The Underwriter's Own Duties

The underwriter is the only participant in a municipal offering with obligations running in two directions at once. To investors it owes a reasonable basis for the securities it recommends, which requires it to examine what the issuer says rather than transmit it. To the issuer it owes fair dealing, along with a plain statement that its interests are not aligned with the issuer's. Neither duty substitutes for the other.

The conditions that precede a bid

Two conditions are stated in the federal rule and both are absolute. Before bidding for, purchasing, offering or selling the securities, the dealer must obtain and review an official statement that the issuer deems final as of its date, subject only to the omission of pricing and closely related terms. Before purchasing or selling, it must have reasonably determined that the issuer or obligated person has undertaken in writing, for the benefit of holders, to provide annual information, audited statements when available and notices of listed events.

Both conditions are drafted around the word review rather than receive. A document collected and filed unread does not satisfy the first; a form of undertaking accepted without checking that it names the right obligated persons and specifies the categories, accounting basis and annual date does not satisfy the second. The rule places the dealer, not the issuer, at the point where these things are checked.

What a reasonable basis requires

The reasonable basis standard is not defined by a checklist, and its content scales with the transaction. The recurring elements are familiar: a review of the audited statements and the auditor's communications to management, inquiry into interim results and budget amendments, examination of the security documents against the summaries in the offering document, direct verification of the repository record rather than reliance on a description of it, and interviews with the officials responsible for each area of the disclosure.

Reliance on other participants is permitted but bounded. An underwriter may take comfort from an auditor's report, from an engineer's feasibility study and from counsel's summaries of the security documents, and it need not duplicate their work. What it may not do is treat their involvement as answering questions within its own competence, such as whether the offering document describes a known deterioration in collections. The distinction is between relying on an expert's conclusion and outsourcing the judgment about what the document should say.

Where a conduit borrower is the source of repayment, the same exercise runs against the borrower, and the underwriter cannot rely on the issuer's limited knowledge of it. Where a project depends on projections, the inquiry extends to the assumptions behind them and to the qualifications of whoever prepared them. The output of all this is a file, and the file is what later demonstrates that a basis existed at the time rather than in retrospect.

Duties owed to the issuer

Board rules impose an obligation to deal fairly with all persons and prohibit deceptive, dishonest or unfair practices. Applied to an underwriting, that obligation produces a set of disclosures made to the issuer at the outset: that the underwriter's primary role is to purchase the securities for resale in an arm's length commercial transaction, that it has financial and other interests differing from the issuer's, and that it is not acting as a municipal advisor and has no fiduciary duty to the issuer under the federal advisory provisions.

Further disclosure is owed about the transaction itself. Material conflicts, including compensation contingent on closing and any payments to third parties in connection with the offering, are disclosed. Where a complex structure is proposed, the underwriter describes the material financial characteristics and the material risks of that structure, because an issuer receiving a recommendation from a party who profits from it needs the recommendation's downside stated.

Allocation and the order period

A separate body of board rules governs how a primary offering is conducted among dealers: the terms on which orders are taken, the priority provisions that determine which categories of order are filled first, the disclosure of those provisions to the syndicate, and the allocation of securities consistent with them. These rules are about the integrity of the distribution rather than about disclosure, but they bear on the issuer directly because a distribution conducted against the stated priorities affects the price the issuer obtains.

Competitive and negotiated sales place the rules differently. In a competitive sale the price is set by bid and the underwriter arrives after the document is largely written, which compresses its review into a short window and makes the preliminary document the principal basis for it. In a negotiated sale the underwriter is present through structuring and drafting, which gives it more information and correspondingly less room to say that a defect in the document was outside its knowledge.

They also interact with fair dealing. Representations to an issuer about the composition of the order book, or about the demand that supported a repricing, are statements the fair dealing obligation reaches. The information underlying those representations sits with the underwriter alone, which is precisely the asymmetry the rule addresses.

Where the review meets the issuer's record

The two sides of the transaction converge on the repository. What the issuer filed, when it filed, and whether the filings contained what was promised are facts the underwriter can check independently, and a discrepancy between that record and the compliance statement in the draft offering document is the single most common finding in a diligence file. The drafting of that statement is described in what must be said about a missed filing.

Where the record is clean, the review is shorter but not absent, because the underwriter still has to test the substance of what the document says about finances and security. The allocation of responsibility for those sections is set out in the official statement and the parties responsible for it, and the consequences when the allocation fails are described in enforcement actions over municipal disclosure.