On May 4, 2012, the Commission issued an order approving a proposed rule change by the Municipal Securities Rulemaking Board (MSRB) consisting of an interpretive notice concerning the application of MSRB Rule G-17 to underwriters of municipal securities.1 We write separately to state for the record our views on the MSRB´s interpretive notice, the Commission´s approval order, and the analysis underlying the rulemaking process as a whole.
In our view, neither the MSRB´s nor the Commission´s analysis in this rulemaking is rigorous enough to pass muster.
Any rulemaking — whether by a self-regulatory organization, such as the MSRB, or by the Commission itself — should be the product of a careful and balanced assessment of the potential consequences that could arise. Such an assessment should entail a thorough analysis of both the intended benefits and the possible costs of a proposed rulemaking in order to ensure that any regulatory decision to proceed with the initiative reflects a well-reasoned conclusion that the benefits will come at an acceptable cost. This requires identifying the scope and nature of the problem to be addressed, determining the likelihood that the proposed rulemaking will mitigate or remedy the problem, evaluating how the rule change could impact affected parties for better and for worse, and justifying the recommended course of action as compared to the primary alternatives.
The decision-making process that led to the Commission´s approval of the MRSB´s proposed rule change falls far short of meeting this benchmark. Accordingly, we do not support the Commission order approving the MSRB´s proposed rule change regarding Rule G-17.
In determining whether to approve or disapprove a proposed SRO rule filing, the Commission is statutorily obligated to ensure that the proposed rule change satisfies the relevant legal standard necessary for approval. Here, the relevant standard is set forth in Section 15B(b)(2)(C) of the Exchange Act. As noted in the Commission approval order, this standard requires, among other things, that the rules of the MSRB "be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons facilitating transactions in municipal securities and municipal financial products, to remove impediments to and perfect the mechanism of a free and open market in municipal securities and municipal financial products, and, in general, to protect investors, municipal entities, obligated persons, and the public interest." Equally important — although the Commission approval order fails to address it — is the additional Section 15B(b)(2)(C) requirement that MSRB rules not be designed to impose any burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act.
Determining whether this standard has been met — particularly with respect to whether, on the whole, the public interest is being advanced as well as whether the potential burdens on competition are necessary or appropriate — requires a thorough evaluation of the potential impacts of the proposed rule change, including in comparison to alternative regulatory approaches. Unsupported assertions that the hoped-for benefits will materialize, that the costs will be warranted, and that the statutory standard is met are inadequate to justify a rule change. If there is any question as to the rigor of an SRO´s analysis, then it is all the more paramount that the Commission not defer to the SRO´s claims, conclusions, and judgments. The Commission has a fundamental oversight role with respect to SROs, and undue deference to an SRO in the SRO rulemaking process undercuts the basic structure of that regulatory relationship.
As measured against this benchmark, the consideration by the MSRB and the Commission of the MSRB´s proposed Rule G-17 guidance does not constitute a sufficiently reasoned basis upon which to conclude that the statutory standard required for approval has been met. The arguments set forth in favor of the rulemaking rely too much on conclusory statements and assumptions rather than on rigorous analysis of the real-life consequences that could arise, whether for better or for worse, as underwriters and issuers adapt to the new interpretive guidance. Certain disclosures that the guidance mandates of underwriters illustrate the shortcomings of the MSRB´s and the Commission´s assessment of those potential consequences.
As the Commission approval order explains, under the MSRB´s interpretive notice, "In cases where the issuer personnel responsible for the issuance of municipal securities would not be well positioned to fully understand or assess the implications of a financing in its totality, because the financing is structured in a unique, atypical, or otherwise complex manner, the underwriter in a negotiated offering that recommends such complex financing has an obligation to make more particularized disclosures than otherwise required in a routine financing." The approval order further notes that the "level of required disclosure may vary according to the issuer‘s knowledge or experience with the proposed financing structure or similar structures, capability of evaluating the risks of the recommended financing, and financial ability to bear the risks of the recommended financing, in each case based on the reasonable belief of the underwriter."
We start by observing that the interpretive notice obligates underwriters to make these "more particularized disclosures" in addition to a number of other enumerated baseline disclosures. Specifically, an underwriter must make disclosures regarding the nature of its role, how the underwriter is compensated, and other potential or actual conflicts of interest that could bias the underwriter. The logic behind these baseline disclosures is that an issuer, when armed with this information, can evaluate for itself whether or not to engage a particular underwriter and, once an underwriter is engaged, can determine how best to protect its own interests in the transaction and the related offering.
In determining whether it is appropriate to impose further requirements beyond these baseline disclosures, it is necessary to assess the potential incremental impact of each additional regulatory obligation. In doing so, it is essential to recognize that at least some of the cost of the accumulating disclosure demands placed on underwriters may ultimately fall on issuers and, therefore, in the case of issuers of municipal securities, on taxpayers. And yet, in our consideration of the underlying record in this rulemaking and the approval order, we do not see the MSRB or the Commission adequately engaging the risk that issuers will end up bearing some of the regulatory burden — a risk that is at odds with the goal of protecting municipal issuers.
For example, absent is a careful analysis of the potential adverse effects of the regulatory uncertainty that could result from the MSRB´s guidance — specifically, from the imposition of the imprecise and ambiguous guidance to which an underwriter must look to determine its disclosure obligations. The terms and concepts — such as how "complex" or "atypical" a financing is and the extent of an issuer´s "knowledge" — that determine what an underwriter must disclose are undefined, which is to suggest that an underwriter may be denied fair notice of what MSRB Rule G-17 demands. The use of such undefined terms and concepts could potentially lead to a more costly and less efficient underwriting process in certain instances. A vague regulatory obligation creates the risk that underwriters will too often be too cautious by assuming in offerings of municipal securities that the financing is complex and the issuer is unsophisticated and thus will make heightened disclosures.2 This is so even in cases where the issuer in fact is sophisticated, having, for example, participated in similar offerings in the past, possibly even with the same underwriter. Even when the underwriter makes these additional disclosures, the underwriter still faces the risk that regulators, with the benefit of hindsight, will second-guess whether the disclosures were fulsome enough.
The MSRB guidance does not address the potential negative impact that such a cautious approach could have on both underwriters and issuers. For example, the analysis underpinning the approval of the MSRB rule change does not examine in a serious and rigorous manner the potential ways that underwriters may "price" the cost of this uncertainty into the terms and conditions for municipal offerings or, for that matter, the possibility that this regulatory uncertainty could chill underwriters from participating at all in certain offerings.
In other words, the practical result of the guidance could be to discourage underwriters from distinguishing between less sophisticated municipal issuers that may benefit from and prefer to receive more extensive disclosures and those issuers that may determine that the additional disclosures are unnecessarily costly with little or no corresponding benefit. As we have already noted, at least a portion of the increased cost to underwriters, including the cost associated with having to manage the regulatory uncertainty the guidance creates, would likely be passed on to municipal entities and, accordingly, to taxpayers. To be clear, municipal issuers that may derive little or no benefit from many of the regulatory burdens that the MSRB´s interpretive guidance imposes will still bear certain costs, a result that would harm some of the very entities the rule purports to protect. More to the point, if underwriters provide issuers with extensive disclosures, there is a risk that some issuers will be overwhelmed by the information they receive — an outcome that actually could frustrate the effectiveness of issuer decision making.
In sum, the analysis underlying this rulemaking fails to appropriately engage the potential adverse effects of the rule change on the capital-raising process for municipalities and the market for municipal securities on the whole.
These potential adverse consequences of the MSRB´s rule change highlight why evaluating regulatory alternatives is critical if an analysis of proposed regulation is to be sufficiently rigorous to justify regulatory action. The potential advantages and disadvantages of alternatives to the MRSB proposal deserved much more consideration than the approval order indicates that the MSRB and the Commission gave them.
In particular, one alternative that received too little consideration is the alternative of fashioning the "more particularized disclosure" obligation as a default instead of a mandate. Under the MSRB´s interpretive notice, an issuer can only scale back its "more particularized disclosures" at the peril of being second-guessed by regulators, which, as discussed above, may chill an underwriter from tailoring its disclosures in practice. Under a default, on the other hand, an underwriter and an issuer would have the choice to "opt out" of the disclosures to the extent they so agreed. A default, in other words, would allow underwriters and issuers the flexibility to structure their affairs in a mutually-beneficial way, including voluntarily arranging their duties and responsibilities as they see fit given their particular circumstances and preferences. If issuers risk bearing some of the cost of the interpretive notice, and if the regulatory uncertainty that underwriters encounter works to disadvantage issuers too, then at least some issuers may welcome the opportunity to opt out of certain of the Rule G-17 requirements. Unfortunately, this prospect was given very short shrift by the MSRB and the Commission.
Indeed, in general, we are struck by the lack of substance to the MSRB´s responses to the comments received on the proposed rule change. The MSRB´s responses to commenter concerns are, to too great of an extent, summarily dismissive and do not adequately credit the legitimate issues commenters raised. This is so not only with respect to comments that address what the guidance provides for, but also with respect to the concern, expressed by multiple parties at several different stages of the rulemaking process,3 that the interpretive guidance is premature because the Commission has not yet adopted a final definition of "municipal advisor" and the MSRB has withdrawn its municipal advisor rule proposals.4 A well-reasoned regulatory decision requires that regulators undertake a thoroughgoing analysis of a proposal´s potential impacts in the context of the whole of the relevant regulatory regime — a requirement that regulators seem unable to meet when fundamental features of the regulatory regime are still not in place, as is the case here.
Repeatedly, the Commission approval order relies on the MSRB´s stated beliefs and assumptions in finding that the statutory standard has been met. This is to say that, in our view, the approval order indicates that the Commission inappropriately deferred to the MSRB´s judgment in assessing the consequences of the interpretive guidance. This is particularly problematic because the MSRB does not support its claims and conclusions with adequate analysis; nor does the Commission adequately explain its reasons for accepting the MSRB´s claims and conclusions. The approval order summarizes commenters´ views on the material aspects of the proposed guidance. However, with respect to critical comments, the order goes on to find, consistently and without meaningful explanation, that the MSRB has adequately addressed the comments in the MSRB´s amendments and response letters. The Commission makes these findings even in response to commenters´ concerns regarding issues that implicate the Commission´s own regulatory responsibilities, such as anticipated Commission rulemaking regarding the adoption of a final definition of "municipal advisor." For the Commission simply to summarize the MSRB´s responses to comments and conclude that the MSRB has adequately responded to the concerns raised by commenters is not an adequate substitute for meaningful Commission analysis, especially given the conclusory nature of the MSRB´s responses. Put differently, we are hard-pressed to find a careful and balanced assessment of the potential consequences — including both the costs and benefits — that could arise from the MSRB´s interpretive guidance.
In conclusion, therefore, it is our view that the Commission´s consideration of the MSRB´s proposed rule change, both on its own and in combination with the MSRB´s analysis, was insufficient to adequately justify the basis of the Commission´s decision to approve the rule change. The MSRB has offered an insubstantial basis to support the proposed rule change and, in issuing its approval order, the Commission has unduly deferred to the MSRB´s assertions and conclusions without establishing a properly reasoned basis upon which to determine that the relevant statutory standard has been met.
Accordingly, we were regrettably unable to join in the Commission´s approval of the MSRB´s proposed guidance and respectfully dissented from the approval order.
1 Order Approving Proposed Rule Change, as Modified by Amendment No. 2, Consisting of Interpretive Notice Concerning the Application of MSRB Rule G-17 to Underwriters of Municipal Securities, Exchange Act Release No. 34-66927 (May 4, 2012), available at http://www.sec.gov/rules/sro/msrb/2012/34-66927.pdf.
2 Indeed, the MSRB expressly directs this approach in its response to commenter concerns, stating, "If there is any doubt on the part of the underwriter as to whether a financing is complex, it should err on the side of concluding that the financing is complex and provide requisite disclosures." See Letter from Margaret Henry, General Counsel, Market Regulation, MSRB, dated November 10, 2011.
3 See Letter from Leslie M. Norwood, Managing Director and Associate General
Counsel, SIFMA, New York, New York, dated September 30, 2011; Letter
from Leslie M. Norwood, Managing Director and Associate General
Counsel, SIFMA, New York, New York, dated November 30, 2011; Letter
from Leslie M. Norwood, Managing Director and Associate General
Counsel, SIFMA, New York, New York, dated January 27, 2012; Letter
from
Michael Nicholas, Chief Executive Officer, Bond Dealers of
America, dated January 30, 2012.
4 The MSRB acknowledged these concerns in two response letters. On November 10, 2011, the MSRB summarized the concerns in two paragraphs before responding, "The MSRB is aware of ongoing rulemaking by the SEC and the CFTC and has taken care to ensure that any requirements of the Notice are consistent with such Rulemaking." On February 13, 2012, the MSRB included an even shorter summary before stating, "The MSRB disagrees for the reasons described in its November 10, 2011 letter." Letter from Margaret C. Henry, General Counsel, Market Regulation, Municipal Securities Rulemaking Board, Alexandria, Virginia, dated November 10, 2011; Letter from Margaret C. Henry, General Counsel, Market Regulation, Municipal Securities Rulemaking Board, Alexandria, Virginia, dated February 13, 2012.