Why Issuers Need an Independent Financial Advisor

Bond/Note Pricing – When an issuer is pricing a transaction, the investment banker or underwriter may provide a pricing scale prior to the actual bond sale. An independent financial advisor has the ability to make sure that the pricing scale is “on market” and that the issuer is selling its bonds/notes at a market price.

Swap Pricing – The Pennsylvania Local Government Unit Debt Act (Act 23) was amended in September of 2003 to specifically allow Pennsylvania municipalities to enter into derivative transactions (interest rate swaps). Under Act 23 any municipality entering into a derivative transaction is required to hire an independent financial advisor to make sure that the issuer is receiving a fair market price. Act 23 only governs municipalities in Pennsylvania. Many times municipalities in other states, as well as Higher Education and Healthcare issuers enter into swaps without hiring an independent financial advisor. An issuer should always have an independent firm verify the pricing of a derivative transaction regardless if it is expressly required by law. Interest rate swaps are complex transactions where the pricing is not transparent. Federal regulatory agencies such as the Securities and Exchange Commission (SEC) and the Internal Revenue Service (IRS) are starting to focus on derivative transactions.

Transaction Structuring – An independent financial advisor can assist an issuer in structuring a financial transaction that meets the needs of the issuer, preserves maximum flexibility and allows the issuer to receive a fair market price. The optimal financial structure for the issuer may not be the most profitable for the firm that is selling and marketing the transaction. As an independent financial advisor, we work for the issuer alone and do not face the conflict of interest inherent in a relationship where structuring advice is provided to the issuer by transaction counter-party.

Regulatory Agencies - The IRS plans to be more active in reviewing transactions in the state and local government and healthcare industries. IRS examinations and audits can have a significant effect on an issuer’s ability to access the capital markets, result in substantial financial penalties and ultimately the loss of tax-exemption. The IRS is targeting transactions that are “banker-driven” – transactions where the investment banker or underwriter structures, prices, and sells the bonds without any independent verification on the pricing of the deal. An independent financial advisor provides issuers with an additional level of security and due diligence that the transaction is properly priced and structured.

MSRB Rule G-23 - The Municipal Securities Rulemaking Board states that there is an inherent conflict of interest when an investment bank or underwriting firm acts as both a financial advisor and an underwriter or broker-dealer to an issuer on the same transaction. The Municipal Securities Rulemaking Board has enacted Rule G-23 to provide disclosure and prevent this type of conflict. Below are some excerpts from Rule G-23:

Underwriting Activities - No broker, dealer, or municipal securities dealer that has a financial advisory relationship with respect to a new issue of municipal securities shall acquire as principal either alone or as a participant in a syndicate or other similar account formed for the purpose of purchasing, directly or indirectly, from the issuer all or any portion of such issue, or act as agent for the issuer in arranging the placement of such issue, unless

(i) if such issue is to be sold by the issuer on a negotiated basis,

(A) the financial advisory relationship with respect to such issue has been terminated in writing and at or after such termination the issuer has expressly consented in writing to such acquisition or participation, as principal or agent, in the purchase of the securities on a negotiated basis;

(B) the broker, dealer, or municipal securities dealer has expressly disclosed in writing to the issuer at or before such termination that there may be a conflict of interest in changing from the capacity of financial advisor to purchaser of or placement agent for the securities with respect to which the financial advisory relationship exists and the issuer has expressly acknowledged in writing to the broker, dealer, or municipal securities dealer receipt of such disclosure; and

(C) the broker, dealer, or municipal securities dealer has expressly disclosed in writing to the issuer at or before such termination the source and anticipated amount of all remuneration to the broker, dealer, or municipal securities dealer with respect to such issue in addition to the compensation referred to in section (c) of this MSRB rule, and the issuer has expressly acknowledged in writing to the broker, dealer, or municipal securities dealer receipt of such disclosure; or

(ii) if such issue is to be sold by the issuer at competitive bid, the issuer has expressly consented in writing prior to the bid to such acquisition or participation.

Source: Municipal Securities Rulemaking Board website (www.msrb.org)