Letter to Regulators: End Insider Dominance of Municipal Market Oversight

ACRE, AFSCME, the AFL-CIO, AFR Education Fund, the Consumer Federation of America, and Public Citizen sent a letter to the Municipal Securities Rulemaking Board concerning the need for broader public representation in governance of the Board and oversight of municipal lending markets.

The letter is linked for download here and reproduced below.

Mr. Ronald W. Smith
Corporate Secretary
Municipal Securities Rulemaking Board
1300 I Street NW, Suite 1000
Washington, DC 20005

RE: Request for Comment on Draft Amendments to MSRB Rule A-3 on Membership on the Board (2020-02)

To Whom It May Concern:

On behalf of ACRE, AFSCME, the AFL-CIO, the Americans for Financial Reform Education Fund, the Consumer Federation of America, and Public Citizen, thank you for the opportunity to comment on the above referenced Draft Amendments (the “Amendments”) concerning the Municipal Securities Rulemaking Board’s (“MSRB” or “Board”) rules regarding Board membership and governance.

All of our organizations share a concern for the protection of municipal issuers from exploitation by large Wall Street banks and financial institutions that act as underwriters, advisers, and dealers in municipal finance markets. There is a long history of such exploitation in the municipal markets. Examples over the past two decades include the sale of complex derivatives by bank dealers which, far from reducing costs and risks to municipal issuers as advertised by dealers, ended up creating enormous additional costs for public borrowers. They also include the deep involvement of dealer banks in the largest municipal bankruptcies in U.S. history, such as Detroit, Jefferson County, and Puerto Rico.

MSRB regulated entities significantly contributed to and profited from these abusive transactions. But the MSRB did not sound the alarm in advance or use its regulatory powers to take action. This is true even though MSRB Rule G-17 has for many years imposed a ‘fair dealing’ standard for Wall Street dealers interacting with municipal clients. This standard has apparently been ignored in all too many recent cases, in ways that have created enormous costs to the public. The MSRB could have taken action to clarify and help to enforce this standard, to define unacceptable practices, and warn the market concerning them. But unfortunately, the record shows that all too often the Board, which should be the municipal market’s watchdog, has been toothless and ineffective.

Current pressures on state and local budgets due to the pandemic crisis will make the MSRB’s oversight role even more important. These pressures can lead profit-seeking dealers and advisers to recommend excessively risky transactions to municipal entities desperate to escape fiscal burdens. Examples can include transactions such as pension obligation bonds, bond anticipation notes and capital appreciation bond transactions (such as the hundreds that followed the Great Recession), or other similar borrowings that seek to defer payments far into the future. The MSRB must be more effective than it has been in the past.

The Board’s governance and membership selection process is at the heart of needed reform. The MSRB has gained a reputation as dominated by the sell-side intermediaries it is supposed to regulate — banks and dealers that sell products that have all too often imposed unnecessary and sometimes ruinous costs on issuers. It was due to these concerns regarding sell-side dominance that Congress in the 2010 Dodd-Frank Act sought to reform Board governance by requiring that a majority of Board members be independent public members rather than from regulated entities, and explicitly required the Board to protect the interests of issuers and municipal entities.

Unfortunately, since the passage of the Dodd-Frank Act we have seen that Board governance has not been reformed in line with Congressional intention. Sixteen public members out of a total of thirty-six that were appointed between 2010-2011 to 2019-2020 have had significant past or recent connections or ties to MSRB regulated dealers or banks.  This number does not include public investor members that spent significant time at investment advisory affiliates of broker-dealers.   If we exclude fiscal year 2010-2011 from this calculation, a year when public members were still required to be approved by the Securities and Exchange Commission, fourteen public members out of a total of twenty eight, or half of all new public members, had such connections. A list of such Board members and details of their connections is appended to this comment. (This list is not intended to imply that any individual Board member lacks integrity or is unable to perform their duties, but simply to demonstrate the extent of connections between Board public representatives and regulated dealer banks).

If the normal process at the MSRB continues be that half of so-called independent members have significant professional ties to dealer banks, then the MSRB will clearly face barriers to acting as an independent watchdog that forcefully protects the public interest. Since the interest of dealer banks can be diametrically opposed to those of the municipal issuers who pay them, it is also clear that the MSRB will face conflicts in protecting the interests of issuers and municipal entities, as it is required to do. This policy will also lead to Board membership that continues to be marked by a striking lack of racial, socioeconomic, and viewpoint diversity as compared to the issuers and the public that are affected by its decisions. In requiring a majority of public representatives, Congress did not intend for the MSRB to simply shift its membership from currently employed bankers to recently retired bankers.

Now that members of Congress have taken an interest in the issue of MSRB independence, the Board is advancing these Amendments to address this long-standing issue. Unfortunately, taken as a whole the reforms in these Amendments appear inadequate to fully satisfy the statutory intent in the Dodd-Frank Act that the MSRB have a true public interest majority. There is one significant reform proposed here – the shift from a two year to a five year mandatory separation period for public members. We believe that this change would make a difference in shifting Board membership to more effectively represent the public interest and we strongly support it. We support a number of other changes in the Amendments as well, but view these changes as more incremental in nature and unlikely to have a major impact.

We are also struck by elements that are missing from these Amendments, including a reconsideration of conflict of interest provisions. We believe that the Board needs to reconsider its approach to member qualifications at a much deeper level than is evident in these Amendments, including its interpretation of the statutory statement that members should be “knowledgeable of matters relating to the municipal securities markets”.  As discussed below, there is no reason an independent member needs to have previously worked for a regulated entity in order to be knowledgeable concerning the municipal markets.  We particularly noted Question 2 in the Amendments, which asks “Would a public representative who has been away from the industry for five years continue to maintain sufficient municipal market knowledge to serve effectively”? The question reflects an implicit assumption that only recent “in the industry” experience working for a regulated entity gives knowledge of municipal markets. In our experience this attitude has been reflected in the assessment of new member applications.

We discuss several specific issues below.

Definition of “material business relationship”: We strongly support the proposed expansion from a two to a five year separation period in the definition of “material business relationship” that determines qualification for independent member positions. This new requirement alone is far from a complete fix for issues around selection of independent members, but it is still a significant shift that would show the Board is attempting to address such issues. Arguments against the change to a five year separation period are unconvincing. As discussed below, there are in fact a very large number of qualified candidates for independent member positions who were not recently employed by banks or other regulated entities, or were never employed by such entities.  A greater period of mandatory separation will help to produce members who have a whole-market and public interest perspective rather than a sell-side orientation and socialization.

However, given that the Board is re-examining the definition of material business relationships, we were surprised that there was no apparent effort to either clarify or expand the conflict of interest provisions in that definition. Rule A-3 currently states the following, with the bolded section referring to conflicts of interest:

“The term “no material business relationship” means that, at a minimum, the individual is not and, within the last two years, was not associated with a municipal securities broker, municipal securities dealer, or municipal advisor, and that the individual does not have a relationship with any municipal securities broker, municipal securities dealer, or municipal advisor, whether compensatory or otherwise, that reasonably could affect the independent judgment or decision making of the individual.”

However, as documented in the Appendix to this letter, several individuals have been appointed as independent members who would appear to have significant conflicts of interest by this or any definition. For example, Robert Cochran served as an independent member (and in fact the chair of the independent members) but was the Managing Director and co-founder of the Build America Mutual Assurance Company. Although bond insurer fees are technically paid by issuers, the use of bond insurance and the selection of a bond insurer is almost always at the discretion or recommendation of MSRB regulated entities. This would seem to create a major conflict of interest that was not taken into account by the Board in selecting Mr. Cochran.  This and other examples where conflict of interest provisions appear to have been ignored indicate a need for significant strengthening of conflict of interest protections in the selection of independent members. This issue is not addressed at all in these Amendments.

Approach to Independent Member Qualifications: More broadly, we believe that the Board needs to shift its underlying approach and attitude regarding the selection of independent members in order to prioritize genuine diversity of viewpoints and backgrounds and a clear and unconflicted commitment to the public interest. The Board already has a large number of representatives from regulated entities. These regulated entity representatives bring detailed and specialized knowledge of municipal markets and a perspective informed by the role of market intermediaries such as banks, dealers, and advisors. The goal of selecting independent representatives is not to replicate these contributions of regulated representatives with individuals who do not happen to currently work for a bank. It is instead to bring a broad view informed by all the goals and objectives of a well-functioning municipal finance market.

It is our belief that the Board instead tends to prioritize insider knowledge of technical elements of bond underwriting in ways that lead to a selection process which does not create the needed breadth of perspective and background in its membership. This is particularly evident in the Board’s interpretation of the statutory statement that members should be “knowledgeable of matters relating to the municipal securities markets”. Rather than interpreting this brief and general statutory statement in a manner that sharply restricts the potential pool of public representatives, the Board should interpret it more expansively and more in line with its plain meaning. Congress did not mandate that board members should be technical experts steeped in the current state of the art regarding bond underwriting processes. The statute instead simply specifies that new members should be “knowledgeable” of “matters relating to the municipal securities markets”.

There are numerous pools of individuals who are knowledgeable about the municipal markets and motivated to serve the public interest but do not have a professional background in working for MSRB regulated entities. Examples of such groups are:

  • Employees or elected officials at issuers who have not previously worked for banks or dealers: There are numerous individuals who work for states and localities, have devoted their careers and lives to municipal budgetary issues, are knowledgeable about municipal finance markets, but have never worked for a bank.
  • Academic experts in financial markets: There are many individuals who have strong expertise in the workings of financial markets, have published peer-reviewed articles on municipal securities markets, but have never worked for a bank.
  • Community and labor activists and advocates: There are many individuals who, through activism or advocacy on issues ranging from local bond issuances to policies surrounding the municipal markets, have gained substantial knowledge concerning municipal markets, but have never worked for a bank.

These pools of candidates alone encompass many thousands of people who could be well qualified to serve as independent members of the MSRB, but do not have professional connections to a bank.

Thank you for your time and attention to our comments. Should you have questions, please reach out to Marcus Stanley at Americans for Financial Reform Education Fund at 202-674-9885 or marcus@ourfinancialsecurity.org, who can also connect you to relevant staff at other signatory organizations.



Action Center on Race and the Economy (ACRE)



Americans for Financial Reform Education Fund

Consumer Federation of America

Public Citizen