Episode Transcript:  Robert Doty PART II

Johan –  It seems to me that the current dialogue and the state of affairs is proof that this is an important function that needs to be somewhat standardized and regulated. 

Robert – I believe that.

Johan – This is just a natural evolution of capital markets and the identification of a role in capital markets that necessary.  That's my view of it.  So I think it probably should happen.

Robert – I fully support what you said.  You know to me, the financial advisory profession has never become what it could become.  It has never gained the level of professionalism that it can gain.  There are some very good firms, and I don't mean to tarnish the entire profession because there are a number of firms that are very, very good.  They tend to be in the leadership of the Financial Advisors Association.  Having said that, I think that we all, including myself, can benefit from having first class continuing education as changes occur in the market.  Training is very important.  Ethical training is very important.  Because I think a number of financial advisors really are just, they are almost underwriters in the way they go about it.  Sometimes they even do distribute securities, and I think it raises a lot of questions about broker-dealer regulation and that sort of thing.  To me the profession has never become what it could become.  I really think that for the tens of thousands of small issuers, especially now that the Government Finance Officers Association is recommending the use of financial advisors, we could really improve this profession.  It can make a huge difference in the market if the profession became what it could become. 

Johan – There are some who believe that financial advisors already need to register as investment advisors under the 1940's Act because they are providing advice as to the sale or structuring of securities.  Wouldn't that registration suffice in creating the regulatory governmental oversight over the industry?

Robert – Well you said investment advisors. 

Johan – Yeah, I know it doesn’t fit perfectly…

Robert – I don’t think structuring securities makes me an investment advisor.  I could see an argument that structuring securities might make me a broker-dealer.  I don't agree with it.  At Association annual conferences we've taken great pains to have SEC staff come talk with us.  In my case, for example, when I advise a client I don't use success fees.  I charge strictly by the hour.  I get paid regardless of what happens.  I don't deal with investors.  I don't sell securities.  I help my clients hire underwriters who do the marketing, and I don't agree that I'm a broker-dealer.  I'm certainly not an investment advisor because I'm not rendering advice to my clients on how to invest the monies from the bond issues.

Johan – Well therein lies one of the problems, right?  Because the vast majority of the financial advisors are not compensated the way you described, they're compensated with contingent upon settlement of the transaction.  If the deal goes through you get paid and if it doesn't, you don't and that's one of the big issues that you raise in your letter. 

Robert – Absolutely it's a big issue.  I continue to believe that the financial advisory function is different from a broker-dealer function.  But I can see an argument that would say that under those circumstances those firms ought to register as broker-dealers.  That has not happened.  The Commission is aware of the situation.  I wrote the Commission two years about it and raised the question about the wisdom of these contingent fees.  I think that one of the first things that needs to be done in regulation is to deal with the contingent fee issue.  I don't know all the answers.  I don't think I'm willing to say there should never, ever, ever be a contingent fee, but I think the discussions that occur with the issuer in its decision to use a contingent fee and the disclosures made to the issuer need to be regulated in some way.  The issuer's far better off with a non-contingent fee.  There are other advisors who, like me, don't charge contingent fees.  They charge either a fixed fee that is not contingent or, more likely, an hourly fee. 

Johan – NAIPFA doesn't want FAs to be regulated by MSRB.  They of course have suggested that they're the natural choice.  You have some concerns, you've raised some of those.  With some changes, perhaps, the MSRB is the right entity or is it the SEC or how do think this should shake out on who eventually regulates the financial advisors?

Robert – Well if I had my druthers, I would say it would be a reconstituted MSRB.  Short of that it would be the SEC.  I think that the MSRB has actually done a lot of good and I'm not here to try to beat up on the MSRB or to bash them or anything like that.  I strongly disagree with some things they've done but overall I think they have done a very nice job.  I really like the real time price transparency.  I think the EMMA system is going to be good and helpful in terms of continuing reporting.  It's going to create a situation in which we are really going to find out, once and for all, which issuers are filing their reports and which aren't.  I think the MSRB is undertaking a lot of positive initiatives.  I know the staff, I know Lynette Hotchkiss and others, and they're well motivated.  But the MSRB right now is a dealer organization, and as I said because those dealers are underwriters they are adversaries of my clients.  I would really be loath to be regulated by someone I'm suppose to be negotiating with on the other side of the table. 

One important area where I disagree with the Municipal Securities Rulemaking Board is with respect to its rule G-23.  I believe that the Board's actions with respect to the rule effectively disqualify the Board from regulating financial advisors in terms of the Board as presently constituted.  In this context the Board has generally provided that a dealer firm may serve as a financial advisor to an issuer, but then can switch into underwriting the securities by following certain formulaic steps.  These steps include informing the issuer that there “may” be a conflict of interest and getting the issuer's written consent.  There isn't any requirement that the information be given to the issuer's policy makers, and indeed there are many times when this "issuer consent" is provided by a minor issuer official.  In addition, there are dealer firms that use this approach really as a marketing tool.  They market themselves as financial advisors and then convince the issuers that the dealers ought to be underwriting the bonds.  I believe that is a terrible conflict of interest throughout the entire representation when this is the practice.  The underwriter is going to have its eye on the underwriting and the underwriting fees, rather than on providing impartial advice to an issuer about whether to proceed, whether a particular structure ought to be used, whether somebody else might be better as an underwriter for the issuer's securities, and so on.  I think that this whole range of conflicts is just too much.  One of the most significant problems with Rule G-23 is that it requires the underwriter only to inform the issuer that there “may” be a conflict of interest, not that there “is going to be” a conflict of interest.  But I think, as I illustrated in my discussion earlier, the conflict of interest is inherent when an underwriter is serving fully as underwriter and does not undertake the conflicting duty to advise the issuer as opposed to investors.  We have a body of law in the securities markets that says, in effect, you can't just tell your companion that there may be a step ahead when you know that only one foot away is the Grand Canyon.  In this case, you've got the financial advisor, a dealer firm who is permitted by Rule G-23 to suggest to an issuer that there may not be a conflict of interest, rather than making the affirmative statement that there is one, and rather than informing the issuer of what the conflicts are.  It's important to remember at the time all of this occurs, the resignation has not yet happened, so the financial advisor who's doing this is still subject to the fiduciary duty.  So I think that the Board has simply been unwilling to consider changing this rule.  They've had many opportunities to do it, and the Government Finance Officers Association has just come out against the Rule and said that this Rule is just completely unsatisfactory and we can't accept it.  So this is an important consideration on why the Board as presently constituted is simply not capable of regulating financial advisors, whether they are dealers or non-dealers.

Johan – There seems to be a flare-up related to these matters.  I hope that something positive comes out of this versus just talk.  It's people like you who take a real effort to put some ideas to paper that cause this to happen.  Are there any particular suggestions that you have in closing that you want to highlight for creating regulation for financial advisors, anything that we haven't covered yet that you want to bring attention to?

Robert – Well, I think that the regulation needs to focused on the fiduciary duty that the advisor owes the issuer and that should be the heart of it.  To that end I think requiring that individuals who engage in financial advisory activities with issuers pass qualifying examinations.  I would assume there's going to be a grandfathering provision for those who have done it for a minimum period at least, but requiring continuing education, requiring a fair dealing rule, rules that govern advertising, rules that would prohibit conflicts of interest, which would include prohibition on resignation to underwrite securities.  It would include regulation of contingent fees, not necessarily a prohibition but a regulation, and would regulate any other conflicts of interest.  I think there needs to be careful attention to avoiding unnecessary costs for small firms.  The small firms are very important.  There are many, many small firms.  Many of them don't even show up in the Red Book, and some of them are extremely good.  What we have to sell is our knowledge, just as a lawyer has knowledge to sell.  A lot of us can benefit from training so we can make those firms better, but we shouldn't be driving them out of business.  We don't need net capital rules because no one is holding client money, no one is investing for their clients, or if they are they should be a registered investment advisor.  We don't need audits because our financial condition isn't going to affect the clients’ monetary interests.  But we do need rules, I think, that regulate the quality of services, that professionalize the business, and that encourage issuers to seek independent advice so that they can make decisions.  When I render independent advice, I caution clients about whether they should go forward with the transaction as proposed.  I can point to several transactions just in the last three or four years that I've either told a client not to undertake at all or that I've recommended strongly that a client restructure, and they did, and we brought a good, sound transaction into the market.  And that's to investor's interests.  Another area where we would perform our job appropriately when clients want us to is when we assist with disclosure, if that's part the scope of our employment.  All of those would be areas that I would hope that regulation would cover. 

Johan– Some of these points that you've raised are highlighted in your letter to Congress, and if people wanted to read this, if they wanted to go to your website, where would they find that particular letter? 

Robert– At www.agfs.com on the home page there is a box that says something along the lines of special report and you can see the link and it says it’s a letter to Congress and the SEC and it can be downloaded there. 

End of PART II

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