FINRA and the MSRB jointly reminded member firms of obligations connected to: (i) privately placing municipal securities directly with a single purchaser; and (ii) using bank loans as alternatives to traditional public offerings in the municipal securities market.
FINRA and the MSRB stated that many firms failed to:
- conduct sufficient due diligence and analysis to determine whether financing the instruments are municipal securities or bank loans when the financing instrument is described as a “loan”;
- fully understand the nature of their roles in transactions where they have engaged in placements of these instruments; and
- fully consider how federal securities laws and the regulations and rules thereunder (i.e., FINRA and MSRB rules) apply to these transactions.
FINRA and the MSRB urged firms to:
- undertake a threshold analysis of whether the nature of the financing instrument of the municipal entity constitutes a security or a loan, as determined by Securities Exchange Act Section 3(a)(10) and the decision of the U.S. Supreme Court case, Reves v. Ernst & Young, Inc. (494 U.S. 56 (1990));
- review transaction documentation when considering whether a particular financing instrument is a municipal security or a loan;
- consider consulting with counsel to determine whether a particular financing instrument is a municipal security or a loan; and
- voluntarily disclose the existence and terms of bank loans in a timely manner.
FINRA and the MSRB expressed mutual concern that the increasing use of direct purchases of municipal securities and bank loans as alternatives to publicly-offered municipal securities may: (i) increase compliance risks for firms engaging in this activity; and (ii) ultimately “erode market transparency.”
Lofchie Comment: The problem with this guidance is that the dividing line between a loan and a debt security is economically indeterminate. That said, the guidance does point out “bad language” in documents that would indicate that a credit obligation to a bank might be deemed a security rather than a bank loan; e.g., the use of the instrument of terms such as “bond” or “security” or “purchaser.” In short, if it is desired that a credit instrument be treated as a “loan,” then the instrument should use loan terminology and not debt security terminology.