Note: This Best Practice (BP) is one of a group of five relating to the sale of bonds. These five BPs should be read and considered in conjunction with each other because of the interaction of the processes to which they apply. The five BPs are:
Selecting and Managing the Method of Sale of Municipal Bonds
Selecting and Managing Municipal Advisors
Selecting Bond Counsel
Selecting Underwriters for Negotiated Bond Sales
Pricing Bonds in a Negotiated Sale
State and local governments select an underwriter team, which may include senior and co-managers, for the purpose of selling bonds though a negotiated sale. They may also select a selling group to assist with retail distribution. The primary role of the underwriter in a negotiated sale is to market the issuer's bonds to investors. Assuming thta the issuer and underwriter reach agreement on the pricing of the bonds at the time of sale, the underwriters are likely to provide ideas and suggestions with respsect to structure, timing, and marketing of the bonds being sold.
Issuers must keep in mind that the roles of the underwriter and the municipal advisor are separate, adversarial roles and cannot be provided by the same party. There is no federal law establishing an underwriter’s fiduciary responsibility to the issuer. Whereas, a municipal advisor represents only the issuer and the Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) establishes that municipal advisors have a fiduciary responsibility to the issuer. In considering the roles of underwriter and municipal advisor, it is important for the reader to know that Municipal Securities Rulemaking Board (MSRB) Rule G-23 prohibits the same broker-dealer from serving as both a municipal advisor and underwriter on the same transaction, and that the new Securities and Exchange Commission (SEC) Municipal Advisor Rule, effective July 1, 2014, has implications for the manner in which an underwriter may interact with an issuer. Issuers should understand and familiarize themselves with municipal advisor and underwriter responsibilities as discussed in the materials related to the SEC Municipal Advisor Rule. Resources to help issuers become familiar with the Rule are included in the References section of this document.
The issuer’s goal in a negotiated bond sale is to obtain the lowest possible borrowing cost for the bonds. To maximize the potential of this occurring, the issuer’s goal in the underwriter selection process is to select the underwriter(s) that has the best potential for obtaining the lowest borrowing cost. Those underwriters are typically the ones that have demonstrated both experience underwriting the type of bonds being proposed and the strongest marketing/distribution capabilities.
The Government Finance Officers Association (GFOA) recommends that, unless the issuer has sufficient in-house expertise and access to market information, it should hire an outside municipal advisor prior to undertaking a negotiated debt financing in order to assist the government with evaluating proposals from underwriters, selecting the underwriter(s) for the transaction, and executing the bond sale. Additionally, governments should carefully review materials related to the SEC’s Municipal Advisor Rule and how this rule affects the manner in which underwriters may interact with issuers. Standards related to the selection of underwriters should also be included in a government’s debt management policy.
GFOA further recommends the use of a Request for Proposal (RFP) process when selecting underwriters in order to promote fairness, objectivity and transparency. The RFP process allows the issuer to compare respondents and helps the issuer select the most qualified firm(s) based on the evaluation criteria outlined in the RFP. An issuer and its municipal advisors should have a clear understanding of the issuer’s underwriting needs and should carefully develop an RFP that complies with state and local bidding requirements (including the use of regional, local or disadvantaged firms if deemed appropriate by the issuer).
A negotiated bond sale does not entail the purchase of any goods or services by an issuer from an underwriter. Therefore, an RFP process for underwriters should not be treated as a procurement process for goods or services, notwithstanding the obligation of the issuer to comply with state and/or local procurement requirements. The only legal relationship between the issuer and an underwriter is created by a Bond Purchase Agreement signed at the time of the pricing of the bonds, wherein the issuer agrees to sell the bonds to the underwriter and the underwriter agrees to purchase the bonds from the issuer at an agreed upon price. However, an issuer may wish to sign an non-binding letter of intent with the underwriter(s) at an earlier state of the transaction to asssit the underwriter in complying with certain provisions of the SEC's Municipal Advisor Rule, as discussed in the GFOA's MA Rule Alert and the SEC's Frequently Asked Questions related to the registration of municipal advisors
An RFP process can result in selection of one or more underwriters for a single transaction or result in identification of a pool of underwriters from which firms will be selected over a specific period of time for a number of different transactions. This may also include senior managers and co-managers. Each issuer should weigh the advantages and disadvantages of each type of arrangement with the assistance of its municipal advisor. Additionally, the use and selection of underwriters may vary depending on the level of municipal market knowledge, expertise and experience of the issuer’s staff.
No firm should be given an unfair advantage in the RFP process. Procedures should be established for communicating with potential proposers, determining how and over what time period questions will be addressed, and determining when contacts with proposers will be restricted.
Request for Proposal Content. The RFP should include at least the following components:
- A clear and concise description of the contemplated bond sale transaction or financing program.
- A statement noting whether firms may submit joint proposals. In addition, the RFP should state whether the issuer reserves the right to select more than one underwriter for a single transaction.
- A description of the objective evaluation and selection criteria and explanation of how proposals will be evaluated.
- A requirement that all underwriter compensation structures be presented in a standard format. Proposers should identify which fees are proposed on a “not-to-exceed” basis, describe any condition attached to their fee proposal, and explicitly state which costs are included in the fee proposal and which costs are to be reimbursed.
- A requirement that the proposer provide at least three references from other public-sector clients, preferably clients where the firm provided underwriting services similar to those proposed to be undertaken as the result of the RFP.
Requested Proposer Responses. RFPs should include questions related to the areas listed below to distinguish firms’ qualifications and experience, including but not limited to:
- Relevant experience of the firm and the individuals assigned to the issuer, and the identification and experience of the individual in charge of day-to-day management of the bond sale, including both the investment banker(s) and the underwriter(s).
- A description of the firm’s bond distribution capabilities including the experience of the individual primarily responsible for underwriting the proposed bonds. The firm’s ability to access both retail and institutional investors should be described.
- Demonstration of the firm’s understanding of the issuer’s financial situation, including ideas on how the issuer should approach financing issues such as bond structures, credit ratingstrategies and investor marketing strategies.
- Demonstration of the firm’s knowledge of local political, economic, legal or other issues that may affect the proposed financing.
- Documentation of the underwriter’s participation in the issuer’s recent competitive sales or the competitive sales of other issuers in the same state.
- Analytic capability of the firm and assigned investment banker(s).
- Access to sources of current market information to provide bond pricing data before, during and after the sale.
- The amount of uncommitted capital available and the ability and willingness of the firm to purchase the entire offering of the issuer, if necessary, in the case of a firm underwriting.
- Disclosure by the underwriter of any conflicts of interest, as stated in MSRB Rule G-17, including finder’s fees, fee splitting, or other contractual arrangements of the firm that could present areal or perceived conflict of interest. Additionally, the firm should disclose if there are any pending investigations of the firm or enforcement or disciplinary actions imposed on the firm within the past three years by the SEC or other regulatory bodies.
Additional Considerations. Issuers should also consider the following in conducting the underwriter selection process:
- Take steps to maximize the number of respondents by posting the RFP on your website, using the resources of your municipal advisor, sending to firms that specialize in your type of credit, using mailing lists, media advertising, and using the resources of the GFOA.
- Give adequate time for firms to develop their responses to the RFP. Two weeks should be appropriate for all but the most complicated RFPs.
- Establish evaluation procedures and a systematic rating process based on objective criteria in the RFP, conduct interviews with proposers, and undertake reference checks. Where practicable, one individual should check all references using a standard set of questions to promote consistency. To remove any appearance of a conflict of interest resulting from political contributions or other activities, elected officials should not be part of the selection team.
- Document and retain the description of how the selection was made and the rankings of each firm.
Underwriter’s Compensation. The underwriter in a negotiated sale is compensated in the form of an underwriter’s discount, which consists of the negotiated difference between the amount the underwriter pays the issuer for the bonds and the amount the underwriter expects to receive selling the bonds to investors. The underwriter’s discount is also commonly referred to as the “spread” or “takedown”. The takedown is the sales commission on the transaction. Current market levels of takedown can be determined by the issuer in consultation with its municipal advisor just prior to the time of negotiation. The takedown is the primary component of the potential profit to an underwriter in a bond sale. The issuer must weigh the impact of takedown on the resulting true interest cost to the bond issuer. An inadequate takedown may result in less aggressive marketing of the bonds and a higher interest cost to the issuer. A fair balance must be struck between a “market rate” takedown and the interest rate on the bonds. Less common forms of underwriter compensation include the management fee and underwriting fee. Issuers should consult with their municipal advisor as to the appropriateness of including management or underwriting fees as part of their underwriter compensation. Costs of issuance and other transaction-related expenses (e.g., credit rating agency fees, CUSIP fees, official statement printing fees) should only be at cost without any additional markup. Any underwriter-related expenses (e.g., underwriter’s counsel fees, travel expenses, administrative overhead) should be clearly identified and negotiated in advance of the bond sale.
Issuers should include a provision in the RFP which prohibits any firm from engaging in activities on behalf of the issuer that produce a direct or indirect financial gain for the firm, other than the agreed upon compensation, and requires disclosure of other conflicts of interest to the issuer.
Procedures should be established for communicating with potential proposers, determining how and over what time period questions will be addressed, and determining when contacts with proposers will be restricted. Readers should also familiarize themselves with the GFOA G-17 Alert and sample disclaimer language about acknowledging the underwriter’s G-17 disclosures.
Finally, as noted above, it is important for issuers to understand and become familiar with municipal advisor and underwriter responsibilities as discussed in the materials related to the SEC’s Municipal Advisor Rule.