduction in the amount of collateral for existing securities.

    The MRSB notes in the Draft Interpretive Notice that, while an underwriter is technically a bondholder during the period it purchases a bond and the time it distributes it to an investor, it is still an underwriter while it holds the bond with a view to distribution and, as such, it will not be negatively affected by the amendments to which it consents.  The MSRB contrasts this with situations where an underwriting firm becomes an investor in the bond (i.e., without a view to distribution) or where amendments agreed to by an underwriter have no effect on existing bondholders.  For example, if an underwriter agreed to amendments to variable rate demand obligations after such obligations had been subject to a mandatory tender, or if all of the existing bonds had been defeased prior to the underwriter’s consent, then the amendments would not affect the previous bondholders.