Sifma criticizes municipal bond issuer health proposal

The Securities Industry and Financial Markets Association (Sifma) has raised concerns that plans to improve transparency about the financial health of state and local government bond issuers would in reality overwhelm investors with information and place heavy compliance burdens on brokerages.

The SEC has proposed amending a rule that requires broker-dealers acting as underwriters in primary offerings of municipal securities to ensure the government entity issuing those bonds agrees to tell the Municipal Securities Rulemaking Board (MSRB) about 14 types of events, such as non-payment-related defaults on the securities and principal and interest payment delinquencies, as they happen.

Under the commission’s plan to change Rule 15c2-12, issuers would also have to notify the MSRB about two additional types of events relating to the bonds:

• The ‘[i]ncurrence of a financial obligation of the issuer or obligated person, if material, or agreement to covenants, events of default, remedies, priority rights or other similar terms of a financial obligation of the issuer or obligated person, any of which affect security holders, if material’
• The ‘[d]efault, event of acceleration, termination event, modification of terms or other similar events under the terms of the financial obligation of the issuer or obligated person, any of which reflect financial difficulties.’

The intention is to protect those buying the bonds and enhance transparency in the municipal securities market by giving investors timely access to information about financial obligations incurred by governments that could impact their liquidity and overall creditworthiness.


‘IMMATERIAL FILINGS’
In a recent comment letter, however, Sifma associate general counsel Leslie Norwood writes that adopting the proposed changes ‘is likely to result in indiscriminate and mostly immaterial filings by issuers and obligated persons of documentation for a broad range of ordinary course-of-business financial agreements, obligations and judgments in order to avoid the time, uncertainty and cost of assessing the necessity of an event notice within the [10]-business-day deadline.’

The ability of an issuer to make the required filings on time would depend on its resources, access to outside counsel, sophistication and internal organization, including whether a disclosure committee with effective disclosure policies and procedures exists, Norwood says. At the same time, the overly broad application of materiality considerations in the SEC’s municipalities continuing disclosure co-operation initiative, which offered favorable settlement terms to underwriters and issuers that self-reported certain violations, has taught issuers that ‘safety resides in over-disclosure,’ she adds.

The likely outcome is the opposite of the SEC’s intention, in that investors and other market participants would have to wade through piles of documentation looking for material, relevant financial information – a particular problem for retail investors, Norwood says.

She suggests that, in addition to refining the definition of financial obligation, the SEC suggest a bright-line proviso similar to one it has used elsewhere, which states: ‘[N]o notice is required if the financial obligations incurred, in the aggregate since the last notice filed under this section or the last annual financial information filed, whichever is more recent, constitutes less than 5 percent of the total outstanding debt of the issuer or obligated person.’

In the absence of guidance to clarify what they are reasonably expected to do to comply with the proposed rule changes, underwriters would face an ‘extremely difficult task’ in reviewing an issuer’s filings ‘as they will contend with the absence of transparency of issuers and obligated persons cited by the SEC as the primary basis for the proposal,’ Norwood says. 

‘Absent express guidance from the commission that underwriters may rely on certifications from issuers and obligated persons on whether financial obligations and events have occurred, underwriters are obliged to second-guess the judgment of an issuer or obligated person as to whether a financial obligation and its terms are material and properly reported, a task that will be difficult and time-consuming,’ she argues.

Sifma also points the SEC to a separate comment letter in which the National Association of Bond Lawyers argues that the real burdens would be more than 100 times those estimated by the agency (CorporateSecretary.com, 4/14).