It has traditionally been a fairly common practice in the municipal bond arena for issuers to either select or have significant input into the selection of underwriter’s counsel in connection with the issuance of municipal bonds. On July 27, 2017, the Municipal Securities Rulemaking Board (MSRB) issued a strong warning to the industry against continuation of these practices by publication of Notice 2017-14.In the Notice, the MSRB notes that it first raised concern over issuer involvement in the selection of underwriter’s counsel in September 1998 and expresses significant concern that the practice is still ongoing. According to the MSRB as stated in the Notice, the practice “gives rise to actual or potential conflicts of interest in the counsel’s representation of the underwriter, and calls into question counsel’s ability to carry out its responsibilities with the necessary degree of independence from the issuer, to act with undivided loyalty and to be free from conflicting allegiances in providing legal counsel to the underwriter.”
The Notice reminds underwriters of their duties to have a reasonable basis for recommending any municipal security and to reasonably investigate issuer disclosures in the offering documents, including compliance by the issuer with its continuing disclosure obligations under SEC Rule 15c2-12. The role of underwriter’s counsel in assisting in fulfillment of these underwriter responsibilities is critical and may be compromised where there is an actual or perceived lack of counsel’s independence by reason of issuer involvement in the selection process. Further, the MSRB is concerned that selection of underwriter’s counsel should be based solely on the competence and expertise of counsel, and not on ancillary considerations which may be introduced through issuer participation.
The MSRB further reminds of the potential consequences to underwriters of failure to fulfill the requisite due diligence duties and investigations in connection with municipal securities issuances, including charges of violations under Section 17(a) of the Securities Act and Section 10(b) and Rule 10b-5 under the Securities Exchange Act. The Notice cites, likely as another shot across the industry bow, the SEC’s 2014 Municipalities Continuing Disclosure Cooperation (MCDC) initiative as evidence of the regulators’ increasing concern with ensuring underwriter compliance with due diligence obligations.
Underwriters should be aware of the MSRB’s position when selecting underwriter’s counsel, and underwriters should make certain that the selected underwriter’s counsel has the necessary experience and expertise to competently serve in such capacity.