If Fiduciary Duty Governs Financial Advice, Why Not Ethics Advice and Officials' Disclosure?

One of the great things about discussions of the conflicts of
interest of people in the securities world is that
"fiduciary duty" is considered the basis for the rules that govern their relationship with government officials and others. In discussions
of the conflicts of interest of those whom they deal with in municipal governments and those who provide other sorts of advice or products to municipal governments, "fiduciary duty" often goes unmentioned.<br>
<br>
I say this as an introduction to a discussion of the Municipal
Securities Rulemaking Board's (MSRB) draft Rule
G-42, entitled "Duties of Non-Solicitor Municipal Advisors"
(the MSRB's text webinar on the draft rule is attached; see below). "Municipal advisors" are the people who advise
municipalities with respect to their issuance of bonds and related
transactions (the definition is complex and outside the bounds of
this post).<br>
<br>

<b>Fiduciary Duties</b><br>
What is important for the purposes of local government ethics is
this focus on fiduciary duty. It's worth noting that the draft rule
derives from the Dodd-Frank Act, which expanded the MSRB’s
jurisdiction to include the regulation of municipal advisors and
which deemed municipal advisors to owe a fiduciary duty to their
municipal entity clients. Effectively, the Dodd-Frank Act determined
that a <i>federal </i>fiduciary duty is owed to clients that are
<i>municipal</i> entities. This determination acknowledges that this is not
an issue that has been, or likely will be, dealt with at the local
or state level. After all, state and local governments find it
difficult to acknowledge the fiduciary duty of those elected or
appointed to manage a community's resources, or of the
consultants and other professionals hired to advise these officials.<br>
<br>
According to the draft rule, one element of a municipal advisor's fiduciary duty is a "duty of care,"
which includes a requirement that an advisor "possess the degree of
knowledge and expertise necessary to provide informed advice." Not
only are municipal officials not held to such a requirement, but those who
provide them with ethics advice are also not held to such a
requirement. Government attorneys with no training or experience in government
ethics routinely provide ethics advice.<br>
<br>
One of the requirements derived from municipal advisors' fiduciary
duty is that they and their affiliates are "expressly prohibited
from engaging in any principal transactions with their clients, even
in the case of disclosure and client consent." That is, there can be
no direct dealings between the advisor and the municipality or its
officials, and there is no cure for such dealings.<br>
<br>
With respect to ethics advice, this requirement would
mean that an ethics adviser can have no direct dealings with the
municipality or its officials. This requirement would prohibit any
government attorney, or her law firm if she has an outside practice, from giving legal advice to or representing
the municipality or its officials. Since this is their job, it is
clear that the two positions are in conflict and a government
attorney should, therefore, be prohibited from providing ethics
advice. This (along with the requirement of expertise) is the basis
for having an independent ethics officer.<br>
<br>
Another element of a "duty to care" involves inquiry and
investigation. Municipal advisors are required to "make reasonable
inquiry as to the facts that are relevant to a client’s
determination to proceed with a course of action or form the basis
of advice," and they are also required to "conduct reasonable
investigation to determine that it is not basing any recommendation
on materially inaccurate or incomplete information."<br>
<br>
This element of
a "duty to care" is not commonly applied to ethics advisers, whether
government attorneys or independent ethics officers, although ethics
officers often do make inquiries and, when they feel it is
necessary, do some level of investigation. It is more uncommon for
government attorneys to fulfill this element of the "duty to care."<br>
<br>
<b>Disclosure Requirements</b><br>
Also derived from a municipal advisory's fiduciary duty is the draft rule's
disclosure requirement. This includes a requirement of a municipal advisor to, prior to the
inception of its relationship with a municipality, disclose in
writing all material conflicts of interest, providing sufficient
details and explaining how the advisor addresses or intends to
manage or mitigate each conflict.<br>
<br>
This is an element of fiduciary duty all
officials should be held to, but rarely are. They often wait until a
vote before disclosing a conflict, provide little or no detail about
their conflict or their prior involvement in a matter, and do not
address how they plan to manage or mitigate the conflict, other than
not voting at that particular meeting. As the MSRB recognizes, much more
should be required of fiduciaries.<br>
<br>
In terms of what needs to be disclosed, it's notable that the rules
expressly include indirect conflicts, such as advice, services, or
products provided by an affiliate of the advisor, relevant payments
from third parties, and fee-splitting arrangements. Too few
municipalities require their officials to disclose indirect
conflicts. It is no accident that it indirect conflicts often lead to the municipal scandals
that fall short of criminal violation.<br>
<br>
<b>Campaign Contribution Limits</b><br>
In an MSRB board meeting in early May, the chair suggested that the
board will consider applying to municipal advisors limits on
campaign contributions similar to those currently applied to
broker-dealers, that is, individuals and entities seeking municipal
securities business. This would be done in a revised <a href="http://www.msrb.org/pdf.aspx?url=http://www.msrb.org/Rules-and-Interpre…; target="”_blank”">Rule
G-37</a>.<br>
<br>
The chair is quoted in <a href="http://www.msrb.org/News-and-Events/Press-Releases/2014/MSRB-Holds-Quar…; target="”_blank”">the board's press release on this meeting</a> as
saying, “Extending these provisions to municipal advisors will help
prevent <i>quid pro quo</i> political corruption, or the appearance
of such corruption, in public contracting for both dealers and
municipal advisors.” It's notable that the chair felt it necessary
to go beyond the fiduciary duties described in detail in the
proposed Rule G-42, due to the U.S. Supreme Court's decision in the
<i>McCutcheon</i> case, where the majority opinion expressly stated
that only <i>quid pro quo</i> corruption can be the basis for
restrictions on campaign contributions.<br>
<br>
Rule G-37 prevents broker-dealers from engaging in municipal
business with an issuer within two years after a contribution by the
firm or by a member of that firm to an official for an issuing
municipality. Broker-dealers are also required to disclose
contributions they make to bond ballot campaigns (of which there are
many at the local level and for which there is rarely any
disclosure), because there has been a demonstrated link between
these campaign contributions and resulting securities business.<br>
<br>
According to <a href="http://www.bondbuyer.com/issues/123_87/msrb-ma-pay-to-play-rules-coming…; target="”_blank”">an
article in the <i>The Bond Buyer</i></a>, the MSRB chair said
that revisions to Rule G-37 would be proposed in about a month,
which means any day now, but the executive director wasn't quite so
sure about the timing.<br>
<br>
Robert Wechsler<br>
Director of Research-Retired, City Ethics<br>
<br>
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