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.

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).

Fiduciary Duties
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 federal fiduciary duty is owed to clients that are municipal 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.

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.

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.

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.

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."

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."

Disclosure Requirements
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.

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.

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.

Campaign Contribution Limits
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 Rule G-37.

The chair is quoted in the board's press release on this meeting as saying, “Extending these provisions to municipal advisors will help prevent quid pro quo 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 McCutcheon case, where the majority opinion expressly stated that only quid pro quo corruption can be the basis for restrictions on campaign contributions.

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.

According to an article in the The Bond Buyer, 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.

Robert Wechsler
Director of Research-Retired, City Ethics

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