The SEC’s municipal advisor exam findings

Municipal advisors’ most common examination deficiencies are maintaining books and records, travel and entertainment expenses, and service contracts, officials from the Securities and Exchange Commission said in a virtual conference on Thursday.

Karla Serna, a senior staff accountant at the SEC’s Chicago regional office said that one of the largest problems municipal advisors face in maintaining accurate and up to date books and records as required by rule is maintaining records of written communication.

Municipal advisors know that they are “required to keep their originals and copies of all written correspondence as paper as well as electronic communication,” Serna said, and often struggle with retaining their messages and text messages.

Deleted email messages must be archived in order to comply with the Commission’s rules on written communications.

“I always suggest checking your third party provider or your cloud server to make sure that they’re set up to capture that deleted folder or any messages that are deleted and then wiped off the system after a certain amount of days to make sure that they’re being retained in accordance with the rules and regulations,” Serna said.

Text messaging is also deemed written communication by the Commission and must be archived and like all communications must be retained by the firm for five years.

“The same goes for text messaging, if you’re allowing personnel to use text, those messages are a record of the firm,” Serna said. “If the use of text messaging is prohibited by your firm, based on your policies and procedures, you should have a process in place to determine if your personnel are adhering to your policy.”

Also, if you’re reviewing email or text message correspondence and you’re seeing very little communication between your representative and your clients, you should “use a little bit of skepticism and try to determine if that communication is happening in a medium that you may not be capturing,” Serna said.

If internal controls around communications are loose, there are service providers out there that can capture specific text and email messages related to a specific topic.

But written communications and records often encompass much more than just direct correspondence, and one of the biggest exam deficiencies the Commission sees is a firm’s inability to maintain written consents to service of process for personnel who are engaged in activities with the municipal advisor.

“Firms should be incorporating a review for consents to service to make sure that they’re compliant,” Serna said. Firms often fail to implement an internal policy for maintaining those records.

Travel and entertainment expenses have also been a major deficiency observed in SEC exams, despite the fact that these have not been as much of an issue since the onset of COVID-19 and related lockdown measures.

“The big issue that we know in this area has to do with the firm’s ability to review for compliance with MSRB rule G-20, which is the gift and gratuity rule,” Serna said.

The rule says that the gifts must be non frequent, and not so excessive as to raise a question of providers. “We found that the way firms are tracking these expenses fall short of allowing them to be in full compliance with the rule,” Serna said.

Tracking these expenses must be done in a way that allows the firm to aggregate on a per recipient basis. Not implementing that kind of tracking shows the Commission that the firm is unable to reasonably supervise the entertainment expenses, Serna said. Small firms may be able to tell examiners easily how much they’re spending per client, but for larger firms, that becomes a lot more difficult to estimate.

These concerns by the Commission have slowed down slightly in the COVID-19 era, but they expect them to pick up again as travelling and meeting in person returns to normal.

Engagement or service contracts is another area where Commission staff see exam deficiencies, as the engagement letter should be reflecting the services provided and the compensation for those services.

“They should be disclosing any expenses associated with the advisory relationship and for the activities being performed,” Serna said.

The Commission is noticing instances where firms are charging their clients for consistent expenses for general services performed during a bond offering, such as computing and structuring, phone delivery and copy and drafting services, Serna said.

“Things of that nature that come up on almost every offering, but those expenses or services are not being disclosed on the contract,” Serna said.

Firms should also include services in the contracts they’re providing to clients. “If it’s something that you’re doing in practice, as part of servicing your client, you should make sure that’s included,” Serna said.

Documenting many of these services becomes arduous and some have begun consulting outside counsel to help with the documentation.

“We’ve used outside compliance counsel to review our engagement letters,”said Jerry Ford, president at Ford Associates, a Florida based financial advisory firm. “Every time we try to make it a little bit tighter, they want to expand it back out. So it includes all of those things that we normally do and then it includes those things that may come up on a semi-regular basis.”

Mark Zehner, deputy chief of the SEC’s Public Finance Abuse in the Division of Enforcement had a few recommendations to close out the presentation.

First, don’t try to conduct advisory activities without first getting fully registered with both the SEC and the MSRB and have someone take and pass the Series 50, Zehner said. The Series 50 exam is required for municipal advisor representatives.

“We’ve had to bring cases against people who simply have conducted full fledged municipal advisory activities out to closing without ever being registered,” Zehner said. “That is not a good idea. Don’t do it.”

In respect to what should be included in engagement letters, Zehner made a different point than Serna. “Sometimes the most critical thing in your engagement letter is what you are not going to do, what you have not agreed to do,” he said.

Zehner’s third pillar of recommendations boiled down to transparency.

“Don’t hide how you got the business or how you’re going to get paid,” he said. “Similarly, don’t take money that isn’t very clearly authorized by your client. If you are saying that you’re going to assist in preparing the official statement, then assist in preparing the official statement.”

“Everything you’ve heard so far today, take seriously,” Zehner said.