After a two-year examination of the structure and integrity of the municipal securities market, the SEC issued a report on the municipal securities market (the “Report”) mandated by the Dodd–Frank Act. In broad terms, the Report cites two primary concerns regarding the municipal securities market: (1) concerns relating to disclosure requirements and (2) concerns relating to the municipal securities market structure; and provides a number of specific recommendations, particularly with respect to improving disclosure and price transparency for investors.
The Report identifies several areas of concern regarding existing disclosure practices in the municipal securities market. The main areas of concern relate to the types of disclosures in offering documents made by municipal entities at the time of issuance, continuing disclosure practices and compliance, the timing and content of financial statements, the nature and level of disclosures regarding derivatives, pension obligations, conflicts of interest and certain material relationships, and the adoption and implementation of quality internal controls and procedures by an issuer that would ensure proper disclosure and financial reporting.
The Report recommends a combination of approaches to improve disclosure in the municipal securities market, including legislative and regulatory recommendations.
Legislative Recommendations to Address Disclosure Concerns
The Report provides several recommendations to improve disclosure practices in the municipal securities market. Among other things, the Report recommends legislation that would provide the SEC with the authority to establish disclosure requirements and principles, including timeframes, frequency of dissemination of municipal securities offerings, and continuing disclosures and minimum disclosure requirements, including financial statements and other financial and operating information.
The Report notes that such authority would allow the SEC to be able to address the lack of disclosure by municipal entities. The SEC cites concerns that certain municipal entities are not disclosing the impact of their pension funding obligations, their other post-employment benefit obligations, the underlying assumptions used to calculate those post-employment benefit obligations, the exposure of such municipal entities to derivatives and conflicts of interests, and certain other relationships or practices. If granted sufficient authority, the SEC would be able to consider and implement disclosure policies and procedures to ensure appropriate disclosure and financial reporting by municipal issuers.
The Report also recommends eliminating the availability of exemptions from registration with the SEC to conduit borrowers who are not municipal entities under Section 3(a)(2) of the Securities Act of 1933 (the “Securities Act”) as a means of improving municipal security participant disclosure. The Report notes that it does not seek the elimination of other exemptions available to conduit borrowers, such as nonprofits, which benefit from an exemption from registration under Section 3(a)(4) of the Securities Act. The Report emphasizes, however, that a conduit borrower should not be exempt from registration simply because the conduit issuer through whom it has access to the capital markets is entitled to such an exemption as a municipal entity.
Regulatory Recommendations to Address Disclosure Concerns
The Report notes that the SEC found that compliance with continuing disclosure obligations under Rule 15c2-12 of the Securities Exchange Act of 1934 has been inconsistent. Rule 15c2-12 was created to establish standards for the procurement and dissemination of disclosure documents by underwriters as a means of enhancing the accuracy and timeliness of disclosure to municipal securities investors. While Rule 15c2-12 has been amended over the years as the municipal securities market has evolved, the Report concludes that a “one-size-fits-all” approach to disclosure is unnecessary and undesirable. The Report suggests that disclosure rules should instead focus on the need for greater and more timely disclosure in several key areas, such as disclosures relating to financial information, the use of standard accounting principles, and the avoidance of “stale” or misleading information.
The Report also recommends amendments to Rule 15c2-12 to achieve the recommended results should the legislative approach not be feasible. Such amendments would include amending the definition of “final official statement,” which the Report notes does not currently establish the form and content of financial information and operating data required to be disclosed in an official statement for a primary offering of municipal securities.
The report notes that the SEC should also consider issuing updated interpretive guidance regarding the disclosure obligations of municipal securities issuers. The Report cites the comprehensive interpretative guidance of the disclosure obligations from the 1994 amendments to Rule 15c2-12 which addressed the disclosure of conflicts of interest, the disclosure of the terms and risks of securities, and the disclosure of the importance of the timeliness of financial statements.
Market Structure Concerns
In the Report, the SEC also identifies several concerns regarding the structure of the municipal securities market. In contrast to its recommendations with respect to the disclosure concerns and recommendations highlighted above, the SEC’s recommendations regarding market structure do not include additional statutory authorization for the SEC. Instead, the Report recommends that the SEC and the Municipal Securities Rulemaking Board (the “MSRB”) use existing authorization to adopt new rules to enhance price transparency and disclosures to, and execution of transactions for, investors.
The primary concerns cited in the Report include the limited access that investors currently have to pre-trade price information, the disparity in access to pricing information that institutional investors have in comparison to retail investors, the lack of an explicit rule regarding best execution that applies to market participants in the municipal securities market, and the lack of liquidity and price transparency in the municipal securities market that makes it more expensive for investors to trade municipal securities than to trade corporate bonds or equity securities.
Regulatory Recommendations to Address Market Structure Concerns
In order to address these concerns regarding the market structure of the municipal securities market, the Report recommends that the SEC and the MSRB adopt new rules pursuant to existing legislative authority to increase pre-trade and post-trade price transparency and improve execution of transactions for investors.
To improve pre-trade price transparency and provide access to firm bid and ask quotations, the Report observes that the SEC could consider amendments to Regulation ATS to require an alternative trading system (ATS) with material transaction or dollar volume in municipal securities to publicly disseminate its best bid and offer prices and, on a delayed and non-attributable basis, responses to “bids wanted” auctions. In addition and in conjunction with such amendments, the Report suggests that the MSRB should consider rules requiring a broker’s broker with material transaction or dollar volume in municipal securities to publicly disseminate the best bid and offer prices on any electronic network it operates and, on a delayed and non-attributable basis, responses to “bids wanted” auctions.
The Report also provides recommendations to improve post-trade price transparency. The Report notes that institutional investors tend to have access to a variety of sources of municipal securities pricing information, while retail investors have access to relatively little pricing information about municipal securities. To combat this discrepancy, the Report recommends that the MSRB consider requiring municipal bond dealers to report “yield spread” information to its Real-Time Transaction Reporting System (RTRS) to supplement existing interest rate, price, and yield data. The Report also recommends that the MSRB promptly pursue enhancements, such as enhanced search functionality, to its Electronic Municipal Market Access system website (“EMMA”) so that retail investors have better access to pricing and other municipal securities information. The Report also provides additional suggestions involving education and increased disclosures by dealers to retail investors of pricing information in order to improve pricing and increase transparency.
The SEC also recommends that the MSRB consider issuing more detailed interpretive guidance to assist dealers in establishing the “prevailing market price” for a municipal security, for purposes of determining whether the price offered a customer is fair and reasonable. The Report recommends that the MSRB consider adopting a rule that would require municipal bond dealers to seek “best execution” of customer orders for municipal securities, as no such rule is currently in place.