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94-37 SEC Issues Interpretive Statement Regarding Municipal Securities Disclosures; Proposes Changes To Rule 15c2-12
Effective March 9, 1994, the Securities and Exchange Commission (SEC) published an interpretive statement regarding the disclosure obligations of participants in the municipal securities markets. The SEC is seeking comment on the issues discussed in its statement. In a companion release, the SEC published for comment proposed changes to Rule 15c2-12 under the Securities Exchange Act of 1934 (Act) that would prohibit broker/ dealers from underwriting and recommending municipal securities for which adequate information is not available. Comments on these issues are due on or before July 15, 1994.
In September 1993, the Staff of the SEC Division of Market Regulation reported to Congress on several aspects of the municipal securities market. One of the topics discussed was the disclosure requirements of various market participants.
According to the report, investors need sufficient current information about issuers to protect themselves from fraud and manipulation, to evaluate offering prices, to decide which municipal securities to buy, and to decide when to sell. In addition, the report found that, with the growing number of individual investors purchasing municipal securities, the need for sound recommendations by broker/dealers is assuming even greater importance.
As a result of these findings, the SEC decided to issue interpretive guidance regarding disclosure under the anti-fraud provisions of the federal securities laws. The SEC issued its statement March 9, 1994.
In a companion release, the SEC also proposed rule amendments to existing Rule 15c2-12. The amendments would prohibit a broker/dealer from underwriting an issue of municipal securities unless the issuer or its designated agent has undertaken in a written agreement or contract to provide certain information to a nationally recognized municipal securities information repository. Moreover, the proposed changes would prohibit a broker/dealer from recommending the purchase or sale of a municipal security without having reviewed the information the issuer has provided.
Description Of SEC Interpretive Statement
The SEC statement issued on March 9, 1994, focuses largely on the disclosure obligations of municipal securities issuers. It notes that, while disclosure by municipal issuers has significantly improved over the last two decades for primary offerings, concerns still exist, particularly for offerings of non-general obligation bonds and smaller issues. The statement goes on to note that secondary market disclosure practices present greater concerns.
In its statement, the SEC discusses the application of the anti-fraud provisions of the federal securities laws to disclosure in both the primary offering and secondary markets. The statement also addresses voluntary guidelines issued by the Government Finance Officers Association that have gained acceptance among a number of larger issuers. A significant portion of the statement focuses on areas where improvement is needed.
For the obligations of municipal securities broker/dealers, the statement reaffirms interpretations expressed by the SEC during the proposal and adoption of Rule 15c2-12 in 1989. According to the SEC, underwriters must have a reasonable basis for recommending any securities and, in fulfilling that obligation, they must review in a professional manner the accuracy of statements made in connection with the offering.
The SEC also emphasizes the responsibilities of broker/dealers trading securities in the secondary market. Unlike an underwriter, a broker/dealer ordinarily is not obligated to contact the issuer to verify information. However, if a broker/ dealer discovers any factors that indicate the disclosure is inaccurate or incomplete, or signal the need for further inquiry, a broker/dealer may need to obtain additional information, or seek to verify existing information.
Rule 15c2-12 Proposals
The SEC adopted Rule 15c2-12 to prevent fraud by enhancing the quality, timing, and dissemination of disclosure in the municipal securities market.
Proposed paragraph (b)(5) would prohibit a participating underwriter from purchasing or selling municipal securities in an offering without making a reasonable determination that the issuer or its designated agent has undertaken in a written agreement or contract to provide certain information to a nationally recognized municipal securities information repository (NRMSIR).
The information that must be provided includes:
- Current financial information, at least annually, concerning the issuer of the municipal securities and any significant obligors.
- Timely notice of the following events, if material:
The written agreement or contract also must specify the accounting principles used to prepare the audited financial statements; the financial and pertinent operating information being provided on an annual basis, in addition to audited financial statements; and the time within which the annual information for the preceding year will be provided to the NRMSIR.
Proposed paragraph (b)(5) requires the issuer or its designee to provide financial and operating information on "significant obligors" of an issuer of a municipal security in the final official statement and in annual financial information. The proposed amendments, in paragraph (f)(9), also define the term "significant obligor" as any person who, directly or indirectly, is the source of 20 percent or more of the cash flow servicing the obligations supporting the municipal securities payments of interest or principal.
As proposed, a new paragraph (c) prohibits any broker/dealer from recommending the purchase or sale of a municipal security unless such broker/dealer has reviewed the issuer's information. The proposed amendment does not specify the form in which information must be reviewed, or which documents must be obtained. The proposed amendment allows participants in the municipal securities market to obtain and review this information through any means of dissemination.
While the information may be available from documents placed in a repository, this may not be the only source of information. Broker/dealers may obtain this information directly from the issuer, from professionals such as attorneys, accountants, or other municipal securities dealers, or from any other reliable source. If, in reviewing this information, they suspect that disclosure is inaccurate or incomplete, or that it requires additional investigation, broker/dealers may need to obtain additional information or seek to verify existing information. If, however, the rating is known and information placed with a repository has been reviewed and raises no questions, a broker/dealer does not need to look further for information about the security recommended.
Consistent with other provisions of Rule 15c2-12, the proposed amendments only apply to primary offerings of municipal securities with an aggregate principal amount of $1 million or more.
The proposed amendments include a new exemption in paragraph (d)(2) that provides, in addition to the $1 million threshold applicable to Rule 15c2-12 generally, that offerings would be exempt if, at such time as the issuer of municipal securities delivers the securities to the participating underwriter, the issuer: (a) will have less than $10 million in aggregate amount of municipal securities outstanding, including the offered securities; and (b) the issuer will have issued less than $3 million in aggregate amount of municipal securities in the 48 months preceding the offering.
This exemption is designed to exclude small issuers that do not frequently issue municipal securities.
The proposed amendments also include a new exemption in paragraph (d)(3) to permit recommendations in the secondary market of securities that were not subject to the disclosure requirements in paragraph (b)(5), either because they were sold in a primary offering of municipal securities with an aggregate principal amount of less than $1 million, or because they came within the existing exemptions under newly designated paragraph (d)(1) for limited placements, short-term securities, and securities with demand features, or within the exemption in new paragraph (d)(2) for small, infrequent issuers.
Newly designated paragraph (g) of the rule contains a transitional provision for the proposed amendments, under which the provisions of paragraph (b)(5) apply to a participating underwriter that had contractually committed to act as an underwriter in an offering on or after the effective date of the rule change.
* * * * *
NASD members that conduct a municipal securities business are urged to review the SEC's interpretive statement in its entirety. A copy of the statement follows this Notice. The SEC is seeking comments on these issues and possible future action. The SEC also is requesting comment on the proposed amendments to Rule 15c2-12.
Members that wish to comment on either the interpretive statement or the Rule 15c2-12 proposed amendments should do so by July 15, 1994. Comment letters should refer to File No. S7-4-94 (Interpretive Statement) and File No. S7-5-94 (Rule 15c2-12 proposed rulemaking) and should be sent, in triplicate, to:
Jonathan G. Katz
450 Fifth Street, N.W.
Washington, D.C. 20549
Members are requested to send copies of their comment letters to:
1735 K Street, N.W.
Washington, D.C. 20006-1500
Questions concerning this Notice may be directed to Brad Darfler, District Coordinator, Compliance Department, (202) 728-8946.
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 211, 231, and 241
[Release No. 33-7049; 34-33741; FR-42; FILE NO. S7-JJ-94]
Statement of the Commission Regarding Disclosure Obligations of Municipal Securities Issuers and Others
AGENCY: Securities and Exchange Commission.
ACTION: Interpretation; Solicitation of comments.
SUMMARY: The Securities and Exchange Commission ("Commission") is publishing its views with respect to the disclosure obligations of participants in the municipal securities markets under the antifraud provisions of the federal securities laws, both in connection with primary offerings and on a continuing basis with respect to the secondary market. This interpretive guidance is intended to assist municipal securities issuers, brokers, dealers and municipal securities dealers in meeting their obligations under the antifraud provisions. The Commission is seeking comment on issues discussed in this release and possible future agency action.
DATES: This Interpretation is effective March 9, 1994.
Comments should be received on or before July 15, 1994. ADDRESSES: Comments should be submitted in triplicate to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., Stop 6-9, Washington, DC 20549. Comment letters should refer to File No. S 7-4-94. All comments received will be available for public inspection and copying at the Commission's Public Reference Room, 450 Fifth Street, NW., Washington, DC 20549.
FOR FURTHER INFORMATION CONTACT: Ann D. Wallace ((202) 272-7282), Amy Meltzer Starr ((202) 272-3654), Vincent W. Mathis ((202) 272-3968), Division of Corporation Finance; Janet W. Russell-Hunter (with respect to Sections III.C.6. and V.) ((202) 504-2418), Division of Market Regulation, U.S. Securities and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549.
SUPPLEMENTARY INFORMATION: In a companion release, the Commission is proposing rule amendments that prohibit a broker, dealer or municipal securities dealer from underwriting a municipal issue unless the issuer agrees to disseminate information to the secondary market and from recommending the purchase of a municipal security without reviewing such information.
The recent high volume of municipal securities offerings, as well as the growing ownership of municipal securities by individual investors, has highlighted the need for improved disclosure practices in the municipal securities market, particularly in the secondary market. To encourage and expedite the ongoing efforts by market participants to improve disclosure practices, and to assist market participants in meeting their obligations under the antifraud provisions, the Commission is publishing its views with respect to disclosures under the federal securities laws in the municipal market.
This interpretive release addresses the following:
- Disclosure of potential conflicts of interest and material financial relationships among issuers, advisers and underwriters, including those arising from political contributions;
- Disclosure regarding the terms and risks of securities being offered;
- Disclosure of the issuer's or obligor's financial condition, results of operations, and cash flows. This information should include audited financial statements (or disclosure that the financial statements were not subject to audit) and an explanation of the accounting principles followed in the preparation of the financial statements, unless the statements were prepared in accordance with generally accepted accounting principles ("GAAP") or accompanied by a quantified explanation of any deviation from GAAP;
- Disclosure of the issuer's plans regarding the provision of information to the secondary market; and
- Timely delivery of preliminary official statements to underwriters and potential investors.
Basic mechanisms to address potential antifraud liability include:
- Publication of financial information, including audited financial statements and other financial and operating information, on at least an annual basis;
- Timely reporting of material events reflecting upon the creditworthiness of the issuer or the obligor and the terms of its securities, including material defaults, draws on reserves, adverse rating changes and receipt of an adverse tax opinion; and
- Submission of such information to an information repository.
As detailed in the recent Staff Report on the Municipal Securities Market, the market for municipal securities is characterized by great diversity and high volume. Issuers, estimated to number approximately 50,000, include state governments, cities, towns, counties, and special subdivisions, such as special purpose districts and public authorities. It is estimated that there currently are 1.3 million municipal issues outstanding, representing approximately $1.2 trillion in securities.2 In 1993, a record level of over $335 billion in municipal securities was sold, representing over 17,000 issues. This record financing was heavily influenced by refundings. Nevertheless, the level of long term new money financings, representing 49% of financings for the year, reflected continued growth. In 1993, there were $142 billion of new money long term financings, compared to $81 billion in 1988, a 75% increase.
In recent years, the forms of securities used to meet the financing needs of these issuers have become increasingly diverse and complex. For example, conduit bonds, certificates of participation, and a variety of derivative products have joined3 traditional general obligation and revenue bonds as prevalent forms of municipal financing.4
In addition, there has been a change in the investor profile in the municipal securities market. By 1992, individual investors, including those holding through mutual funds, held 75% of the municipal debt outstanding, compared to 44% in 1983.5
Along with the changing investor profile, there has been a change in investor strategy. Traditionally, municipal bondholders have been buy and hold investors; however, this strategy has changed significantly with the growth and development of municipal bond funds. Many of these funds actively trade their portfolio securities to take advantage of market conditions or to meet redemption needs.
As the agency charged with administering the federal securities laws and overseeing this nation's securities markets, the Commission has an obligation to protect investors in the municipal markets from fraud, including misleading disclosures. As the New York Qty report stated nearly two decades ago:
By virtue of the large dollar volume of municipal securities issued and outstanding each year, such securities are a major factor in the Nation's economy and the national securities markets. In light of the national scope of the municipal securities markets, there is an overriding federal interest in assuring that there is adequate disclosure of all material information by issuers of municipal securities.
Although municipalities have certain unique attributes by virtue of their political nature, insofar as they are issuers of securities, they are subject to the proscription against false and misleading disclosures.6
The burgeoning volume and complexity of municipal securities offerings, as well as the retail nature of the market, heighten the need for market participants to seek to prevent fraud through the timely provision of material information concerning municipal issuers and securities.
While Congress exempted offerings of municipal securities from the registration requirements and civil liability provisions of the Securities Act of 1933,7 and a mandated system of periodic reporting under the Securities Exchange Act of 1934,8 it did not exempt transactions in municipal securities from the coverage of the antifraud provisions of section 17(a) of the Securities Act,9 section 10(b) of the Exchange Act, and Rate 10b-5 promulgated thereunder.10 These antifraud provisions prohibit any person, including municipal issuers and brokers, dealers and municipal securities dealers, from making a false or misleading statement of material fact, or omitting any material facts necessary to make statements made by that person not misleading, in connection with the offer, purchase or sale of any security. In addition, brokers, dealers and municipal securities dealers are subject to regulations adopted by the Commission, including those regulations adopted to define and prevent fraud.11 Municipal securities dealers are also subject to rules promulgated by the Municipal Securities Rulemaking Board ("MSRB").12
In the absence of a statutory scheme for municipal securities registration and reporting, disclosure by municipal issuers has been governed by the demands of market participants and antifraud strictures. Spurred by the New York City fiscal crisis in 1975 and the Washington Public Power Supply System defaults,13 participants in the municipal securities market have developed extensive guidance to improve the level and quality of disclosure in primary offerings of municipal securities, and to a more limited extent, continuing disclosure in the secondary market.
In 1989, the Commission adopted Rule 15c2-12 under the Exchange Act14 to enhance the quality and timeliness of disclosure to investors in municipal securities.15 The rule requires that underwriters (both bank and non-bank) of primary offerings of municipal securities with an aggregate principal amount of $1,000,000 or more obtain and distribute to their customers the issuers' official statements for the offerings. This mechanism provides underwriters an opportunity to review the issuer's disclosure documents before commencing sales to investors.16
There is a consensus that, over the last two decades, these market and regulatory efforts have improved significantly the quality of primary offering disclosure in the municipal securities markets.17 Nonetheless, there continue to be concerns with the adequacy of municipal offering disclosure, particularly with respect to offerings of non-general obligation bonds and smaller issues.18
Secondary market disclosure practices present greater concerns. Recent highly publicized defaults19 and refundings,20 as well as the tremendous level of issuances during the past two years, have heightened interest in municipal secondary market disclosure. 21 The PSA has testified that today "secondary market information is difficult to come by even for professional municipal credit analysts, to say nothing of retail investors." 22 Substantial issuer information, in the form of official statements, state-required reports, and other public documents, is available from the approximately 20% of municipal issuers that come to market frequently, accounting for 80% of the dollar volume of municipal securities issued.23 However, the remaining issuers, representing 20% in dollar volume but 80% in number, which come to the market much less frequently, provide substantially less continuing information. Many of these issues are health care issues, housing issues, industrial development bonds, and other conduit financings,24 financing sectors which have had the greatest incidence of defaults, both monetary and technical.25 In addition, information often is unavailable for smaller issues of securities of general purpose units of government and the securities of special purpose districts and authorities.26
In response to a request by Commission Chairman Arthur Levitt for a recommended "market-participant sponsored solution" to the disclosure issues in the municipal securities market, on December 20, 1993,12 groups and associations representing a broad range of market participants submitted to the Commission a Joint Statement on Improvements in Municipal Securities Market Disclosure (the "Joint Statement").27 The Joint Statement sets forth "a framework for improving the availability of information in the marketplace" that calls for both continued market initiatives to improve issuer disclosure and "support from the SEC and the Municipal Securities Rulemaking Board (MSRB)." 28 Among other things, its participants recommend the adoption of a rule or interpretive guidance restricting underwriting of municipal issues unless continuing information covenants are provided by the issuer.
The antifraud provisions of the federal securities laws prohibit fraudulent or deceptive practices in the offer and sale of municipal securities.29 Disclosure documents used by municipal issuers, such as official statements, are subject to the prohibition against false or misleading statements of material facts, including the omission of material facts necessary to make the statements made, in light of the circumstances in which they are made, not misleading. The adequacy of the disclosure provided in municipal security offering materials is tested against an objective standard: an omitted fact is material if there is a substantial likelihood that, under all the circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable [investor]. Put another way, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the "total mix" of information made available.30
In the primary offering of municipal securities, the extensive voluntary guidelines issued by the Government Finance Officers Association ("GFOA") have received widespread acceptance and, among a number of larger issuers, have been viewed as "in essence obligatory rules." 31 Other groups, including the National Federation of Municipal Analysts ("NFMA"), have published voluntary disclosure guidelines covering industry specific sectors, including among others, housing, student loans, transportation and health care.32 In connection with the offering of municipal securities, the GFOA Guidelines call for: 33
- An introduction to serve as the guide to the official statement;
- A description of the securities being offered, including complete information regarding the purposes of the offering, the plan of financing, the security and sources of repayment, and the priority of the securities, as well as structural characteristics, such as call provisions, tender options, original issue or deep discount, variable rates, and lease purchase agreements;
- Information regarding the nature and extent of any credit enhancement and financial and business information about the issuer of the enhancement;
- A description of the government issuer or enterprise, including information about the issuer's range or level of service, capacity and demographic factors and, in the case of revenue supported offerings, information on the enterprise's organization, management, revenue structure, results of operations and operating plan;
- With respect to obligations of private profit making and nonprofit conduit issuers, information regarding the business or other activity, including the enterprise's form of organization and management, rate-making or pricing policies, and historical operations and plan of operation;
- A description of the issuer's, outstanding debt, including the authority to incur debt, limitations on debt, and the prospective debt burden and rate of its retirement;
- A description of the basic documentation, such as indentures, trust agreements and resolutions authorizing the issuance and establishing the rights of the parties;
- Financial information, including summary information regarding the issuer's or obligor's financial practices and results of operations, and financial statements, prepared in conformity with generally accepted accounting principles and audited in accordance with generally accepted auditing standards;
- A discussion of legal matters, such as pending judicial, administrative, or regulatory proceedings that may significantly affect the securities offered, legal opinions, and tax considerations; and
- A discussion of miscellaneous matters, including ratings and their description and meanings, underwriting arrangements, arrangements with financial advisors, interests of named experts, pending legislation, and the availability of additional information and documentation.
Information concerning financial and business relationships and arrangements among the parties involved in the issuance of municipal securities may be critical to an evaluation of an offering.35 Recent revelations about practices used in the municipal securities offering process have highlighted the potential materiality of information concerning financial and business relationships, arrangements or practices, including political contributions, that could influence municipal securities offerings. For example, such information could indicate the existence of actual or potential conflicts of interest, breaches of duty, or less than arm's-length transactions. Similarly, these matters may reflect upon the qualifications, level of diligence, and disinterestedness of financial advisers, underwriters, experts and other participants in an offering. Failure to disclose material information concerning such relationships, arrangements or practices may render misleading statements made in connection with the process, including statements in the official statement about the use of proceeds, underwriters' compensation and other expenses of the offering. In addition, investors reasonably expect participants in municipal securities offerings to follow standards and procedures established by such participants, or other governing authorities, to safeguard the integrity of the offering process; accordingly, material deviations from those procedures warrant disclosure.
Existing rules and voluntary guidelines call for certain specific disclosures by offering participants. GFOA guidelines call for offering statement disclosure to investors of contingency fees to named experts, including counsel, and any other interest or connection those parties have with other transaction participants.36 MSRB rules call for dealer disclosure to issuers and investors of any financial advisory relationship between an issuer and a broker, dealer, or municipal securities dealer, under certain circumstances.37 MSRB rules also call for dealer disclosure to investors of, among other things, certain fees and expenses in negotiated transactions.38 Beyond existing specific disclosure requirements and guidelines, the range of financial and business relationships, arrangements and practices that need to be disclosed depends on the particular facts and circumstances of each case. If, for example, the issuer (or any person acting on its behalf) selects an underwriter, syndicate or selling group member, expert, counsel or other party who has a direct or indirect (for example, through a consultant) financial or business relationship or arrangement with persons connected with the offering process, that relationship or arrangement may be material.39 Areas of particular concern are undisclosed payments to obtain underwriting assignments and undisclosed agreements or arrangements, including fee splitting, between financial advisers and underwriters.40 If the adviser is hired to assist the issuer, such relationships, financial or otherwise, may divide loyalties. Similarly, affiliations between sellers of property to be used in a financed project and conduit borrowers raise questions regarding, among other things, the determination of fair market value of the property and self-dealing.
Evolution in the financial markets has led to increasingly complex and sophisticated derivative and other municipal products. While these new products offer investors a wide range of investment alternatives, in choosing among the alternatives, investors need a clear understanding of the terms and the particular risks arising from the nature of the products.41
In particular, investors need to be informed about the nature and effects of each significant term of the debt, including credit enhancements and risk modifiers, such as inverse floaters and detachable call rights. Investors in these securities should be aware of their exposure to interest rate volatility, under all possible scenarios. In addition, any legal risk concerning the issuer's authority to issue securities with unconventional features needs to be disclosed. The PSA recently has identified disclosure that should be provided in connection with the offer of financial instruments that include such features as auction and swap-based inverse floaters and embedded cap bonds.42
Credit enhancements are used with increasing frequency in the municipal market. According to published information, over 37% of the dollar volume of new long term issues carry some form of credit enhancement.43 The existence of bond insurance or other credit enhancement creates the need for disclosure concerning the provider of the credit enhancement and the terms of the enhancement44 to avoid misleading investors concerning the value of the enhancements provided and the party's ability to fund the enhancement. The GFOA recommends that appropriate financial information about the assets, revenues, reserves and results of operations of credit enhancers be provided in the official statement. In determining the extent of disclosure, consideration should be given to the amount of the enhancement relative to the income and cash flows of the issuer or obligor, conditions precedent to application of the enhancement, duration of the enhancement, and other factors indicating a material relationship between the enhancement and the investor's anticipated return.
In a trend that has become increasingly common, municipal bond insurers are including in indentures provisions that appear to delegate to the bond insurer the ability to modify terms of the indenture, prior to default, without the consent of, or even prior notification to, bondholders.45There should be clear disclosure of any such provision that may have a material impact on the rights of bondholders or the obligations of the issuer, including the specific material rights of the bondholder that could be so altered.
Although there continues to be some diversity in the financial reporting practices used in preparing financial statements of governmental issuers, practice in the municipal market is evolving rapidly to reliance on generally accepted accounting principles ("GAAP") as determined by the Government Accounting Standards Board ("GASB").48 Only two years after GASB was founded in 1984, financial statements prepared in accordance with GAAP, as promulgated by GASB, were required by 75.2% of cities, 78.3% of counties and 69% of school districts responding to a research survey.49 Forty-six states currently require, or are in the process of establishing a requirement, that state government financial statements be presented in accordance with GAAP.50 In addition, local as well as state governments that receive significant amounts of federal aid must prepare financial statements in accordance with GAAP or provide information concerning variance from GAAP.51
The GFOA Guidelines call for financial statements that are either prepared in accordance with GAAP or accompanied by a quantified (if practicable) explanation of the differences.52 To avoid misunderstanding, investors need to be informed of the basis for financial statement presentation. Accordingly, when a municipal issuer neither uses GAAP nor provides a quantified explanation of material deviations from GAAP, investors need a full explanation of the accounting principles followed.
Accordingly, the offering statement should state whether the financial statements it contains were audited in accordance with generally accepted auditing standards ("GAAS"), as established by the American Institute of Certified Public Accountants.
There are a number of areas in which greater care needs to be taken to provide investors with adequate information. In a pooled financing structure, such as that used by bond banks, in addition to providing financial information concerning the issuing authority or program in the aggregate, it may be necessary to provide information on participating obligors. This will depend on diversification and risk concentration factors, such as the significance of any single obligor to the overall financing.
Conduit bond issuers need to provide operational information concerning the activities of the private enterprise that will provide the cash flows to service the debt—for example, financial reporting, legal proceedings, changes in indebtedness, defaults and other significant developments relating to the underlying corporate obligor. Where the issuing authority in a conduit financing has no remaining obligation for the repayment of the indebtedness, in providing financial information about the issuing entity (as compared to the obligor on the bonds), care must be taken to avoid misleading investors regarding the sources of repayment.56
Municipal issuers also must consider disclosure issues arising from their activities as end users of derivative products. For example, the use of non-exchange traded derivatives to alter interest rate risk exposes the issuer to counterparty credit risk. Disclosure documents need to discuss the market risks to which issuers are exposed, the strategies used to alter such risks and the exposure to both market risk and credit risk resulting from risk alteration strategies. The NFMA has published sector specific secondary market disclosure guidelines calling for a discussion of the issuer's use of derivative products, especially interest rate swaps.57
Moreover, in addition to financial and operating data, the official statement may need to include a narrative explanation to avoid misunderstanding and assist the reader in understanding the financial presentation. A numerical presentation alone may not be sufficient to permit an investor to judge financial and operating condition of the issuer or obligor.58 For example, it may be necessary to explain the presentation of budget information and the relationship of the budget figures to the financial statements.
In addition, issuers must assess whether the future impact of currently known facts mandate disclosure. The GFOA Guidelines call for a description of known facts that would significantly affect the financial information presented or future financial operation of the issuer, as well as a discussion of its projected operations.59 For example, in a hospital financing, a steadily declining population in the surrounding community that, in the future, would not support the size of facility to be built would be important to investors. Disclosure of such currently known conditions and their future impact is critical to informed decision making.
An investor's ability to monitor future developments affecting the issuer, as well as the likely liquidity of a security, are important to an investor's evaluation of an offering. The official statement should state clearly whether ongoing disclosure concerning the issuer or obligor will be provided, including the type, timing, and method of providing such information.61 In deciding whether to purchase the securities or to continue to hold them, investors need to know whether the issuer has committed to provide information on an ongoing basis.62 The absence of such a commitment can adversely affect the secondary market for the securities and increases the risks of the investment.
As discussed above, the Joint Statement recommends that the Commission adopt a rule prohibiting a municipal securities dealer from underwriting securities absent a commitment to provide ongoing information. In the Companion Release, the Commission is proposing such a rule for comment. In order to fully inform investors, an issuer needs to include in the official statement a description of the scope of its continuing disclosure commitment, the type of information that would be provided, the repositories to which the information would be sent, when annual and other periodic information would be available* and the consequences of the issuer's failure to abide by the requirements of the covenant.
Like other disclosure documents, official statements need to be clear and concise to avoid misleading investors through confusion and obfuscation. The expanded level of disclosure in official statements and increased sophistication of municipal securities instruments have, in many cases, resulted in longer and more complex disclosure documents, with the corresponding danger of overly detailed, legalistic, and possibly obtuse disclosure.63
The location, emphasis, and context of the disclosure can affect the ability of a reasonable investor to understand the relationship between, and cumulative effect of, the disclosure.64 As the U.S. Court of Appeals for the Second Circuit has stated:
[D]isclosures in a prospectus must steer a middle course, neither submerging a material fact in a flood of collateral data, nor slighting its importance through seemingly cavalier treatment. The import of the information conveyed must be neither oversubtle nor overplayed, its meaning accurate, yet accessible.65
Appropriate disclosure "is measured not by literal truth, but by the ability of the material to accurately inform rather than mislead" investors.66 As the Commission has indicated in other contexts, legalistic, overly complex presentations and inattention to understandability can render the disclosure incomprehensible and consequently misleading.67
One of the concerns leading to the adoption of Rule 15c2-12 was that underwriters were not receiving official statements within time periods that would allow them to examine the accuracy of the disclosure.68 The Commission noted in proposing the rule that a thorough, professional review by underwriters of municipal offering documents could encourage appropriate disclosure of foreseeable risks and accurate descriptions of complex put and call features, as well as novel financing structures now employed in many municipal offerings. In addition, with the increase in novel or complex financings, there may be greater value in having investors receive disclosure documents describing fundamental aspects of their investment. Yet, underwriters are unable to perform this function effectively when offering statements are not provided to them on a timely basis.69
To address this concern, the rule requires any underwriter, including lead underwriters, syndicate members, and selling group members that receive in excess of the usual seller's commission, to obtain and review an official statement that is deemed final as of its date by the issuer, except for the omission of certain information, before bidding for, purchasing, offering, or selling municipal securities in a primary offering.
Since the adoption of Rule 15c2-12, however, there have been continued problems with the timeliness of receipt by underwriters of the "near final" official statement required by the Rule.70 In addition to compromising the ability of an underwriter to make a reasonable investigation of the issuer, this problem also may limit the ability of potential customers to make informed investment decisions. In a recent NFMA survey, 59% of those responding rated the delivery of preliminary official statements in competitive sales as either not very good or poor, and 50% rated the delivery of preliminary official statements in negotiated sales as either not very good or poor.71
One cause of delay has been confusion as to the point at which the underwriter must have obtained and reviewed the near final official statement in a negotiated offering. The term "offer" traditionally has been defined broadly under the federal securities laws and, for purposes of Rule 15c2-12, encompasses the distribution of a preliminary official statement by the underwriter, as well as oral solicitations of indications of interest. Thus, prior to the time that the underwriter distributes the preliminary official statement to potential investors, or otherwise begins orally soliciting investors, the rule requires it to have obtained and reviewed a near final official statement. If no offers are made, the underwriter is required to obtain and review a near final official statement by the earlier of the time the underwriter agrees (whether in principle or by signing the bond purchase agreement) to purchase the bonds, or the first sale of bonds to investors.72
The Commission has acknowledged that the rule would require greater planning and discipline by some issuers.73 The Commission anticipated that, in order to allow underwriters to meet their obligation to have a reasonable basis for recommending any municipal securities, issuers would have to begin drafting disclosure documents earlier, and perhaps with greater care than in the past.74 This result enables underwriters to receive, and if necessary influence the content of, the final official statement before committing themselves to an offering.75 Moreover, placing an obligation on the issuer to prepare the official statement at an earlier stage is appropriate, because it is the issuer's obligation to ensure that there is timely dissemination of disclosure documents in connection with the offer and sale of the issuer's securities.76
When financing involves a third party as the source of repayment, investors need information on that underlying borrower. The GFOA Guidelines call for description of conduit obligors, which are defined by the GFOA Guidelines to include both private profit-making and nonprofit entities.77 The suggested information includes the nature and development of the business or other activity to be undertakes, by the conduit obligor, (including its form of organization and management), location of principal facilities and service area, ratemaking or pricing policies and historical operations and plan of operations.
To address disclosure issues involving conduit financings in a comprehensive fashion, however, legislation addressing the exempt status of conduit securities under the federal securities laws is necessary. Bonds used to finance a project to be used in the trade or business of a private corporation are, from an investment standpoint, equivalent to corporate debt securities issued directly by fee underlying corporate obligor.78 Payments on these types of conduit securities are derived solely from revenues received by the governmental entity under the terms of a contractual agreement typically a lease or a note, from a private enterprise, rather than from the general credit and taxing power of fee governmental issuer. The tax-exempt status of interest payments does not alter the fundamental analysis that these are private obligations, in which the investor looks, and can look, only to a private entity for repayment.
The private nature of many conduit enterprises distinguishes them from traditional municipal financings. The incidence of bond default appears to be inversely related to the degree a financed project represents an essential public service.79 A study conducted by the PSA on non-rated issues that defaulted found that 75% were issued by local authorities in the areas, of health care and industrial related sectors such as energy, chemical, pollution control and industrial development.80
Given the essentially private nature of non-governmental industrial development financings, investors need the same disclosure regarding the underlying non-municipal corporate obligor as they would receive regarding any corporate obligor, and the same regulatory and liability scheme should apply. Accordingly, the Commission has consistently supported legislative proposals to amend Section 3(a)(2) of the Securities Act81 and Section 3(a)(29)82 of the Exchange Act to remove the registration exemption for the corporate credit underlying municipal conduit securities involving non-governmental industrial development (private activity) financings.83 The Commission today renews that legislative recommendation.
Pending amendment to the securities laws to eliminate the registration exemption, the disclosure provided by such non-governmental conduit borrowers should be substantially the same as if such conduit borrower were subject to the information requirements of the federal securities laws applicable to the particular conduit borrower. For example, financial statements prepared in accordance with generally accepted accounting principles prescribed by the Financial Accounting Standards Board should be provided.
While significant progress has been made m primary market disclosure practices m recent years, the same development has not taken place with respect to secondary market disclosure. The GFOA issued separate secondary market disclosure guidelines in 1979, but they have not yet achieved the broad acceptance accorded its primary offering guidance. In the last five years, the NFMA, the National Council of State Housing Agencies, and the Association of Local Housing Authorities have published sector specific guidelines for secondary market disclosure: the National Advisory Council of the National Association of State Auditors, Comptrollers and Treasurers ("NASACT") is in the process of preparing such guidelines for adoption by the states.84 The GFOA's longstanding Certificate of Achievement program recognizes issuers that have prepared comprehensive annual financial reports meeting its guidelines. The NFMA's Award of Recognition Program likewise recognizes issuers that have committed to provide continuous disclosure.
Participants in the municipal securities market do not dispute the need for ongoing disclosure following an offering of securities, but municipal issuers reportedly resist developing a routine of ongoing disclosure to the investing market because of concerns about the costs of generating and disseminating that information and about potential liability relating to such disclosure. These issuers and obligors are at times advised by their professional advisors that there is no duty under the federal securities laws to make disclosure following the completion of the distribution.85 At least some municipal issuers thus appear to believe that silence shields them from liability for what may later be found to be false or misleading information. As a practical matter, however, issuers do not have the option of remaining silent. Given the wide range of information routinely released to the public, formally and informally, by these issuers in their day-to-day operations, the stream of information on which the market relies does not cease with the close of a municipal offering. In light of the public nature of these issuers and their accountability and governmental functions, a variety of information about issuers of municipal securities is collected by state and local governmental bodies, and routinely made publicly available.86 Municipal officials also make frequent public statements and issue press releases concerning the entity's fiscal affairs.
A municipal issuer may not be subject to the mandated continuous reporting requirements of the Exchange Act, but when it releases information to the public that is reasonably expected to reach investors and the trading markets, those disclosures are subject to the antifraud provisions.87 The fact that they are not published for purposes of informing the securities markets does not filter the mandate that they not violate antifraud proscriptions.88 Those statements are a principal source of significant, current information about the issuer of the security, and thus reasonably can be expected to reach investors and the trading market. As the U.S. Court of Appeals for the Second Circuit has said: "The securities markets are highly sensitive to press releases and to information contained in all sorts of publicly released ... documents, and the investor is foolish who would ignore such releases."89 Since investors obtain information concerning the fiscal health of a municipal issuer from its public statements concerning financial and other matters, "[t]he nature of these statements and the assumptions upon which they are based must be carefully and accurately communicated to the public, so that potential investors may be fully informed of all material facts relevant to their investment decision." 90
The current process by which municipal issuers and their officials release information to market participants does not address the risk of misleading investors, because there is no mechanism for disseminating information about the municipal issuer to the market as a whole. To the contrary, in the municipal market, information released publicly frequently is disseminated only to a narrow segment of the marketplace. For example, market participants who request current information from indenture trustees are often turned away on the grounds that they are not current holders of the securities.91 As a result, investors purchasing municipal securities in the secondary market risk doing so on the basis of incomplete and outdated information.
Since access by market participants to current and reliable information is uneven and inefficient, municipal issuers presently face a risk of misleading investors through public statements that may not be intended to be the basis of investment decisions, but nevertheless may reasonably be expected to reach the securities markets. As market participants have urged,92 in order to minimize the risk of misleading investors, municipal issuers should establish practices and procedures to identify and timely disclose, in a manner designed to inform the trading market, material information reflecting on the creditworthiness of the issuer and obligor and the terms of the security.93
There is general recognition of the need for disseminating comprehensive information on an annual basis and, on a more timely basis, information about material events that reflect on the credit quality of the security.94
Investors need updated comprehensive information sufficient to enable them to evaluate the financial condition, results of operations and cash flows of the issuer or underlying borrower. Although the issuance of comprehensive annual information has not yet become prevailing practice, it is recommended by industry disclosure guidelines, including those published by the GFOA in connection with its Comprehensive Annual Financial Reports ("CAFRs") award program, NFMA, and the other industry specific guidelines,95 and is an effective means of providing the market updated information about the issuer and the issue. The GFOA Guidelines for Continuing Disclosure call for, either in an official statement or comprehensive annual report, a description of:
- The issuer and its structure, management, assets and operations;
- The issuer's debt structure (including changes in indebtedness);
- The issuer's finances (including financial condition and results of operations and financial practices of the issuer or the enterprise);
- Legal matters affecting the issuer, including litigation and legislation;
- Ratings; and
- Interests of certain persons.
For frequent issuers, current information can be disseminated in official statements for w offerings, and thus is readily available without the preparation of a separate annual financial report. Regardless of the form of document relied upon to provide the marketplace with information concerning the financial condition of the issuer or obligor, to minimize risk of misleading investors, issuers or obligors should provide, as discussed above with respect to primary offerings:
- Financial statements that are audited in accordance with GAAS (or disclosure of the absence of such an audit) and that are either prepared in accordance with GAAP, or accompanied by a quantified explanation of material deviations from GAAP or a full explanation of the accounting principles used;
- Otker pertinent financial and operating information (depending on the type of issuer and security sold), as well as the sources for repayment—of course, a variety of information may be appropriate for an issuer with a range of outstanding securities with differing characteristics, from general obligation to revenue and conduit bonds; and
- A narrative discussion that analyzes the issuer's or obligor's financial condition, and results of operations, as well as facts likely to have a material impact on the issuer or obligor.
As discussed above with respect to offering statements, as a general matter, the annual financial information may reasonably be expected to be made available within six months of the issuer's fiscal year end.87 For some conduit entities, annual information may not be sufficient and investors may need more frequent periodic financial information. Under guidelines developed by the National Council of State Housing Agencies, far example, current information on loan portfolio status is compiled and disseminated to information repositories on a quarterly basis.98 Similar ongoing disclosure on a periodic basis appears appropriate for analogous conduit municipal financings such as structured student loan programs, housing and health care financings.
In addition to periodic information, to assure that participants in the secondary market base their investment decisions on current information, commentators have called for timely disclosure of events that materially reflect on the creditworthiness of municipal securities issuers and obligors and the terms of their securities. There is a general consensus among participants in the municipal securities market that investors need information about the following events, among others, where material:99
As discussed above, the municipal market today lacks an effective mechanism for dissemination of material information to investors and the marketplace. To be effective in minimizing the issuer's risk under the antifraud provisions, the annual financial information and event disclosure should be disseminated in a manner reasonably designed to inform the holders of the issuer's securities and the market for those securities.
Trustees can serve as cost effective disseminators of information to the market due to the capacity and duties of trustees under the terms of the indentures, which, positions them to have knowledge of the events requiring disclosure, and the ability and authority to communicate with bondholders.100 The Commission encourages the inclusion of provisions m trust indentures that authorize trustees to transmit information to the market, particularly in structured financings where the issuer's obligations generally are delegated to various participants. Trustees also may provide a service to other small issuers, by enabling them to notify the market in a timely manner and at a lower cost.
The common denominator for current proposals to improve secondary market disclosure for municipal securities is the establishment and designation of one or more information repositories to serve as a collection and access point for annual and current information.101 Such repositories would serve as predetermined sources for information concerning a particular issuer, allowing participants to verify that they have the latest available information concerning the issuer before recommending, purchasing, at bidding for a security. The repositories would supplement, not substitute for, the existing access bondholders may have to issuers to obtain current information.102
In the Companion Release, the Commission is proposing an amendment to Rule 15c2-12 to prohibit, as suggested by the Joint Statement, underwriting of a municipal securities issue unless the issuer of the municipal security has covenanted to provide annual and ongoing disclosure to a repository.
In the Proposing and Adopting Releases for Rule 15c2-12, the Commission set forth its interpretation of the obligation of municipal underwriters under the antifraud provisions of the federal securities laws. The interpretation discussed the duty of underwriters to the investing public to have a reasonable basis for recommending any municipal securities, and their responsibility, in fulfilling that obligation, to review in a professional manner the accuracy of statements made in connection with the offering. The interpretation was set out in the Proposing Release, and modified slightly in the Adopting Release. The Commission reaffirms its Interpretation with respect to underwriters' responsibilities under the antifraud provisions of the federal securities laws.103
Furthermore, the Commission believes that it is also appropriate to emphasize the responsibilities of brokers and dealers in trading municipal securities in the secondary market. The Commission historically has taken the position that a broker-dealer recommending securities to investors implies by its recommendation that it has an adequate basis for the recommendation. 104 A dealer, unlike an underwriter, ordinarily is not obligated to contact the issuer to verify information. A dealer must, however, leave a reasonable basis for its recommendation.105 If, based on publicly available information, a dealer discovers any factors that indicate the disclosure is inaccurate or incomplete, or signal the need for further inquiry, a municipal securities dealer may need to obtain additional information, or seek to verify existing information.106
One of the rules proposed simultaneously with the issuance of this release would require a broker, dealer or municipal securities dealer to review current information provided by the issuer prior to recommending a transaction in a municipal security. In the absence of such current information, the dealer could not recommend a transaction in the issuer's securities. That rule, which would be applicable to municipal securities issued subsequent to the effective date of the proposed rule, would reinforce the obligations of dealers under the antifraud provisions of the federal securities laws to have a reasonable basis for recommendations of outstanding municipal securities.
The Joint Statement also called for a strengthening of the suitability rules to require disclosure of ratings and whether the issuer has committed to provide annual financial reports. Today, the Commission is proposing amendments to its confirmation rules to require disclosure of the absence of a rating in confirmations. The MSRB has indicated it has under consideration a plan requiring municipal securities dealers to disclose to their customers the importance of secondary market information and whether the issuer has agreed to voluntarily provide such disclosures.107 The Commission will defer to the MSRB's reexamination of its suitability rules in implementing those aspects of the Joint Statement.
The Commission intends to continue to monitor developments in municipal securities disclosure practices. Comment is requested regarding the disclosure items discussed in this release, and in particular, items warranting event disclosure. Comment also is requested regarding additional action that should be taken with respect to disclosure in the municipal securities market by the Commission, the MSRB, or Congress.
List of Subjects in 17 CFR Parts 211, 231 and 241
Amendment of the Code of Federal Regulations
For the reasons set out in the preamble, title 17 chapter II of the Code of Federal Regulations is amended as set forth below:
PART 211—INTERPRETATIONS RELATING TO FINANCIAL REPORTING MATTERS
PART 231—INTERPRETATIVE RELEASES RELATING TO THE SECURITIES ACT OF 1933 AND GENERAL RULES AND REGULATIONS THEREUNDER
PART 241—INTERPRETATIVE RELEASES RELATING TO THE SECURITIES EXCHANGE ACT OF 1934 AND GENERAL RULES AND REGULATIONS THEREUNDER
By the Commission.
Dated: March 9, 1994.
Margaret H. McFarland,
[FR Doc. 94-5922 Filed 3-16-94; 8:45 am]
BILLING CODE 8010-01-P
1 Exchange Act Release No. 33742 (March 9, 1994) ("Companion Release").
2 See Division of Market Regulation, Securities and Exchange Commission, Staff Report on the Municipal Securities Market ("Staff Report") (Sept. 1993) at 1.
3 "A Decade of Municipal Finance" The Bond Buyer (Jan. 6, 1994) at 24.
4 Staff Report at 1-2.
5 The BondBuyer 1993 Yearbook ("Bond Buyer 1993 Yearbook") at 61-63.
6 Staff Report on Transactions in Securities of the City of New York ("NY City Report") (Aug. 1977) Chapter III, at 1-2.
7 See section 3(a)(2) of the Securities Act (15 U.S.C. 77 c(a)(2)).
8 See section 3(a)(29) of the Exchange Act (15 U.S.C. 78c(a)(29)).
9 15 U.S.C. 77g(a).
10 15 U.S.C. 78j(b); 17 CFR 240.10b-5.
11 Sections 15(c) (i) and (2)of the. Exchange Acs (15 USX. 78o(c) (1) and (2)).
12 See MSRB Manual tCCHJ.
13 See Securities and Exchange Commission, Report of the Securities and Exchange Commission on Regulation of Municipal Securities (1938); Securities and Exchange Commission, Staff Report on the Investigation in the Matter of Transactions in the Washington Public Power Supply System Securities (1988); Securities Act Release No. 6021, Final Report in the Mattel of Transactions in the Securities of the City of New York (Feb. 5, 1979); NY City Report.
14 CFR 240.15c2-12; see Municipal Securities Disclosure, Securities Exchange Act Release No. 26106 (Sept 25, 1986), 53 FR 37778 ("Proposing Release"); Municipal Securities Disclosure, Securities Exchange Act Release No. 26985 (July 10, 1989), 54 FR 28799 ("Adopting Release").
15 Proposing Release 53 FR at 37779-37782; Staff Report at 25.
16 Adopting Release 54 FR at 28800.
17 National Federation of Municipal Analysts, Membership Survey Results Fall 1392 Disclosure Survey ("NFMA Survey"); Public Securities Association, Municipal Securities Disclosure Task Force, Report: Initial Analysis of Current Disclosure Practices in the Municipal Securities Market (June 1988) ("PSA Survey") (content and completeness of primary disclosure documents and sufficiency of financial information rated satisfactory to excellent by 94% and 93% of firms responding, respectively).
18 See Letter to Chairman Levitt from Charles Mires, Allstate Insurance Company (Nov. 4, 1993, as updated Jan 19, 1994) ("Allstate Letter") (primary market disclosure by conduits found inadequate in 43.9% of rated issues reviewed); NFMA Survey (local housing, special district, hospitals, long term healthcare and industrial development issues were found to provide the least disclosure); PSA Survey (small issue industrial development bonds received a low rating; issues of $10 million or less received a low rating).
19 Examples include the defaults engendered by the failures of Mutual Benefit Life, Executive Life and Tucson Electric Power, and the bankruptcies arising out of the Colorado Special Districts. See, e.g., Hinden, "Mutual Benefit Life's Collapse Shows Fragility of Bond Guarantees," The Washington Post Gul. 22, 1991) at F 27; Levinson, "No Coverage Against Junk," Newsweek [Apr. 22, 1991] at 46; Stamas, "Rep. Dingell Asks SEC to Investigate Defaults by Special Assessment Districts in Colorado," The Bond Buyer [Jan. 25, 1981] at 1.
20 See Gasparino, "Balancing Budgets Through Lease Deals May Pose Credit Risks, Rating Agency Warns," The Bond Buyer (Jan. 25,1993) at 1; Herman, "Municipal-Bond Holders: .Watch Out for 'Call' Shock," The Wall Street Journal (Aug. 29, 1992) at Cl; Hume, "Dealer Threatens Suit Over Proposed Call for Escrowed Bonds." The Bond Buyer (Nov. 8, 1993) at 4; Hume, "Issuer in Louisiana May Run Afoul of Law if Escrowed Bonds Are Called Next Month," The Bond Buyer (Apr. 22, 1993) at 1; Hume, "Rise in Re-Refundings of Escrowed Bonds Likely to Gain Attention at Treasury, SEC," The Bond Buyer (May 12, 1992) at 1.
21 See generally, Testimony of Jeffrey S. Green, General Counsel, Port Authority of New York and New Jersey on behalf of Government Finance Officers Association, before the Subcommittee on Telecommunications and Finance, House. Committee on Energy and Commerce, Oct. 7, 1993 ("GFOA Testimony") at 7-9; Remarks by C. Richard Lehmann, President, Bond Investors Association Before the U.S. House of Representatives Subcommittee on Telecommunications and Finance Concerning the Municipal Securities Market, Oct. 7, 1993 ("Lehmann Testimony") at 4-5; Testimony of Andrew R. Kintzinger, President-Elect, National Association of Bond Lawyers, Before the Subcommittee on Telecommunications and Finance, House Committee on Energy and Commerce, Oct. 7, 1993 ("NABL Testimony") at 8-23; Testimony of Harvey Eckert, Chairman of the Blue Ribbon Committee on Secondary Market Disclosure on Behalf of the National Association of State Auditors, Comptrollers and Treasurers Before the Subcommittee on Telecommunications and Finance, House Committee on Energy and Commerce, Oct. 7, 1993 ("NASACT Testimony") at 3-6; Testimony Relating to the Municipal Securities Market given, by the National Federation of Municipal Analysts, Katherine Bateman, Chairperson, to the Subcommittee on Telecommunications and Finance, Oct. 7, 1993 ("NFMA Testimony") at 1-7; Statement of Gerald McBride, Chairman, Municipal Securities Division, Public Securities Association, Before the House Committee on Energy and Commerce, Telecommunications and Finance Subcommittee, Oct. 7, 1993 ("PSA Testimony") at 5-7; NASACT, State and Local Government Securities Markets and Secondary Market Disclosure (Oct. 1993) at 5; Stamas, "Issuers' Intentions on Secondary Market Disclosure are Starting to Appear in Official Statements," The Bond Buyer (Dec. 14, 1992) at 1; Standard & Poor's, "In Support of Secondary Market Disclosure," CreditWeek Municipal (Mar. 16, 1992).
22 PSA Testimony at 5. See also Lehmann Testimony at 4; NASACT Testimony at 3; Nemes, "Investors' Service Steps in to Fill Void in Hospital Data Disclosure," Modem Healthcare (Feb. 3, 1992) at 46; Quint, "Credit Markets; Aiming for More Data About Municipal Bonds," The New York Times (June 28, 1993) at D5; Schifrin, "Hello, Sucker," Forbes (Feb. l; 1993) at 40.
23 NASACT, Report of the Blue Ribbon Committee on Secondary Market Disclosure—Improving Secondary Marker Disclosure (Aug. 1993) ("NASACT Blue Ribbon Committee Report") at 1-2.
24 See id, at 1. See also Allstate Letter.
25 See Bond Buyer 1993 Yearbook at 3-5; Municipal Bond Defaults—The 1980's; a Decade in Review (J.J. Kenny Co., Inc. 1993)("Kenny Default Report"); Public Securities Association, An Examination of Non-Rated Municipal Defaults 1986-1991 (Jan. 8, 1993)("PSA Default Report"); Staff Report, Appendix B.
26 See NASACT Blue Ribbon Committee Report at 1-2.
27 Joint Statement on Improvements in Municipal Securities Market Disclosure ("Joint Statement") (Dec. 20, 1993) at 1. The Joint Statement was submitted by the American Bankers Association's Corporate Trust Committee, American Public Power Association, Association of Local Housing Finance Agencies, Council of Infrastructure Financing Authorities, Government Finance Officers Association, National Association of Bond Lawyers, National Association of Counties, National Association of State Auditors, Comptrollers and Treasurers, National Association of State Treasurers, National Council of State Housing Agencies, National Federation of Municipal Analysts, and Public Securities Association.
29 See In re Washington Public Power Supply System Securities Litigation, 623 F. Supp. 1466, 1478 (W.D. Wash. 1985). See also Brown v. City of Covington. 805 F 2d 1266,1270 (6th Cir. 1986).
30 TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976).
31 Letter from Harlan E. Boyles, Treasurer of North Carolina to SEC Chairman Levitt, dated December 7, 1993. See Government Finance Officers Association, Disclosure Guidelines for State and Local Government Securities (Jan. 1991) ("GFOA Guidelines").
32 See NFMA, Disclosure Handbook for Municipal Securities 1992 Update (Nov. 1992) ("NFMA Handbook"). See also Government Accounting Standards Board, Codification of Government Accounting and Financial Reporting Standards (2d ed. 1987); PSA, Recommendations for a Consistent Presentation of Basic Bond Provisions in Official Statements (Dec. 1989).
33 GFOA Guidelines at xv-xix (summary).
34 See NASACT Blue Ribbon Committee Report at 1-2; Staff Report at 26. Industry participants generally agreed in testimony before the House of Representatives Subcommittee on Telecommunications and Finance on October 7, 1993, that both the greatest disclosure problems and the greatest risk of default were with unrated hospital, housing, special district and industrial development revenue bonds.
35 See SEC v. Washington County Utility District, 676 F.2d 218, 222 (6th Cir. 1982) ("Flagrant violations" of antifraud provisions arising from failure to disclose use of proceeds to purchase options on property held by issuer's manager and financial arrangements between the manager and the underwriter).
36 Section XII.D. of the GFOA Guidelines.
37 MSRB rule G-23.
38 MSRB rule G-32. See Section 15B(c)(1) of the Exchange Act (15 U.S.C 78o-4(c)(1)) (requiring compliance with MSRB rules); MSRB rule G-17.
39 Gasparino, "The Trouble with Consultants" The Bond Buyer (Nov. 16, 1993) at 1. In his testimony before the Subcommittee on Telecommunications and Finance, Andrew Kintzinger, on behalf of the National Association of Bond Lawyers ("NABL"), stated: "|M)embers of the municipal finance bar should work with issuers to develop procurement procedures for state and local governments to ensure that all material financial arrangements between underwriters within the syndicate and between underwriters and financial advisors and possible conflicts of interest between issuers and members of the underwriting syndicate or other participants be accurately documented and disclosed or, if appropriate, prohibited." NABL Testimony at 28. See Joint Statement at 2.
40 Gasparino, "Several Issuers Start to Scrutinize Ties Between Advisers, Bankers," The Bond Buyer Pec. 27, 1993) at 1. See Section XII.C, of the GFOA Guidelines; rule G-23 of the MSRB.
41 As the NABL Testimony indicates: "Derivatives are sophisticated securities products designed for sophisticated investors and should not be sold to retail investors generally and certainly not without comprehensive disclosure. If issuers choose to undertake the financial benefits of these sophisticated and complicated transactions, they can assume the financial costs of providing * * * information." NABL Testimony at 22.
42 PSA. Recommendation on Dissemination of Product—Specific Terms For Municipal Derivative Products (1993).
43 PSA. Municipal Market Developments (Aug. 1993) at 5.
44 See Revisions to Rules Regulating Money Market Funds. Securities Act Rel. No. 7038, 58 FR 68585.68588 (footnote omitted) ("Money Market Fund Release"); Securities and Exchange Commission, Report by the United States Securities and Exchange Commission on the Financial Guarantee Market: The Use of the Exemption in Section 3(a)(2) of the Securities Act of 1933 for Securities Guaranteed by Banks and the Use of Insurance Policies to Guarantee Debt Securities (Aug. 28, 1987) ("SEC Financial Guarantee Report") at 82: Adopting Release, 54 FR at 28812.
45 See Allstate Letter.
46 See NY City Report at Ch. U p. 92.
47 See GFOA Guidelines at 50.
48 The financial statements of corporate obligors backing conduit securities should follow GAAP for such entities, as established by the Financial Accounting Standards Board and other bodies.
49 Ingram & Robbins. Financial Reporting Practices of Local Governments, Government Accounting Standards Board (1987) at 12 (The survey results were based on information received' from 567 respondents to a survey questionnaire mailed to 1161 government units).
50 State Comptrollers: Technical Activities and Functions (1992 Edition).
51 Where state and local governments programs that are subject to the federal "Single Audit Act of 1984," Public Law 98-502 et seq. prepare financial statements on a basis other than GAAP, "the audit report should state the nature of the variances therefrom and follow professional guidance for reporting on financial statements which have not been prepared in accordance with GAAP." Office of Management and Budget. "Questions and Answers on the Single Audit Process of OMB Circular A-128, 'Single Audits of State and Local Governments.' " 52 FR at 43716 (Nov. 13, 1987). question 35.
52 GFOA Guidelines at 45.
53 See Gauthier, An Elected Official's Guide to Auditing (1992) at vii and xi.
54 State Comptrollers: Technical Activities and Functions: NASACT. Municipal Task Force Report (1990) ("NASACT 1990 Task Force Report") at 12.
55 See generally, GFOA Guidelines; NFMA Handbook. See also infra n. 84.
56 See Letter of John Murphy, Executive Director of Association of Local Housing Finance Agencies to Chairman Levitt (Dec. 20, 1993).
57 NFMA Handbook.
58 See Management's Discussion and Analysis of Financial Condition and Results of Operations; Certain Investment Company Disclosures, Securities Act Release No. 6835 (May 24, 1989), 54 FR 22427; Securities Act Release No. 6711 (April 24, 1987), 52 FR 13715.
59 GFOA Guidelines at 55.
60 See NASACT Blue Ribbon Committee Report at 17. While due dates for audited financial statements of government units differ, a significant majority of states currently require audited financial statements for government units to be filed within six months after the fiscal year end. NASACT 1990 Task Force Report at 12-22.
61 See Fall 1992 NFMA Survey. See also American Bankers Association, Corporate Trust Committee, Four Point Public 1991 Disclosure Guidelines for Corporate Trustees ("ABA 1991 Guidelines") at 2; Stamas, "Issuers' Intentions on Secondary Disclosure are Starting to Appear in Official Statements," The Bond Buyer (Dec. 14, 1992) at 1.
62 See MSRB, Report of the Municipal Securities Rulemaking Board on Regulation of the Municipal Securities Market (Sept. 1993) at 6-7 (Board announced plan that would include requiring underwriters to recommend to issuers that they provide continuing disclosure to the market and requiring municipal securities dealers to disclose to their customers the negative impact that the lack of secondary market information may have on the value and liquidity of the securities and whether the issuer has agreed to voluntarily provide such disclosures).
63 See GFOA Testimony at 6. See also Allstate Letter.
64 Isquith v. Middle South Utilities, 847 F.2d 186, 201 (5th Cir.), cert, denied, 488 U.S. 926 (1988); Kas v. Financial General Bankshares, Inc., et al., 796 F.2d 508, 516 (D.C. Cir. 1986); Kennedy v. Tallant, 710 F.2d 711, 720 (11th Cir. 1983).
65 Isquith, 847 F.2d at 202.
66 McMahan & Company, et. al. v. Wherehouse Entertainment, Inc., 900 F.2d 576,579 (2d Cir. 1990).
67 See. e.g., Limited Partnership Reorganizations and Public Offerings of Limited Partnership Interests, Securities Act Release No. 6900 (June 25, 1991) 56 FR 28979,28980 ("Limited Partnership Release").
68 Proposing Release, 53 FR at 37781.
69 Proposing Release. 53 FR at 37782.
70 As a practical matter, near final official statements distributed to underwriters to satisfy Rule 15c2-12(b)(1) are often the same document as the preliminary official statement distributed to potential customers pursuant to Rule 15c2-12(b)(2). See Mudge Rose Guthrie Alexander & Ferndon (April 4, 1990) ("Mudge Rose") (rejecting the argument that in a negotiated offering, the identification of a credit enhancer and related information about the credit enhancer may be omitted on the assumption that the information depends on pricing). See also Fippinger & Pittman, Disclosure Obligations of Underwriters of Municipal Securities, 47 Business Lawyer 127,140 (Nov. 1991). In addition, underwriters are required to deliver to potential customers, upon request, copies of the final official statement for a specified time period. Rule 15c2-12(b)(4).
71 NFMA Survey. See also Letter from Jeffrey M. Baker, Chairperson, NFMA Industry Practices and Procedures Committee and Richard A. Ciccarone, Past Chairperson, NFMA Industry Practices and Procedures Committee to Arthur Levitt, Chairman, Securities and Exchange Commission, Christopher A. Taylor. Executive Director, MSRB and Joseph R. Hardiman. President and Chief Executive Officer, National Association of Securities Dealers, Inc. (Oct. 19, 1993) (regarding the timeliness of receipt of near final and preliminary official statements).
72 See Mudge Rose.
73 Adopting Release, 54 FR at 28804. The Commission also noted that the requirements of Rule 15c2-12(b)(1) could be met through the use of multiple documents. For example, a frequent issuer might be able to supply a recent official statement, together with supplementary information containing the terms of the current offering, as well as any material changes from the previous offering materials.
74 Proposing Release, 53 FR at 37790.
76 See Adopting Release, 54 FR at 28811 N. 84 (official statement is issuer's document).
77 GFOA Guidelines at 26. In a recent policy statement, the GFOA referred to "conduit bonds" as "municipal securities issued by a state or local government for the benefit of a private corporation or other entity that is ultimately obligated to pay such bonds * * *." GFOA, Committee on Governmental Debt and Fiscal Policy, Improvements in Municipal Securities' Market Disclosure (Feb. 1, 1994) ("GFOA Disclosure Policy Statement").
78 See Money Market Fund Release, 58 FE at 68588 (proposal to subject tax exempt money market fund investments in conduit securities to restrictions similar to those applicable to securities of comparable obligors offered to taxable funds).
79 Kenny Default Report at 2.
80 PSA Default Report at 12.
81 15 U.S.C 77c(a)(2).
83 Sit Reroaaia of De» id &. Rader, Chmnirnaa. SEC. "Disclosure in the Municipal Ssciiriiies. Mar Iteta," Before the Public Securities. Aseoeiatioo tOct. 23, 1987) at 17-1S; Lettet Scorn John. SJL. Steak Chairman, SEC to Representative Timothy £. Wkth, Chairman. House Subcommittee on Telecommunications,. Consumer Protection, and Finance (March 12, 1985k 124 Cong, Ree. 21,63a (197S)r0etter from SECChaiman HaroldM. Williams to Senator Harrison A. Williams 1. There were two bills introduced, one in 1975 and one in 1978, that wouTd have repealed the exemption fiom the registration requirements of the Securities Act of 193 J. The I97B bill would have subjected certain industrial development bonds to the registration requirements of the Securities Act of 1933. the filing amf qualification provisions of the Trust Indenture Act and the periodic reporting requirements of the Securities Exchange Act of 1934. Neither hrH was enacted*. See also "Municipal Securities FtrH Disclosure Act of 1976,"S. 2963, 94th Cong., 2tf. Sess. (Feb. 17,197BT.
Governmental industrial' development financings, which would have retained their exempt status under prior proposals, mcfmfe (hose* financings in which, lh» bond's are> repa kf from (he general revenus&ef trie governments! unit or the project or facility »» public facility for part of » pubffit facility) and owned and operated fey or on beftaif of the goveimanilat unit. The prior proposals to the separate exemption for securities fsauwj h*f nonprofit ttaritabi* orgBntzations fe Section 3fff)Wp of the Securities Art (1SU.&C 77efaB)f.
84 See Association of Local rfouiingFraaiice . Agencies, Guidelines for Information Disclosure to the Secondary Market (I39ZI ("Local Housing Guidelines'*!^ National Conncil of Stale Housing, Agencies. Quarterly ffeport/ngFormat jfbr Stale Housing Finance Agency Single Family Housing Bonds ("1989) and Malti-pmity Disclosure Format (ISOTJ'cofrecfirely fStete rfeirsmgOrfctemies"!; NFMA Handbook. See afso Heaffftcare Rnanri^ Management Association, Statement of Principles of PublicDaelostaeofFinancial andOperating Information bj HeQftfioore'ftDritfcrsr^tjrosure Draft dato* Aqg, t,f993f PfftfflthcaTe DfscIoOTre Principles"?.
85 See Stamas, "Issuers* Intentions on Secondary Market IMsefosurfr Are Smarting to Appear hi OfHcial StatBraentsv" TheBond Pbyerfltec. 14, 1992) at 1; Stamas, "Why thefssue'of Secondary-Marfcet DiscBosute RemaSns orr (he Baci; Bametr R Can Be Risfcy,"* The Bond Bnyer&ept. 20.19S0 at 1; Stamas, "Analysts Wtai fesners About Some Lawyers" Bferfosare AdVicBw" ThvSond Bayer (Jin. 15. t991Jaf I.
86 See NASACT Blue Ribbon Committee Report at 2, 24; NASACT 1990 Task Force Report at 21.
87 See Public Statements by Corporate Representatives, Securities Act Release No. 6504 (Jan. 20, 1984) 49 FR 2468,2469; In re Ames Dept. Stores Inc. Stock Litigation, 991 F.2d 953, 965-67 (2d Cir. 1993) (with respect to corporate information).
88 See Fippinger, The Securities Law of Public Finance (2d ed. 1993) at 291 ("[P]ress releases, conversations with analysts, information meetings, official comments on budget negotiations, and even angry reactions by public officials to rating agency downgrades" are subject to antifraud provisions).
89 Ames, 991 F.2d at 963 (corporate information).
90 NY City Report at Ch. HI at 2. The report found that public statements by City officials were misleading, since they were characterized by unwarranted reassurances as to the soundness and attractiveness of the City's securities, including statements that the City's budget problems, no matter how serious, had nothing to do with the City's ability to pay its debts. Id, at 110-111.
Municipal issuers should also be sensitive to whether their official statements contain forward-looking statements, such as projections of revenues, that remain alive in the market and may require updating in light of subsequent events. Guides for Disclosure of Projections of Future Economic Performance, Exchange Act Rel. No. 5992 (Nov. 7, 1978), 43 FR 53246. To the extent that the official statement in many cases remains the principal (or perhaps even the sole) source of information concerning an outstanding security, the potential for an obligation to update is of particular importance.
91 Under notice provisions of indentures, the issuer and trustee generally are required to provide notice to existing bondholders of events of default and other significant matters, such as a draw on reserves, a failure to renew a letter of credit, or a substitution of collateral. ABA 1991 Guidelines at 10. Indeed, trustees often deny requests by market participants for information out of concern for liability arising from exceeding the authority set forth in the indenture. Fippinger at 325. This situation led the American Bankers Association Corporate Trust Committee, in cooperation with the National Association of Bond Lawyers, to develop agreed upon guidelines for indenture provisions permitting the trustee to provide public notice of specified events. See ABA 1991 Guidelines.
92 See GFOA Guidelines at 91-97; Joint Statement.
93 National Association of Bond Lawyers and Section of Urban, State and Local Government Law, American Bar Association, Disclosure Roles of Counsel in State and Local Government Securities Offerings at 135 (forthcoming 1994) (Pre-publication Draft) ("ABA Disclosure Roles") (noting that many municipal issuers have concluded that post-issuance disclosure in accordance with GFOA guidelines can be more efficient and expose them to less potential liability than ad hoc disclosures).
94 See GFOA Testimony; Mires, "An Investor's Framework for Examining Disclosure Issues and Possible Solutions," The Bond Buyer (Feb. 7, 1994) at 24; NASACT Blue Ribbon Committee Report at 7. See also PSA Testimony at 6, supporting annual financial statement filing requirements and submission of information regarding any material fact for issuers who borrow $1 million or more annually.
95 See ABA Disclosure Roles at 134-136; ABA 1991 Guidelines; Association of Local Housing Guidelines; Healthcare Disclosure Principles. The Disclosure Task Force of the National Council of State Housing Agencies is developing standards for the issuance of audited financial and annual reports.
96 See GFOA Certificate of Achievement for Excellence in Financial Reporting Program; GFOA Guidelines at 64.
97 See Section HI.C.3.d. above.
98 State Housing Guidelines.
99 In 1980, the American Bankers Association Corporate Trust Committee drafted a proposal identifying t6 factors that it believed were important fef issuers to disclose to bondholders and the marketplace. American Bankers Association Corporate Trust Committee. Proposed Disclosure Guidelines far Corporate Trustees IABA Draft far Discussion Purposes) (June 12, 1990) ("ABA 1990 Guidelines"!. As published in final fan in September of 19S4 ("ABA 1991 Guidelines."), the Guidelines contained a nonexclusive list of five types of events that could i» disclosed by notice to » repository. Htunsnms market participant* have referenced! the ABA draft proposal, or variations of that proposal, aa c suiting point (or identifying straightforward, ntrajadgsjeiital, categories o£ events that oil for prompt disclosure. Ad addendum to the Jewrrt Statement provided four examples ea "significant information" that the participants considered appropriate for disclosure. The nonexclusive examples were (1) nontechnical defaults, (2) draws from a debt service reserve fund, (3) failure to make a regularly scheduled payment, and (4) any draws on any credit enhancement. Joint Statement, Addendum. The list set forth above is drawn from these proposals.
100 See ABA 1991 Guidelines at 3.
101 Consistent with the recent recommendation of the Joint Statement the GFOA Guidelines call £m lodging secondary market disclosure with a repository, as did the ABA guidelines published in 1991. GFOA Guidelines, Procedural Statement No. 8; ABA 1991 Guidelines at 3.
102 The American Bankers Association Coiposate Trust CoraaiBttee and the National Association of Bond Lawyers, as well as. the Joint Statement, have expressed coacern that securities depositories an« thein pasticijs)$u2t& do not retransmit notices they receive from trustee* and issuers to the beneficial owners o£ the issuer's securities The ABA Cocpojate Trust Committee sought to address the problem by calling Cot simultaneous JTtggm.inat.kwi of the infocmaiion k> the maxketpiAce through, an information repository. The National Association of Bond Lawyers has suggested that the Coranaisskin pronmlgate a cule xnuidatiJSfi thftt adk depositories-and, their direct and indirect participant* promptly retransmit notices received from the isiueror indenture trustee. While the establishment of information repositories may address the problem to some extent, the Commission staff intends to work with the relevant organizations to assure that steps are taken to provide for consistent retransmission of the information.
103 In light of the underwriter's obligation, as discussed in the prior releases, to review the official statement and to have a reasonable basis for its belief in the accuracy and completeness of the official statement's key representations, disclaimers by underwriters of responsibility for the information provided by the issuer or other parties, without further clarification regarding the underwriter's belief as to accuracy, and the basis therefor, are misleading and should not be included in official statements.
104 See Donald T. Shelddn, Securities Exchange Act Release No. 31475 (Nov. 18, 1992); Elizabeth Bamberg, Securities Exchange Act Release No. 27672 (Feb. 5, 1990); Feeneyv. SEC, 564 F.2d 260 (8th Cir. 1977); Nassar S Co., Securities Exchange Act Release No. 15347 (Nov. 22, 1978). See also Proposing Release, 53 FR at 37787, n.72-73.
105 Richard J. Buck & Co., 43 SEC 998 (1968), aff'd sub nom. Hanley v. SEC, 416 F.2d 589 (2d Cir. 1969). See also The Obligations of Underwriters, Brokers and Dealers in Distributing and Trading Securities, Particularly of New High Risk Ventures, Securities Act Release No. 5275 (Aug. 9, 1972) 37 FR 16011,16012-13; In Re Blumenfeld. Securities Exchange Act Release No. 16437 (Dec. 19, 1979) (broker-dealer charged unfair mark-ups and recommended transactions in municipal securities without a reasonable basis); J.A. Winston & Co., hie. 42 S.E.C. 62 (1964) (broker-dealer recommended transactions without a reasonable basis, and made representations that were false and misleading).
106 See Merrill, Lynch, Pierce, Fenner & Smith, Securities Exchange Act Release No. 14149 (Nov. 9, 1977) ("A recommendation by a broker-dealer is perceived by a customer as (and in fact it should be) the product of an objective analysis (which] can only be achieved when the scope of an investigation is extended beyond the company's management); John R. Brick, Securities Exchange Act Release No. 11763 (Oct. 24, 1975) ("the professionaL.is not an issuer. But he is under a duty to investigate and see that his recommendations have a reasonable basis"); M.G. Davis S Co., 44 SEC 153,157-58 (1970) (broker-dealer registration revoked because "representations and predictions" made and market letter relied on by registrant "were without reasonable basis," and "registrant could not reasonably accept all of the statements in the [market letter] without further investigation"), aff'd sub nom. Levine v. SEC, 436 F.2d 88 (2d Cir. 1971). See also Merrill, Lynch, Pierce, Fenner & Smith, Securities Exchange Act Release No. 14149 (Nov. 9, 1977) (noting that if a broker-dealer lacks sufficient information to make a recommendation, the lack of information is material and should be disclosed).
107 See supra n. 62.