A federal court should strike down the Securities and Exchange Commission’s conditional exemption for muni advisors because the regulator did not solicit stakeholders’ input and was “arbitrary and capricious,” according to the Securities Industry and Financial Markets Association.
SIFMA made its case in a newly-filed brief in the U.S. Court of Appeals in Washington D.C., asking the court to vacate the SEC’s Temporary Conditional Exemption (TCE) that allows non-dealer municipal advisors to facilitate certain private placements of municipal bonds. SIFMA announced its legal challenge in August.
“SIFMA’s goal in filing this lawsuit was to make clear our objections to the temporary conditional order stated in our many comment letters … there was certainly a feeling that our concerns were not heard,” said Leslie Norwood, managing director, associate general counsel and head of municipals at SIFMA.
In June, the SEC issued the TCE, which is set to expire on Dec. 31. When it was announced, SEC Chair Jay Clayton argued that many issuers faced declining revenue or delays in collecting it, and faced increased nonbudgeted costs as a result of COVID-19. Thus issuers have turned to private placements as a source of liquidity, the SEC said.
The issue is sensitive because dealer firms have always maintained that placement activity is their realm, and that anyone wishing to engage in that business should properly register as a broker-dealer. The order also provides no benefit to municipal advisory firms who are registered broker dealers as well.
The SEC proposed a similar exemptive order in 2019 but said it would not be moving forward with it.
“While the temporary order expires at the end of the year, that doesn’t eliminate the fact that we believe they failed in process in doing the temporary order in the first place and they still have laying out there the original proposal,” said Kenneth E. Bentsen, Jr., president and CEO of SIFMA.
The TCE is more limited than the 2019 proposal, including a $20 million cap on the size of a deal. SIFMA said the biggest difference between the 2019 proposal and the TCE is the length of time that the exemption remains in effect.
“Even this difference is uncertain, however, because the commission expressed its intent to ‘monitor the situation’ and to modify the substance or temporal scope of the 2020 order as it deems appropriate,” SIFMA wrote in the lawsuit.
SIFMA said the SEC violated the Administrative Procedure Act, which governs the process in which federal agencies develop and issue regulations, by not providing the public with notice and an opportunity to comment. The SEC did solicit comment for the 2019 order.
The TCE should also be stopped because it was based on “incoherent rationale” and depended on “an unsupported factual premise,” SIFMA said.
The SEC based the TCE on the pandemic disrupting the primary market driving issuers to rely on other financing mechanisms such as direct placements, SIFMA said.
“But the 2020 order does not find that municipal issuers are having any difficulty availing themselves of these financing alternatives absent the exemption,” SIFMA wrote. “Because the 2020 order makes no finding that municipal issuers lack adequate access to the available financing alternatives and no finding that the 2020 order would in any way ameliorate the only disruption it does identify, it is arbitrary and capricious.”
SIFMA said the SEC relied on several news articles detailing market disruption but ignored the same news sources indicating that the disruption had ended before June when the SEC issued the TCE.
The SEC created a disparity in creating the TCE and gives an advantage to MAs over broker-dealers in soliciting direct placements, SIFMA said. Dealers have argued that broker-dealers have legal and regulatory obligations to protect investors, while MAs have no obligation to look out for investors.
“The commission has offered no reason why this disparity between similarly situated market actors is necessary to ameliorate any disruption in the primary market for municipal securities and for this reason, too, the 2020 order is arbitrary and capricious,” SIFMA said.
SIFMA is concerned that the SEC will consider extending, reinstituting or revising the TCE, making SIFMA’s argument relevant past the end of the year when the TCE is set to expire.
“The SEC has not commented publicly on this and they are free to do so if they so choose and that is certainly one of our concerns,” Norwood said.
MAs and issuers largely supported the TCE, but broker-dealers said it contradicted longstanding legal principles and others said current market conditions did not warrant that relief for MAs.
The SEC releases data every few months on the use of the TCE. From Aug. 1 to Sept. 30, the median issuance principal amount was $2,253,500 — much smaller than the maximum allowed of $20 million.
The SEC declined to comment on the lawsuit. Next, the SEC will file its brief, and the court will schedule oral argument.