ISSUES IN DEBT MANAGEMENT.

• Author: Doty, Robert W.
• Position: Financial advisors

What Governments Should Know About Their Financial Advisors

A significant topic in the municipal securities market in recent years surrounds the concept of fiduciary relationships. One particular focus concerns how certain municipal finance advisors--financial advisors, investment advisors, underwriters acting in advisory or agency capacities, and other specialized consultants--relate to issuer clients. Some municipal finance advisors are surprised to learn that they may have fiduciary status. Governmental securities issuers also need to know about recent affirmations of principles espoused long ago for similar service providers.

The emphasis in this article is upon identification of such fiduciary relationships. This is a matter of relationships, not of contracts. Contracts, providing only a portion of the relevant facts and circumstances, may not be determinative. [1] Since relationship identification usually arises in the context of a dispute over whether a municipal finance advisor should have provided certain information to an issuer, authorities discussed herein examine further whether a duty to speak to the issuer existed.

More than 50 years ago, the SEC set the stage in its decision in In the Matter of Arleen Hughes, [2] in which the Commission strongly emphasized the fiduciary relationship of an investment advisor with her clients. The advisor had recommended securities to the clients, and then, as a broker-dealer acting in a principal capacity, had sold the securities to them.

The Commission's view was that the advisor should have disclosed not only her principal capacity (which she had done in an initial contract with each client), but also that she should have disclosed, in each transaction, in terms each client could understand, her mark-up and the availability of securities at other prices, including the most favorable price.

In 1963, in SEC v. Capital Gains Research Bureau, Inc., [3] the Supreme Court discussed in some detail common law and securities law bases for identifying fiduciary relationships between investment advisors and their clients. Those relationships, in the Court's view, required disclosure of information relating to conflicts of interest.

In the municipal securities market itself, as early as 1977, the Municipal Securities Rulemaking Board referred in the development of its Rule G-23 to "the high level of fiduciary responsibility owed by securities professionals to issuers they advise." [4] The Board cited favorably the 1953 decision in Miami v. Benson, [5] in which the Florida Supreme Court declared void, due to conflict of interest considerations, a contract between a city and its financial advisor for the financial advisor's purchase of the city's bonds.

In recent years, as the Securities and Exchange Commission emphasized disclosure responsibilities of municipal securities issuers, the roles of municipal finance advisors emerged correspondingly as pivotal to the decision-making processes of a substantial number of issuers, [6] the vast majority of whom are small and inexperienced. [7]

As the Commission indicates, issuers may be subjected to penalties and liabilities, even when their advisors do not render appropriate advice or services to the issuers. The fact that issuers may be held responsible, however, does not absolve municipal finance advisors from responsibility to the issuers (or to investors, jointly and severally with the advisors issuer clients). Not only may advisors misstate information to issuers, but they also may fail to come forward affirmatively to inform the issuers of information of which the issuers should be aware in making their decisions. [8]

Professional Responsibilities

Two key aspects of responsibilities of municipal finance advisors to their issuer clients are the duty of care (to render advice or services with an appropriate level of competence and care in accordance with professional standards) and the duty of loyalty (to deal honestly with clients and not to take for oneself something belonging to clients). This article discusses briefly and preliminarily only certain aspects of fiduciary relationships. Other sources discuss in greater detail fiduciary relationships, the duty of care and the duty of loyalty, as applied in municipal finance transactions. [9]

An important consequence of establishing the existence of a fiduciary relationship in given facts and circumstances is a concomitant recognition of a duty to speak, that is, affirmatively to inform the client of significant information. Without a fiduciary relationship, such a duty may not exist. [10]

The emphasis in this article is upon recent judicial decisions. The SEC, in a variety of releases, and Administrative Law Judges have reached similar conclusions in actions too numerous to consider in this brief paper. [11]

Judicial decisions provide strong support for the proposition that municipal finance advisors have fiduciary relationships with their issuer clients under appropriate facts and circumstances. Commonly, courts take into account and cite facts and circumstances, based generally upon state common law principles, including inequality between the parties; reliance by the issuer upon the municipal finance advisor with respect to the subject matter of the...