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Banks Face Disclosures of Conflicts in Municipal Bond Sales

Banks hired to arrange bond sales for U.S. states and cities may be forced to disclose that underwriting securities places their interests at odds with those of public officials.

The requirement, part of a regulation proposed today by the Municipal Securities Rulemaking Board, is aimed at preventing government officials from looking at underwriters as financial advisers. Unlike banks, financial advisers have a duty to act in their customers’ best interests.

The proposal is part of a push by regulators to keep banks from reaping excessive profits from dealings with public officials, who sometimes rely repeatedly on the same firms to handle securities sales. Banks make money by buying new securities and selling them to investors, a role that can allow them to earn more by picking up bonds at below-market prices.

With the passage of the Dodd-Frank law governing Wall Street activities, municipal securities regulators were charged with drawing up rules to protect the states and cities that sell securities as well as those who buy them.

The board’s proposal amends one made earlier this year and must be approved by the Securities and Exchange Comission. Among other things, it requires an underwriter to disclose that it has financial interests that differ from those of taxpayers and that it doesn’t have a fiduciary duty to the government that hired it.

The proposed rule would also force greater disclosure about the risks of some financings, such as the derivative-laden bond deals that cost taxpayers billions when they unraveled in the wake of the 2008 credit crisis.

Specific Terms

“It is important that state and local governments understand in very specific terms what to expect from their underwriters and the financial risks of the transactions underwriters recommend,” Lynnette Hotchkiss, executive director of the municipal board, said in a statement.

Leslie Norwood, who lobbies on municipal issues for the Securities Industry and Financial Markets Association, said the group was supportive of steps that would spell out underwriters’ roles to their customers.

She said SIFMA is reviewing the proposal and that the industry is concerned because the risk disclosures to be required of banks are typically done by financial advisers.

“They might be potentially confusing the issuer as to who had a fiduciary duty to provide this sort of information,” she said.

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