Managing the bond issuance team.

• Position: Panel Discussion

Frank Hoadley, capital finance director, State of Wisconsin

Common wisdom says that a team of underwriters, advisors and attorneys all are working in the best interests of the issuer; that is, to efficiently structure and sell bonds at the lowest cost to the issuer. Recent disclosure of events in the municipal bond industry is resulting in broad discussions of the roles and responsibilities of parties involved in bond transactions, particularly with regard to questions of conflict of interest. I believe that these discussions will not result in changes in the roles these parties play in a bond transaction but in a renewed understanding of the roles these parties play.

I believe that much of what is being perceived as a conflict of interest is caused by a misperception by issuers, whereby they assume that a role of trust exists where, in reality, it does not and should not. The essence of a negotiated transaction is that there are inherent conflicts of interest. These conflicts should not prevent a negotiated sale from being conducted in a courteous and businesslike fashion, but they should never be forgotten.

The role of the underwriter in a transaction best typifies the presence of inherent conflict of interest. While the investment bankers may bring critical skills and knowledge to the structuring and presentation of a transaction, they typically are paid from the spread of the bond issue. Because the spread represents the negotiated difference between the price at which the issuer sells to the underwriter and the price at which the underwriter sells to the investor, it is the only source of profit for the investment bank, whose sole reason for existence is to provide such services for profit. The "buy low, sell high" nature of the underwriter's transaction means that there is always a tension between the underwriter and the issuer and between the underwriter and the investor.

The relationship of the issuer to the underwriter and the relationship of the underwriter to the investors always must be presumed to be in conflict. Misunderstanding this relationship leads to practices that can cause difficulties during negotiation. Negotiation must be viewed as adversarial and must be carried out at arm's length. This requires that discretionary power to carry out true negotiations and to recommend a transaction for final approval to the governing body must be given to the individual responsible for those negotiations. This negotiating relationship is hampered from the start if the process used for selecting the underwriter(s) implies a contractual "hiring" of the bankers prior to the negotiations or some other form of agreement, such as an appointment letter. The only written agreement that should exist between the issuer and the investment bankers is a bond purchase agreement, and only after all terms have been negotiated and approved. The power granted to the negotiator ideally should direct initial negotiations with the selected underwriter(s). In the event negotiations are unsuccessful, however, the negotiator should be authorized to return to the approving body with any other negotiated bid or competitive bid for the bonds.

Because there is a presumption of conflict of interest with the underwriter, there is little need to investigate further what "side agreements" and "secret deals" may exist. One can assume that the nature of the business leads to an almost endless chain of working understandings and agreements with other parties. To the extent that judgmental recommendations are made by an underwriter, those...