Selecting and Managing Underwriters for Negotiated Bond Sales
Unless the issuer has sufficient in-house expertise and access to current 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.
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:
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. Underwriters often provide ideas and suggestions with respect to structure, timing, and marketing of the bonds being sold. In addition to the actual sale of bonds, underwriters often work with the municipal advisor (MA) and financing team in the municipal bond rating process
Issuers must keep in mind that the roles of the underwriter and the MA 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 MA represents only the issuer, and the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) establishes that municipal advisors have a duty of care and duty of loyalty (i.e.a fiduciary responsibility) to the issuer. In considering the roles of underwriter and MA, 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 MA and underwriter on the same transaction. The Securities and Exchange Commission (SEC) Municipal Advisor Rule, which became 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 both MA and underwriter responsibilities as discussed in the materials related to the SEC Municipal Advisor Rule.
The issuer's primary 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 MA prior to undertaking a negotiated debt financing in order to assist the issuer with evaluating proposals from underwriters, selecting the underwriter(s) for the transaction, and executing the bond sale. Additionally, the issuer 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 and/policies related to the selection of underwriters, including any goals related to diversity, equity, and inclusion (DE&I), 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 outline in the RFP. An issuer and its MAs 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). The RFP should be very clear as to the goal of the RFP, the required/scope of services being sought, contract timeframe, and type of relationship/communications needed throughout the specified PERIOD. In addition, the RFP should comply with applicable procurement requirements (i.e. diversity, equity, and inclusion and definitions thereof established by the entity).
A negotiated bond sale does not involve 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 and any issuer policies regarding DE&I. 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 a non-binding letter of intent with the underwriter(s) at an earlier state of the transaction to assist 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 the 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 MA. 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.
Procedures should be established for communicating with potential proposers, determining how and over what time period questions will be addressed, and determining when contact 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 requirement that firms provide a statement affirming that they are licensed as registered broker/dealers.
- 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 including a detailed break-down of fees including: management fee, underwriting fee, expenses, and take-down (commission).
- 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 and analytic capability 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 and 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 rating strategies 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 a real 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 to three weeks should be appropriate for most RFPs; however, the more complicated RFPs may require additional response time.
- Establish evaluation procedures and a systematic rating process based on objective criteria in the RFP, conduct interviews with proposers, if necessary, 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.
Finally, as noted above, it is important for issuers to understand and become familiar with MA and underwriter responsibilities as discussed in the materials related to the SEC’s Municipal Advisor Rule.
- Board approval date: Friday, February 28, 2014