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Panel IV: Fiduciary and Other Duties of Transaction Participants1999 Municipal Market Roundtable United States Securities and Exchange Commission Moderator Eisenberg: All right, if you'll all take your seats we'll be able to get started. Moderator Eisenberg: All right. I want to welcome you to this – Please turn off your cellphones. It's like in a play in a theater, please turn off your cellphones, no photographs unless authorized. My name is Mike Eisenberg. I'm Deputy General Counsel of the Commission. And we have an august panel for you to discuss fiduciary and other duties of transaction participants. I want to say first before I introduce the panel that this is supposed to be, I am instructed, a free-flowing discussion, not a group of talking heads who will take 15 minutes apiece. So we will try to do that. But we will also try to cover specific subjects so that we have an interchange of ideas. I understand that you are welcome to write out your questions. And if I think the question is appropriate I may get to ask it. First let me introduce the panel, probably in the order in which the questions are going to be asked, just for convenience. Now, since this is unrehearsed and I haven't met many of the members of the panel you can be assured that this is going to be an unrehearsed, unstructured discussion. Robert Bendzinski at the end is more or less the representatives of the financial advisors. Mr. Bendzinski is the chairman of, you'd be surprised to know, Bendzinski & Company, municipal finance advisors, a firm which was established all the way back in 1976. And they basically provide financial advisory services to municipalities. Prior to having Bendzinski & Company open he was a financial consultant. He was controller and assessor and active as the city manager on various occasions for the city of Gross Pointe, which I assume is in Michigan. And Mr. Bendzinski served as accountant for the city of East Detroit, which I know is in Michigan. He was one of the first persons to be designated a certified independent public finance advisor or a CIPFA as prescribed by the rules and testing requirements of the National Association of Independent Public Finance Advisors. The second person who is basically an underwriter of municipal bonds is Tom Stanberry, who is where? Mr. Stanberry: Right here. Moderator Eisenberg: Yeah, okay. I should read the sign. He's director of fixed income and capital markets for US Bancorp Piper Jaffray and is responsible for corporate and government underwriting, trading and institutional sales and municipal underwriting. And Mr. Stanberry is a member of the Management Committee of the Board of Directors of US Bancorp Piper Jaffray. The issuer end of this discussion will be carried by Ann Butterworth who is the Assistant to the Controller of the Treasury of the State of Tennessee. She has served as Assistant to the Controller of the Treasury for Public Finance since the beginning of this year. But before that served as the "Director of the Division of Bond Finance for the State of Tennessee for over 12 years. And she was responsible for the debt programs of the state Funding Board and various Tennessee local development authorities. Representing the lawyers, not a small group, is Fred Weber, who I do know, who is a partner of Fulbright in Houston. Ric has a extensive background in municipal finance. He heads his firm's public finance and administration department. He practices in the area of public finance, acts as bond counsel, underwriter's counsel and borrower's and credit enhancer's counsel. And he has considerable experience in the non-profit area as well. The investment or investor end of this is going to be covered by Tom Kenny from Franklin. And it's, I guess it's Franklin Advisors, Inc. And he's the Director of Franklin's Municipal Bond Department which includes ten portfolio managers and 21 research analysts. And he oversees a portfolio management of about 38 tax free funds. Those are, you know, The Franklin Group. That's one of the largest fund groups in the country with assets of over $51 billion. In addition, Mr. Kenny is the lead manager of the 6.5 billion Franklin High Yield Tax Free Income Fund which has – in which he's worked since 1986, a fund which is regulated by my friend Mr. Roye. Tamar Frankel who I also know well. Tamar is a professor of law at Boston University. Tamar has taught at Boston University. She's taught at Harvard. She's taught at Boult Hall, University of California at Berkeley, and basically has done a significant amount of work in fiduciary responsibility. She's an expert on mutual funds. Her textbook on mutual funds, fiduciary responsibility and related financial institutions I think has been widely used. Current research and teaching interests she says involve corporations and regulation of financial markets and financial institutions. Not only was that her current interest, it's been her past interest as well. In 1999/2000 Professor Frankel will be a faculty fellow at the Berkman Center for Internet and Society at Harvard University. And I'm going to find out what that is. Sitting next to me is another person I do know, and that's Paul Roye who is the Director of Division of Investment Management. Before Paul came with the Commission, which was at about the same time that I came, which was the end of last year, he was a partner, long-time partner at Dechert Price & Rhoads. And his specialty has been over the course of his professional career has been mutual funds and investment advisors and related issues. Paul comes to this in terms of the relationship between the financial advisor and registered investment advisors. And we'll hear from him later. All right. Now, what we want to explore is the relationship of the financial advisor, the duties that a financial advisor has, what role a financial advisor actually plays, and the legal responsibilities that are imposed on investment advisors particularly under federal law and perhaps also under state agency law. We also want to deal with the issues of what are the duties of underwriters of municipal instruments and the duties of the – of bond counsel which has been the subject of much discussion. Let me just say before we get into those questions and before we talk about those specifics, I was a partner at Ballard Spahr. I know Rick Ballard is here in the room. And he will forgive me if I say that when I was there, there was a – it was a fairly substantial bond counsel end, the people who did securities work always had trouble understanding the bond people. And I know the bond people had difficulty understanding the securities people. My first official statement that I authored I raised a lot of questions. That's the last one they gave me. (Laughter.) Moderator Eisenberg: I think we've come a long way since those days. But I think the issues that have developed are ones that peculiarly employ the issues that are common to investment companies and investment advisors who register under the act. Because what we're really talking about is the control of conflicts of interest. And the Investment Company Act and the Advisors Act basically deal with the recognition of conflicts of interest, fiduciary duty and how to resolve those, those questions. To the extent that municipal financing involves conflicts of interest and the roles of the financial advisor, the underwriter and bond counsel, some of the lessons which have been learned from the institutional area under the Investment Company Act and the Advisors Act as well as the antifraud provisions of the '34 Act, might be useful whether they apply or whether they're particular precedent or whether or not the lessons apply under other laws, under state laws. For instance, the conflicts of interest that are inherent in an investment company situation is where the investment manager has a conflict in determining the fee that he will charge with the directors of the mutual fund which is being advised. Just yesterday the Commission issued for comment a proposed rule which would deal with strengthening the role of the independent director vis-a-vis the management company. And there are many conflicts in that area which we call fiduciary duty, which some people call agency, and which has specific requirements under the federal securities laws, the '40, both '40 Acts. Now, what we're going to talk about is the resolution of conflicts of interest and the identification of conflicts of interest and how to apply them in the context of the municipal bond market. And I have been taught and I recognize that the municipal bond market has been to some extent a separate animal in the way it operates. However, over the past decade the rules of the Commission and the rules that have applied to other issuers have become applicable in one guise or another to the municipal bond industry or the municipal – the people who participate in the municipal bond area. There have been Commission enforcement cases, there are the G-23 and the other rules of the MSRB, and there is the fuzzy line when investment – when people become investment advisors or whether they have remained financial advisors and aren't required to register. So, with all of that introduction let me just throw open the question, first to Mr. Bendzinski, what do you do, what is the role of a financial advisor? And that may seem a little simplistic to start with, but there are some problems arising out of what the definitions are. So how does it work? Mr. Bendzinski: Well, there are two types of financial advisors or we classify them as, one, are independent financial advisors who are not underwriter related, broker/dealer related, bank related, account related, engineering related, and don't provide advice on investment of any type. Their primary role is first to develop the project and find out the entire cost of the project. Then provide the technicians, the bond attorneys and local attorneys, with the necessary information to prepare the bond authorizing documents, including the, where applicable, the development of the necessary revenue stream to pay for those debt obligations that are being issued. For example, we frequently attend special assessment hearings and follow through the procedures of special assessment hearings to make sure they comply with Michigan law before we even proceed with the issuance of the bond documents with – co-developing them with the bond counsel. And so, if it's a revenue issue we make sure that the revenue issue, the revenue stream is in place, all the additional bond tests are met, all the covenants are met, and advise the client on what additional covenants might be put in place to make the issue more marketable to the investment community. In Michigan we have what is called the Municipal Finance Division of the Michigan Department of Treasury. Prior to any issue being sold or offered for sale we much secure approval from the Michigan Department of Treasury. And we assist the clients in doing that. We also assist the client in the possibility and feasibility of insuring the issue, credit – meetings with the credit rating agencies. And then we prepare as their representative and in conjunction with the information provided by the client and other sources, and in Michigan we're so very fortunate we have many state agencies that require reports that are information that are required under 15c2-12. So, we prepare the official statement on behalf of the client. We do due diligence with that client and then put out the preliminary official statement for our client. We then prepare the notice of sale in conjunction with bond sale – bond counsel, advertise the bonds for sale, and then proceed with the bond sale. Now, Michigan you must remember is primarily a competitive bid state. Michigan does permit negotiated sales under certain conditions and with certain bells and whistles, as I like to refer to them as, on the type of issue. So about 95 to 98 percent of our annual bond sales, and we average somewhere around 100 a year, are of competitive nature. After the bond sale we then assist the client and bond counsel in preparing the legal transcript and the delivery of the bonds, including the printing of it. At that point we then become available to the client to deal with project and bond issue matters. We have a specific contract with each of our clients which outlines our services and the services that we will provide and the basis of establishing our fee. Our contract does not include the investment advice of bond proceeds. Moderator Eisenberg: Do you consider yourself to be a fiduciary of the issuer? Mr. Bendzinski: No. Moderator Eisenberg: You're not a fiduciary. What kind of responsibility do you have with respect to, for instance, the material which you say you help prepare, the official statement? Mr. Bendzinski: The information in the official statement, and over our competition I have one advantage, as you read in my short sketch there, I had been in local government for ten years in the state of Michigan. So I know all the reports that are generated, which reports go to the state agencies, which agencies they go to. And I even teach our staff the form numbers to make it easier so when they're communicating with state bureaucrats. So, we're taking that information from reports that are required to be filed by the various officials and officers of the municipality with various state agencies. In the discussion we had Friday one of the questions that arose was what do we do with tax collections? How do we know they're correct and accurate? In most cases we go directly to the counties who are the collection agent in Michigan for delinquent taxes. So we go directly to the county, find out what the issuer has returned in delinquent taxes, and part of that return is a warrant signed by the treasurer and attested to by the clerk, I believe, that these, this was the levy, these were the collections, this is what's uncollected. So we gather that information from these reports that are filed with the state treasurer. They're public information under Michigan's Freedom of Information Act. They're part of the procedure that the treasurer is liable for in the state of Michigan and is bonded for – not bonded as municipal bonds but as a security bond in the performance of his duties. Moderator Eisenberg: Now, you have a duty of due diligence? Mr. Bendzinski: Yes. We perform due diligence on competitive sales. We sit down with the various officials, the assessor, the treasurer, the administration, and go through the preliminary official statement prior to publication of that document. Moderator Eisenberg: **MR. Weber, is he a fiduciary? Mr. Weber: I would say that not only is he not a fiduciary in the sense that he's only giving advice to an issuer that then uses that advice in making its own decision, and we're talking typically about issuers who have probably full-time directors of finance or some other finance officials. Mr. Bendzinski: Not necessarily. I'd say about half. Mr. Weber: Half. I think you can, if you can think of a case in which you had a small special district that had no employees and had all volunteer board members and didn't have the capacity to make an independent judgment to take the advice and process itself, in that circumstance I think it's possible the financial advisor in effect is acting as a fiduciary. But I think in the normal case it's providing advice to an entity to someone who has a full-time paid job to run the finances of the governmental unit. And I think in that case the financial advisor is not acting as a fiduciary. I buy only used automobiles. And typically when I do that I get a lot of advice from the person making the sale about the car, but I don't think for a minute that the salesman is a fiduciary. Ms. Butterworth: I'm sorry, are you comparing financial advisors to used car salesmen? (Laughter.) Mr. Weber: Did I make that comparison? Ms. Butterworth: I think at this point it would be helpful to me to get a better definition then of what is a fiduciary because, I must say, I thought based on our conversation Friday that we were going in a little different direction. Obviously I wasn't paying enough attention. If I could defer to the more learned person on our panel. Moderator Eisenberg: Tamar is the designated learned person. Ms. Frankel: Oh, my! It seems, let me put it this way, I would say that the fiduciary is somebody who gets power or property from another person in order to efficiently give service to that person. So including, for example, a doctor who performs an operation on me, he has control over my body but that's only for the purpose of making me better. And the same applies to a money manager to whom I give my money. It's not for him. It is given for control, but given for a particular person – purpose and not for any other purpose. So once we do that we can then calibrate the more control that person has for the purpose of performing his duties, the more control that person has the higher the duties that person has. It's not a yes or no. It is a function of how much power you have over another person's let's put it just property. Now, if you had an advisor to whom somebody delegates really the power to do exactly what you're doing, and that is of finding out all the information, doing due diligence and so on, there is a delegation of power which binds that person legally. That's the definition of anagent. Yes? It binds legally. And I think depending on how much that person relies, that would give you the degree of legal duties. And, last, we have a whole family of fiduciaries. We start with bailees. When I put my car in the garage, that person is a fiduciary, he is a bailee. But his powers are very limited and his duties are very limited. Then I go all the way up to a trustee who not only I can't control the trustee. I didn't pick him up. I'm a 2-year-old beneficiary. In that case the trustee has tremendous strict duty. And so when we talk now about you, it's not exact, there isn't a bright line, but we kind of feel we know the degree of duty that you would have. Moderator Eisenberg: Professor Frankel, you've heard what Mr. Bendzinski does. Ms. Frankel: Right. Moderator Eisenberg: Do you think he's a fiduciary to Ms. Butterworth if he undertakes those things? Ms. Frankel: I think he is but his duties may be very limited if the client reviews, controls what he does, looks and asks him questions, Why don't you go again and check for me? and so on. The less discretion he has, the less fiduciary he is. Moderator Eisenberg: All right. Now, Ms. Butterworth, in the real world you're hiring Mr. Bendzinski, what kind of responsibility do you think he has given what he's going to be doing for you? Ms. Butterworth: Well, listening to what he was describing it sounded as if he had taken over the preparation and going forward and was acting in the place of an issuer, determining the structure, developing the documents, providing the interface. And that's a little different from the experience I have had in public finance. But it seems like to me that the description of what a financial advisor will do in terms of a contractual document does not differ that often, enough that I could look at a document and say, well, in this case it was intended to create the fiduciary relationship, but in this case it did not. It seems like to me a lot of the distinctions that we may be trying to draw here are in the actual application. And you could have a contract that sets out the same language but you may in this case have an issuer where there is extensive review of the documents being brought back in. But I don't know you're going to find that kind of distinction in the written contractual document. Ms. Frankel: May I say just one thing first? Moderator Eisenberg: Sure. Ms. Frankel: I am not sure that the contract determines the status of the advisor. I think the court does. The court may listen, may look at what the parties intended, but only at the terms, not at the legal classification. The court can say you decided XYZ and, therefore, you are a fiduciary or you are a fiduciary or you are not. And, so, I don't think that that classification will help. Mr. Roye: Professor Frankel, does that mean that contractual provisions in a contract that attempt to disclaim responsibility for being a fiduciary or saying that you're not an agent would generally be – Ms. Frankel: I don't think – Mr. Roye: – ignored by the courts or? Ms. Frankel: The courts may pay some attention to the parties' intent but I've seen many cases in which the court said we are looking not at what you said you are, we are looking at what you said or what you do. And we come to the conclusion that you are a fiduciary or you are not. Moderator Eisenberg: Well, Professor Frankel's analysis is supported by the district court opinion in Dain Rauscher in District Court of Arizona. Now, in effect that says, that case says "the Supreme Court has held that parties have a duty of disclosure to one another when a fiduciary or agency relationship exists or when the circumstances exist such that one party has placed trust and confidence in the other." (Ciarella v. U.S.) Now, when you hire him to do the things that he said he would do are you placing that kind of trust and confidence in him with respect to the official statement and recommendations and the kinds of things that he's doing? Ms. Butterworth: I would think so in that case because his description of his job was to say that I would – that he would go on my behalf, seek out that revenue information, go out, get all the relevant information for it. And so I would say. Moderator Eisenberg: All he said that he wouldn't do was he wouldn't tell you what to do with the proceeds. Ms. Butterworth: Right. Moderator Eisenberg: But that's not enough to negate that trust and confidence that you're placing in him. For instance, in terms of duty of disclosure which the court in I guess it's Rauscher Pierce at the time was talking about in which the other courts in the 9th Circuit have been talking about, the duty to disclose other payments, the duty to disclose his relationships with others, what the arrangements are, does he have a duty to do that? Ms. Butterworth: I would think so. But based on what he said earlier, he doesn't have an arrangement with anyone else on any other basis. So I think in his case uniquely. Moderator Eisenberg: No, well, obviously no. But if he did. Mr. Bendzinski: I think, if I may, the key is that we're independent advisors. We're representing a single client. The due diligence issue, we prepare the official statement based upon the information. We hold a due diligence meeting with the client and all the appropriate officials. Moderator Eisenberg: Right. Mr. Bendzinski: That meeting we're asking them, is this information accurate, complete, not misleading? Have we omitted anything that could be misleading or anything that could give the investor the wrong opinion of this security that's being offered. And we do sit down and explain this at the beginning of the meeting. The whole purpose here is not to develop the Chamber of Commerce program but for here to have a securities offering and be factual. And I'd like to use the case of one of our clients who was very upset with us because we had a preliminary official statement when we met with the rating agencies, and we refused to put in this preliminary official statement that the county was about, was about to – and the word "about to" is very important here – enter into an agreement for the development of a new regional shopping center, enclosed shopping center, which would be the first in the west side of the state. And after meeting with the rating agencies the county manager in this case said to the rating agencies. Well, we have this coming but we don't know when we're going to finalize. And God bless his soul, old Wade Smith at Moody's, who most of you in this room are probably too young to remember, said, no, you should not disclose that. Moderator Eisenberg: Now, taking it away from you because we don't want to personalize this, supposing a financial advisor knows or has reason to know that things that are being asked, that he's being asked to put into the official statement are really not so. Then he has a duty not to put it into the OS? Mr. Bendzinski: I believe – Moderator Eisenberg: I think you would all agree with that. Mr. Bendzinski: I believe he does not – he should not put it in. Moderator Eisenberg: He should not. If he does, he's liable? Mr. Bendzinski: I think so, yes. Moderator Eisenberg: Mr. Weber? Mr. Weber: Even I would agree with that. (Laughter.) Moderator Eisenberg: See, now we're really getting someplace. Mr. Bendzinski: One for the prologues. Moderator Eisenberg: Go ahead. Mr. Weber: I think fiduciary is a term that's used too loosely and too often, I think. And the results of several of the enforcement actions that have occurred I think can be more easily explained just in terms of a breach of the duty of care in performing the service that financial advisor or the bond counsel was hired to perform. If you – if an issuer hires a financial advisor or disclosure counsel to basically give it advice on what should be disclosed and to prepare the disclosure documents, then it seems to me a financial advisor or disclosure counsel that does not take the issuer through the questions that the issuer should ask of itself to see whether it has information that is material and that is not being disclosed and that makes what is said misleading is not doing his job. And so that you could I think state an action for negligence if the issuer then offers the securities with material misstatements and incurs liability. It's another question, though, if you have a financial advisor or disclosure counsel that has advised the issuer on the sorts of things that should be disclosed, the issuer comes back and says, here is everything that fits that description, and the question is does the financial advisor have a duty to go check on the principal or the issuer that has supplied the information? The only rationale I can think of for that – and by the way, there is a footnote in the 1988 SEC release that proposed Rule 15c2-12, the original rule, that takes the position that at least in a competitive offering under some circumstances the financial advisor has the same responsibility to check on the information that's disclosed that a manager of negotiated offering – managing underwriter would have. It says – I can't read the footnote number, it's too small on my copy – but it says that, it mentions that financial advisors typically publicly associate themselves with the offering by having a section financial advisor or indicate in the offering document their role in the financing or putting it together. And it says, "Where such financial advisors have access to issuer data and participate in drafting the disclosure documents, they will have comparable obligations under the antifraud provisions to inquire into the completeness and accuracy of disclosure." The only rationale I can think of, the only support for that proposition is that by publicly associating itself with the preparation of the offering document it leaves the investor with the impression that it has independently checked the accuracy and completeness of the information supplied by the issuer. Moderator Eisenberg: Mr. Stanberry, you're the – Mr. Weber: And it seems to me that is an impression and can be typically is negated by a disclaimer. Moderator Eisenberg: Mr. Stanberry, you're the underwriter and you see this situation. What do you expect or what do you understand to be the relationship with the financial advisor? Can you rely on that? what do you do when you get the draft official statement and you start looking into whether or not you want to underwrite this offering. Mr. Stanberry: I'm assuming you're talking about a competitive sale? Moderator Eisenberg: Yes. Right. Mr. Stanberry: Well, we do rely upon the financial advice. We operate from the assumption that the document that we receive is the issuer's document. So that the issuer, whether they have delegated responsibility to a third party financial advisor, the issuer is fully responsible for everything that's in that document. And if we have questions, we may call the financial advisor as the issuer's agent or we may go directly to the issuer at that point. But if they have engaged a financial advisor we operate on the assumption that they're the agent of the issuer and that they're engaged in a fashion that they can speak on behalf. Moderator Eisenberg: Do you have a lot of contact with the financial advisor in the real world and you speak to them, talk to them, they come to Minneapolis and talk to you? Mr. Stanberry: We have our, I mean our competitive underwriting desk speaks to financial advisors in I would say the majority of the competitive transactions we underwrite. Moderator Eisenberg: You view them as agents of the issuer? Mr. Stanberry: Unless we're aware of some circumstance where there isn't an agency relationship we view them as the agent. Moderator Eisenberg: You don't look at the contract, do you? Mr. Stanberry: No, we never, we never – I shouldn't say never, we rarely see the contract. We see the disclosure document, we see the notice of sale. We may receive a call from the financial advisor asking us if we intend to bid on the transaction. And then whoever the senior underwriter is makes the assessment and either calls the issuer with questions or calls the financial advisor with questions. Moderator Eisenberg: Mr. Stanberry, do you think they're your agent? Mr. Stanberry: What? Moderator Eisenberg: The financial, the financial advisor. I'm sorry. I didn't mean to make that – Ms. Butterworth: I got thrown off by the initial part of the question. Could you repeat the question? Moderator Eisenberg: I don't remember. No, in terms of in effect Tom Stanberry is saying that we regard the financial advisor as the agent of the issuer. You're the issuer. Do you regard the financial agent as your agent? Ms. Butterworth: I would think so, because we – Yes. We have contractually, we have hired a financial advisor to represent us in dealing with rating agencies. I would say, though, having not thought this out fully beforehand that the agency relationship does have its limits in terms of the representations that can be made on our behalf. And working through or with, for example, an RFP process and the selection of firms, oftentimes we have the financial advisor serve as the sole contact for communication and keeping communication from being made elsewhere within the issuer system. So, yes. Mr. Stanberry: I think one thing needs to be clarified here. And I side with Rick on this. We're throwing around a lot of technically legal terminology. "Contract with an agent," well, you can contract with a lot of people who aren't going to be your agent. You can contract with an independent contractor who may decide that they want to have fiduciary responsibility but may in fact have no legal fiduciary responsibility. So, as you start throwing around the terminology "Does someone have a fiduciary obligation, have they entered into a contract?" I think you have to be real careful what you're saying. We may contract with someone in a situation where it's absolutely clear we have no fiduciary responsibility but we may willingly engage in a fiduciary relationship and commit ourselves to one for one reason or another. But I think you need to decide, you just need to be careful as you walk down this path. When Ann says, I've contracted with somebody, I don't think that necessarily means you have a fiduciary obligation. Moderator Eisenberg: Professor Frankel? Ms. Frankel: Just to ask, if a secretary calls and gives information to you, you don't consider the secretary to be, or an administrative assistant to be the agent which is defined as the person who can bind another person to legal obligations. If you take that definition which I think we do, then you could distinguish then the secretary would not be the agent, you wouldn't rely on it though, would you? Mr. Stanberry: Presumably the secretary isn't an officer or isn't in a position to bind that agent. Ms. Frankel: Correct. Mr. Stanberry: So, no, we wouldn't. We wouldn't rely upon that. Ms. Frankel: So this is the distinction you would make. Okay. Ms. Butterworth: But does it matter whether I have left the impression that anyone answering that particular telephone line has the ability? It says, "For further information call this number," and when you're talking on the phone you can't tell whether that's an administrative assistant or a vice president. Ms. Frankel: You'd better identify. Moderator Eisenberg: Well, already said be careful. Mr. Stanberry: I'm loath to jump into this but I can't – Ms. Frankel: Me too. Ms. Butterworth: They're falling asleep. You have to. Mr. Stanberry: I know. I can't help myself. There has to be an element of common sense that comes to play here. If Mr. Bendzinski says that he is, let's say he says he's an agent or he sends us an official statement or my senior underwriter has a question and she calls his office and it's after hours and speaks to the maintenance person, presumably she's not going to rely upon that conversation. So, you know, again at some point common sense has to function here. Moderator Eisenberg: Okay, but if you talk to Mr. Bendzinski or you talk to one of his vice presidents and there are discussions had about some of the things that he has undertaken to do for the state of Tennessee is he acting as an agent? I mean that's not necessarily a legal question it's also do you regard him as representing and standing in the shoes of the state of Tennessee? Mr. Stanberry: I think for most, for most purposes on that competitive sale, yes, we do. Moderator Eisenberg: Do you regard yourself as an agent of the state of Tennessee if you are retained by the state? Mr. Bendzinski: If we were retained by (Laughter.) Moderator Eisenberg: All right, now that means something in legal terms which is that there is a duty of certain kinds of disclosure with respect to conflicts of interest. Now, you're in a position where you say we don't have any conflicts of interest because we're independent. You want to tell us about financial advisors that do have relationships? What kind of relationships do the ones that aren't independent financial advisors have? And what are – are their responsibilities different? Mr. Bendzinski: I think they are because I've been in that situation prior to starting my own firm was – I worked for two brokerage houses, broker/dealers who were very large in the municipal bonds. They were the premier house at one point in time. Really the story on Friday of the situation where we were, I was providing the service as the financial advisor to a particular client and the underwriting desk came up to me, and those were in the old days where we actually went out to the municipality's board which generally met in the evening, and we opened bids there. And, thank God, most of them had Frieden so we could calculate the bids at the time, but the underwriter came to me and said, Here, Bob, here's two envelopes. Envelope A, if there's other people there, envelope B if there's nobody else there.And I looked at our underwriter and said, Sorry, I'm representing the issuer and I will not take out two envelopes. You give me an envelope that you want to submit as your bid. Hopefully it's the best bid. And if there's somebody else there, if there's nobody there, too bad. Well, needless to say, I had held the pay for about six months before I would not enrich the company for the benefit of my client. I think that happens all the time. The other circumstance that I found myself wrestling with when I was working for these brokerage houses was a client calls me and says what we now call a material event, one of the 11 deadly sins, what do I do? I can't go to my underwriting desk because that would giving information to our, my firm and would be placing me in jeopardy in terms of disclosing to one firm who might enrich itself because of the information provided by me as an employee of that firm. So frequently I would just say to the client let's, I'll meet with you today, tonight, tomorrow, whatever, and we will put a disclosure letter together and send it out to everybody. Moderator Eisenberg: Now, Mr. Stanberry, does Piper Jaffray act as financial advisor as well as underwriter in some cases? Mr. Stanberry: Yes, we do. Moderator Eisenberg: And how does that work and how does that complicate your life? Mr. Stanberry: I think in situations where we're a financial advisor – I agree with a lot of what Mr. Bendzinski said – I think you have to set up some type of Chinese wall procedure to segregate what goes on, on the underwriting side of the house from what goes on, on the financial advisory side of the house. And if there is material information that comes into the hand of the financial advisor it can't be shared with the underwriting desk. So you provide the segregation, not unlike the kind of segregation you'd provide with the Chinese wall in a corporate finance operation between the fundamental research analysts and the investment banking team or the research analysts and the underwriting desk. So in those situations we make it clear that the bankers who are engaged as financial advisors don't communicate that information with the underwriting desk and essentially set themselves up as an independent unit inside the department. Moderator Eisenberg: And that's the way things work in the industry generally? Mr. Stanberry: I don't know that I can say it's the way things work in the industry generally. I think that if you're, if you are functioning as a financial advisor in an environment where you have other duties, where you have underwriting desks, sales operations, you need to figure out some way to segregate the two operations. Moderator Eisenberg: Ms. Butterworth, do you work with financial advisors that are also underwriters? Ms. Butterworth: The state of Tennessee used to select firms for those entities that had the ability to choose negotiated sales and entered into contracts, written documents that provided for both underwriting and financial advisory services. And several years ago it was determined that we would move away from that, move towards a single financial advisor for all state level debt issuers. And it was determined by contract we would say during the period of this relationship you cannot be involved in the underwriting of the debt of any of the issuers for whom you are serving as financial advisor. But we have not taking a policy position to say we will not hire or consider firms that both underwrite and provide financial advisory services, and, in fact, have hired several firms. So we do not have a predisposition towards a financial advisory only firm. Moderator Eisenberg: Is this general throughout the states or is Tennessee a minority? Ms. Butterworth: I don't think there's any uniformity there. Mr. Stanberry: More often than not when we're hired as a financial advisor we're asked or at least persuaded to agree not to bid on a competitive sale. So we come to the same conclusion or the clients have come to the same conclusion that you have that notwithstanding the Chinese wall, I think that's a hard concept for many clients to understand. So we do that internally. Clients just simply ask us not to bid. Ms. Butterworth: Okay. Mr. Bendzinski: I might add that there are several public finance departments, as they're referring to in the underwriting, associated with underwriters who claim on a competitive sale all they have to do is disclose in the offering circular, the preliminary official statement, that they are acting as financial advisor. And that absolves them from the requirements of G-23. I don't necessarily agree with that. Mr. Weber: In a competitive or a negotiated sale? Mr. Bendzinski: Competitive. Moderator Eisenberg: There are two things I want to cover now, first from the point of view of the investor because Mr. Kenny runs a very large portfolio of bond funds, and the other is from the point of view of the Commission staff. And I want to talk, have Paul Roye talk about when you cross the line from financial advisor to investment advisor which requires registration under the Advisor's Act. So, first, from the point of view of a portfolio manager, how do you view these relationships? And does it matter to you? Do you just look at the numbers and say, okay, the yield is safe, this is what we're going to do? How much analysis do you do? Mr. Kenny: Well, first, I'm glad to hear that everyone really agrees on the definition of fiduciary and contracts and whatnot. But from an investor perspective, to us it really doesn't matter whose responsibility is defined internally. You have an underwriter, you have an issuer. And all three of them from our opinion are involved. It's their document in total, whether the issue is driving it, the FA or the underwriter. And if the deal goes sour because there wasn't full and accurate information disclosed, we're going to go after everyone. Moderator Eisenberg: That's right. Debbie Gatzick would go after all three of them. That's right. Mr. Kenny: I think she would. Moderator Eisenberg: Sure. But which is interesting in terms of who do you look to if you have questions; would you go to the financial advisor? Mr. Kenny: It depends on – Moderator Eisenberg: Or would you go to the underwriter? Mr. Kenny: It depends on the deal. Most of the time on negotiated deals you'll go directly to the underwriter and the issuer to get answers to your questions. And many times even on negotiated deals the FAs will bring the issuers through our offices for meetings to go over the transaction and some of the numbers. So it really depends on the issuer. Moderator Eisenberg: Yeah, well, you're really concerned about credit worthiness. Mr. Kenny: Yes. Moderator Eisenberg: And so you rely on the credit, the credit bureaus. And but you have your own analysts that look into the credit worthiness of the deals? Mr. Kenny: These days you can't rely on the credit bureaus, you have to be doing your own homework. And so, therefore, the information provided is extremely important to us, not only to accuracy but also that we're getting full and complete. Moderator Eisenberg: And so to do that who do your people go to, to the underwriter? Mr. Kenny: Primarily the underwriter. But many times the underwriter will delegate to the issuer to answer some of the specific credit questions because the underwriter won't have the answers many times to the questions. And so they will bridge between the issuer and us. And many times put us directly in touch with the issuer. Moderator Eisenberg: Do you have relationships with specific underwriters who you look to, to fill your needs? Mr. Kenny: We look to all underwriters. Moderator Eisenberg: To all of them, yes. Mr. Kenny: Some are better than others. Moderator Eisenberg: Well, we'll take names. (Laughter.) Mr. Kenny: I'll stop there. Moderator Eisenberg: All right. I wanted to save some time for a question which I think is important to us. And I think important to all of you. Paul, when does a financial advisor step over the line and become an investment advisor which would be subject to the provisions of the federal securities laws?Mr. Roye: The fiduciary duty question I think it's clear that once you step over the line and meet the definition of an investment advisor that the Supreme Court says you're a fiduciary. So at least resolved that issue, once you become an investment advisor. But the Investment Advisor's Act of course contains a definition of what an investment advisor is. And it essentially has three prongs to it. It's any person who for compensation is engaged in the business of providing investment advice or advice with regard to securities. And each of those three elements – compensation, being in the business, providing investment advice – has traditionally been construed fairly broadly by both the courts and the Commission. Those of you who want to study this issue I would recommend that you look at Investment Advisor's Act Release Number 292 which tries to work through each of those three elements. In order to be an advisor you have to meet all three of those elements On the compensation front, again, it's construed broadly as pretty much any form of economic benefit to the organization or individual providing the service. It doesn't have to be specifically defined or specifically confined to "investment advice." It can be compensation that's a range of services, part of a package of services, indeed part of the package of the services that Bob outlined that they perform, in addition to investment advice. It can be bundled up there. The compensation doesn't have to come necessarily from the issuer, it can come from a third party, it can come from entity who's compensating the advisor because the issuer bought securities and they received a commission or some kind of payment in that regard. So you can find compensation in a variety of different ways under the definition. I note that there were some no action letters that a number of financial advisors have relied on, I guess the Knight Group and Dominion Resources. Other letters. Those letters in some respects tend to suggest to determine the fact that there was no compensation paid in connection with occasional type of advice with regard to securities, temporary investment of idle proceeds in connection with bond offerings. And even though those letters talk about they're not being compensation, I personally question whether or not when you look at those relationships whether or not you couldn't find compensation. I know in other types of situations I think the Commission – Commission staff rather has come to the conclusion that there is compensation. But when I look at those no action letters it seems to me that when the staff took the no action position that it took in those letters involving financial advisors it was really in my mind it was really more the second test, which is whether or not you're in the business of being an investment advisor. If the nature of the investment advice with regard to securities was really so isolated, it was at the instance of the issuer, it wasn't something held out as a service that the financial advisor would provide to its clients, and it was really more, in my mind that was more driving, what was driving the Commission to take those kinds of positions. Again, it has to be investment advice with regard to securities. As these municipal deals have evolved from investing proceeds into government securities, you know, where there is an exemption, if you're giving advice only with respect to government securities there is an exclusion in the Advisor's Act for that kind of advice. If you're giving advice with regard to repos, forward contracts, GICS, you're outside that exclusion and you're giving advice with regard to securities. When you look at the O'Brien Partners settled enforcement proceeding that's exactly what was going on. In that situation indeed their contracts called for the financial advisor to provide investment advice with regard to investment of bond proceeds. It was part of the contract, it was part of the understanding. They were making recommendations on investing in repos and GICS and forward contracts. So it seems clear in that kind of situation that it was contemplated that they would be giving investment advice with regard to securities and each of the elements of the investment advisor definition was met. So I guess when you go back and you analyze the no action letters and you look at the O'Brien Partners case I guess the message you take away is that look at the Knight Group letters fairly narrowly, a narrow set of facts. Bob pointed out that his contract doesn't even suggest in any way that they give investment advice. If you had a contract that contemplated investment advice, even albeit for temporary proceeds, I suggest that maybe you're holding yourself out as an investment advisor suggesting that was an issue there. So, you know, I think it's an area that my understanding when the O'Brien Partners came out there was some confusion out there as to what was the Commission's position. But I think you can distinguish the two situations, at least in my mind, pretty clearly. I don't think it turns so much on whether or not there was compensation or not, I think it really turns on really the issue of are you really in the business of giving investment advice. I think this is an area that, you know, we'll look to see if in some form or fashion we can't somehow issue additional guidance and clarification. But that's kind of a summary of the law I think from my perspective. Moderator Eisenberg: Two things, of course. There is no exemption from the antifraud provisions. And if, in fact, as Mr. Kenny has pointed out, his general counsel would look to all three groups for if something really goes wrong in terms of if they can show fraud, as the allegations in Rauscher Pierce, for instance, or Orange County concerned, there's no exemption. And the question of whether or not there is a breach of fiduciary duty in connection with the purchase or sale of securities in connection with the advice given, the question would be whether or not the actions of the financial advisor was such as to establish that kind of a relationship where they were responsible. And with respect to the underwriter, similarly. And then there is the question of the conflicts of interest and whether or not the duty of disclosure devolves on those people disclosure of what? Disclosure of their possible conflicts which if the issuer had known about the conflicts of interest they would not have entered the transaction and so on. There is one last question. And I want to wind up on time. A question from the audience: In public documents the SEC has suggested that underwriters bear or should bear a fiduciary obligation to issuers in negotiated transactions. Is that the SEC's position? What? Ms. Butterworth: We didn't get on the bond attorney. Mr. Weber: That's all right by me. Moderator Eisenberg: Well, we're not finished yet. Now, how much time do we have, Paul? Mr. Maco: About ten minutes. Moderator Eisenberg: We have ten more minutes? Mr. Maco: Go till 5:00 o'clock. Moderator Eisenberg: Okay. We'll get to the bond attorneys for the next ten minutes. Now, go ahead. Mr. Roye: I'm the investment management lawyer. Moderator Eisenberg: The question is, in public documents the SEC has suggested that underwriters bear or should bear a fiduciary obligation to issuers in negotiated transactions. Is that the SEC's position? Mr. Weber: I would hope not. Mr. Stanberry: Well, want to give the legal definition, the lawyers. Moderator Eisenberg: Well, I mean why is it different from anything underwriters of corporations have to do? Mr. Weber: Well, I mean there are also other public documents SEC has released that indicates that disclosures enhance that there is a healthy tension between underwriters and issuers, that investors rely upon underwriters to kick the tires and to go beyond the representations of issuers in a negotiated transaction at least, and to make some inquiries too. Moderator Eisenberg: Right. Mr. Weber: And it's very difficult for me to rationalize that environment in which the underwriters are expected to act in effect as an adversary almost and doubt the information that the issuers are supplying and at the same time imply a fiduciary obligation on the part of the underwriters to the issuer. And it strikes me you're creating a – you're really creating impossible expectations of the underwriter as intermediary.Mr. Stanberry: Well, you put the underwriters in an incredibly untenable position. While that may be the articulated viewpoint of the SEC I think – I can't speak for the entire underwriting community – but certainly for our firm and for most of the firms that I know that are in the negotiated underwriting business, we unequivocally believe we don't have a fiduciary obligation. Our job – Moderator Eisenberg: To the issuer. Mr. Stanberry: To the issuer. Our job is to purchase bonds. Either to purchase bonds in a negotiated transaction or a competitive transaction. In doing that we'll work with – and I have a situation. In a competitive situation if we see the financial advisor providing us a transaction that is not market worthy we'll give the financial advisor advice that certain terms and conditions need to be changed. In a negotiated transaction we give that advice directly to the issuer and we don't – unless we contract to do so we don't take discretionary responsibility, we don't make decisions on behalf of the issuer. We make sure that the issuer makes it. Moderator Eisenberg: Let's make this concrete. Does the underwriter have an obligation to disclose to the issuer financial arrangements which it might have with the financial advisor? Mr. Stanberry: We may. If, you know, if there are conflicts of interest that arise, if in some way it could impact some material element of the transaction, if it could impact the tax exempt status of the transaction we clearly have a duty to disclose that. So I think, yes, in most cases we have a duty to disclose those kind of financial obligations. That doesn't make us fiduciary – Moderator Eisenberg: Ms. Butterworth would want to know what kind of deal you had with the financial advisor. Mr. Stanberry: Absolutely. If we're buying a bond in a competitive transaction and we have a side agreement with the financial advisor I'm sure she'd want too know that because in my opinion we'd probably taint the sale at that point. But, again, – Moderator Eisenberg: So there is some kind of obligation? Mr. Stanberry: To the issuer. There may be, there may be an obligation. There may be an obligation to disclose certain conflicts of interest or certain material information. We've got to go back to what we started talking about earlier. That doesn't rise to the level of a fiduciary obligation. We are not a fiduciary, we are the purchaser of securities. Moderator Eisenberg: Well, forget what you call it, there is an obligation to make disclosure with respect to the conflict of interest that exists with respect to you and the financial advisor and for the financial advisor to disclose the conflicts that he has in his arrangements with you when he is being hired. Ms. Butterworth: I may be saying the wrong thing but in a competitive sale you as underwriter I do not believe have a responsibility to disclose to me your arrangement with my financial advisor. I would be looking to my financial advisor for the – Moderator Eisenberg: To be responsive. Ms. Butterworth: Because unless I put that in my bid form as one of the requirements of information I'm soliciting I don't believe I – I mean I can want you to tell me that. But I don't believe that I should be relying on you to disclose that. I believe the disclosure of that relationship must come from my financial advisor. Mr. Stanberry: I think that's a case where you need to distinguish between legal obligations and what I would consider to be good business practice obligations. Ms. Butterworth: What we try to think of if it appears on the paper, front page of the paper, the next page or the banner on the internet site the next day – Mr. Stanberry: Right. Ms. Butterworth: – can you retain your job by noon? Moderator Eisenberg: All right. Professor Frankel? Ms. Frankel: There's one thing, you're right, I don't think that you have a duty to disclose except for one thing. If you help somebody who is a fiduciary to breach the obligation, through that back door you may be liable. Moderator Eisenberg: Mr. Bendzinski? Mr. Bendzinski: Well, I think I wanted to make the distinction between an independent advisor and a public finance department. And my comment was going to be is this where the Chinese wall starts crumbling? Because if you're giving advice to your public finance department, Tom, to structure the deal in this fashion isn't that Chinese wall starting to disappear? Moderator Eisenberg: You'll remember what happened to the Chinese when the Mongol's appeared at the Chinese wall. Ms. Frankel: I wasn't there, Meyer. Mr. Stanberry: No, I don't think so, because I think that's still – there still are circumstances where you can act as the financial advisor and keep that relationship on one side of the Chinese wall and keep the underwriting relationship on the other side. Moderator Eisenberg: All right. Now let's turn to counsel. Do you have any conflicts that you ever deal with? What do you disclose to your clients? Let's assume you're – can you represent an underwriter and a financial advisor at the same tie? Mr. Weber: I think you, I think you can. We have circumstances in which we represent an issuer and a conduit borrower, for example. But under ethical rules we need the consent of, the informed consent of each. We explain the potential danger as well as the potential benefits to them of having common representation and then get their informed consent. Typically when we do that we explain that there are on the several issues where there are like – where their interests are not likely to be consistent that we'll not provide advice to either of them and they look to their own internal counsel or somebody else for that advice. I think it's possible also to represent both an underwriter and an issuer. We have done that in some circumstances. You have the same issue of informed consent. But we typically will go on and counsel the underwriter that they have a much weaker in effect due diligence defense if they have hired the issuer's counsel or not only someone who represents the issuer from time to time but is representing the issuer in that transaction. But sometimes there are transactions that are small enough, there are general obligation bonds, there's really not a lot of question about need for a lot of diligence and tricky disclosure issues, and so as a cost savings sometimes we will end up representing both parties. Because the key I think is that there needs, when counsel has conflicts like that, under professional rules of ethics we need to have a consultation call which discloses the risk followed by the consent.Mr. Stanberry: Rick, when you say represent the issuer do you distinguish between bond counsel versus disclosure counsel versus actual counsel to the issuer, their general counsel? Mr. Weber: That can, that can have an impact on the relative risks of the conflict, that is what, it really depends on what advice they're looking to us for. If they're looking only for us to render an opinion as to the legal validity of the bonds there's really pretty limited risk. If they're looking to us to help negotiate the legal terms of documents then there is much great risk. And so it would have an impact on that. But, still, it seems to me you're a lawyer and you have to have a client that you represent. And if you're going to – and if it's proposed that you represent more than one client in a substantially related manner you need to have informed consent. Moderator Eisenberg: Okay. It's 5:00 o'clock. Paul, I understand you have some closing comments. I'd like to thank all of the members of the panel for the discussion. And we really do appreciate your all coming and listening. Thank you. (Applause.)
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