SEC Releases its Report on the Municipal Securities Market

On July 31, 2012, the Securities and Exchange Commission (SEC) issued its comprehensive Report on the Municipal Securities Market (the Report) with recommendations to improve the $3.7 trillion municipal securities market, particularly through improved disclosure and price transparency for investors. Despite its size and importance, this market is not currently subject to the same level of oversight and regulation as other capital markets.

The Report notes that historically the municipal securities market has been characterized by relatively low liquidity, significantly lower risk of default, and low occurrence of issuer bankruptcy. In recent years, however, the market has been marked by significant growth and greater diversity. This comes in the midst of decreased independent oversight due, in part, to a decline in forms of credit enhancement, such as bank-issued letters of credit, governmental guarantees and bond insurance. As the use of credit enhancement has diminished, investors are placing an increased emphasis on comprehensive disclosure by issuers.

The Report finds that compliance with continuing disclosure obligations under Rule 15c2-12 has been inconsistent. The Report concludes that a “one-size-fits-all” approach to disclosure would be unnecessary and undesirable, and instead focuses on the need for greater and more timely disclosure in several key areas. The key areas of focus for improved substantive disclosure include financial statements and financial information, use of standard accounting principles (particularly GASB), as well as the avoidance of “stale” or misleading information.

The Report recommends a combination of approaches to improve disclosure in the municipal securities market including:

Legislative

• Requiring timeframes for issuers to prepare and disseminate official statements and disclosure, setting requirements for frequency and minimum disclosure, and creating tools for enforcement.
• Removing exemptions in the Securities Act and Exchange Act for conduit borrowers that are not municipal entities.
• Establishing a standard form and content for financial statements.
• Requiring audited financial statements.
• Providing a safe harbor from private liability for forward-looking statements.
• Permitting the Internal Revenue Service to share with the SEC information from returns, audits and examinations, as it relates to municipal securities offerings.
• Providing a mechanism to enforce compliance with continuing disclosure agreements, including authorization of trustees to enforce compliance.

Regulatory

• Updating SEC interpretive guidance regarding disclosure obligations.
• Amending Rule 15c2-12 to improve disclosure requirements.
• Strengthening the rules of the Municipal Securities Rulemaking Board (MSRB) and improving its online central repository for disclosure (the EMMA website).

The Report characterizes the municipal securities market as relatively opaque, noting that although improvements have been made in recent years to increase price transparency, numerous changes to the market structure are warranted to enhance price transparency and promote fair access. These changes will be particularly significant for household and “retail” investors, which constitute a significant portion of investors in municipal securities.

Recommended changes related to market structure include:

Pre-trade price transparency

• Requiring alternative trading systems and brokers with material transaction or dollar volume to publicly disseminate best bid and offer prices for municipal securities.

Post-trade price transparency

• Requiring municipal bond dealers to report “yield spread.”
• Enhancing the MSRB’s EMMA website so that investors have better access to pricing and other information.

Enhance existing dealer pricing obligations

• Creating initiatives to improve investors’ understanding of the ways in which they may buy and sell securities and encouraging alternative trading systems as a means of widely disseminating quotes and providing fair access.
• Increasing the use of electronic networks to widely disseminate quotes and provide fair access.
• Encouraging or requiring municipal bond dealers to provide retail customers relevant pricing information.
• Issuing by the MSRB of more detailed interpretative guidance to assist municipal bond dealers in establishing “prevailing market price” to better determine whether the price offered a customer is “fair and reasonable.”
• Requiring municipal bond dealers to disclose the amount of any markup or markdown.
• Requiring municipal bond dealers to seek “best execution” of customer orders.