Hospitals who were out of the bond markets last year are finding out that expanded securities laws now require underwriters to disclose their allegiances to borrowers. The new disclosures may surprise those who rely on underwriters for financial advice.

In A Nutshell…

  • Federal laws now require bond underwriters to make new written disclosures to clients.
  • Unlike municipal advisors, underwriters do not have a fiduciary duty to borrowers.
  • In a pinch, most underwriters will side with investors rather than borrowers.
  • Underwriters cannot tell clients not to hire a financial advisor.

In August 2012, the Municipal Securities Rulemaking Board (MSRB) published an interpretive notice regarding the application of Rule G-17. Interpretive notices may not be as entertaining as interpretive dancing, but they do become part of federal securities laws. This one requires bond underwriters to provide a number of written disclosures to hospitals and other municipal issuers to distinguish their role from that of a financial advisor.

Middlemen Are Not Always Right in the Middle

In all fairness, bond underwriters have a tough job. They are middlemen serving two masters: sellers of bonds (a hospital or other borrower) and buyers of bonds (bondholders and other types of investors). If terms are too lenient or yields too low, investors may balk. If it’s the other way around, the underwriter may get fired.

Some underwriters do a better job of balancing these opposite interests, but in a pinch, most will side with investors because they are large, sophisticated funds with significant market clout, and they buy week after week, year after year. The average hospital on the other hand goes to the bond markets maybe every 2 or 3 years –if that often– and without independent advice, most will never know what they left on the table.

The same inherent conflict also affects underwriters who choose to serve as financial advisors in certain transactions. Investors will be watching closely and if they’re not happy, they will be sure to let the underwriter know on the next bond offering.

Here Comes the Fine Print

With the passage of the Dodd-Frank act, the MSRB was told by Congress to protect municipal entities: the various states, local governments, and not-for-profit borrowers who issue tax-exempt debt and had been complaining in recent years that investment bankers had tricked them into buying complex products (like swaps) without explaining them properly.

Before the interpretive ruling, underwriters were required under G-17 to deal with issuers “fairly”. The MSRB came to the conclusion that some underwriters had a different concept of fairness than others and decided that fair dealing alone wasn’t specific enough. The new interpretive rule requires underwriters to notify issuers in writing that, unlike municipal advisors:

  • Underwriters don’t owe issuers a fiduciary duty;
  • Their financial and other interests differ from those of the issuer;
  • They are not required to act in the best interests of the issuer.

The new disclosures could be easily buried somewhere in the fine print, and as everybody knows (with the possible exception of securities lawyers), the more fine print there is, the less people want to read it. The MSRB is aware of this modern-age predicament and requires underwriters to get written acknowledgment from clients –just in case their written confessions were to go unnoticed– or explain why they didn’t.

Your FA Is Still OK

The interpretive rule has strengthened the business case for hiring independent financial advisors (FA).

Unlike bond underwriters, FAs don’t have investors to cajole and their fiduciary duty is to look out for the hospital’s best interests. To dissuade underwriters who might think otherwise, the MSRB has gone one step further: underwriters are prohibited from telling clients not to hire a municipal advisor. That’s also part of the new written disclosures.

Compared to the corporate debt markets, municipal finance is still a murky pond where conflicts of interest abound. The hope is that the MSRB interpretive rule helps not-for-profit hospitals and other municipal borrowers get more clarity on who owes what and to whom.

The full text of the August 2012 MSRB interpretive notice is available at