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Delinquent Disclosure

WASHINGTON - More than half the municipal bonds sold between 1996 and 2005 have been delinquent in filing financial disclosures, showing the secondary market disclosure system for the municipal market is flawed, mostly because there are "no consequences for not filing," Peter J. Schmitt, president of DPC Data Inc., said yesterday about a new study released by his firm.

The study shows that more than 50% of bonds sold between 1996 and 2005 have one or more years of disclosure delinquency and that more than 25% are in chronic delinquency, missing three or more years of disclosures.

While over 42,000 borrowers brought one or more issues to market during that period, only about 33,000 borrowers filed annual disclosure documents, the study found.

DPC Data said it is uniquely qualified to do this kind of study because it is one of four nationally recognized municipal securities information repositories that collect secondary market disclosure data from municipal issuers under the SEC's Rule 15c2-12 on disclosure.

That rule, which took effect on a phased in basis beginning in July of 1995, states that a broker-dealer may not underwrite municipal securities unless the issuer of the bonds has contractually agreed to disclose to all four NRMSIRs annual financial and operating information, as well as the occurrence of any of 11 specific material events, such as rating changes, bond calls, and adverse tax opinions, or events affecting the tax-exempt status of the bonds.

If an issuer fails to meet its disclosure commitments, the only remedy for bondholders is to take action against the issuer. The SEC has never taken action against a broker-dealer for underwriting the bonds of an issuer that failed to file its annual financial disclosures.

SEC officials said yesterday that the release adopting 15c2-12 stated: "The amendments do not prohibit participating underwriters from underwriting an offering of municipal securities if an issuer or obligated person has failed to comply with previous undertakings to provide secondary market disclosure. However, if a failure to comply with such previous undertakings has not been remedied as of the start of the offering, or if the party has a history of persistent and material breaches, it is doubtful whether a participating underwriter could form a reasonable basis for relying on the accuracy of the issuer's or obligated person's ongoing disclosure representations."

Schmitt said the study shows a lax regulatory environment concerning secondary market disclosure.

"There is virtually no enforcement in the secondary market, it's not taken seriously," he said. "There are no consequences for not filing and what you get is bad disclosure behavior."

Schmitt stressed that the study, which has been in the works since November, only aims to present data collected by DPC as a NRMSIR and does not urge any specific changes to the SEC rule. Nonetheless, it comes as the commission is considering changes to 15c2-12 that would effectively replace the four NRMSIRs for the purposes of secondary disclosure with a new central repository run by the Municipal Securities Rulemaking Board called EMMA, or Electronic Municipal Market Access.

DPC Data is believed to be the NRMSIR that will be most harmed by a switch to EMMA, but Schmitt declined to talk about any issues other than the data in the survey.

The study shows that in 2006, bonds in "disclosure delinquency" represented more than $348 billion in par value. It also shows that the number and proportion of continuing disclosure delinquencies are increasing every year, particularly since 2004, when disclosure delinquencies began to show an upturn, a trend that continues to accelerate.

Though the total number of delinquencies between 1997 and 2003 hovered at the "reasonably constant" range of 16% to 20%, the percentage of delinquencies began to escalate after 2004, topping 25% in 2006, the study showed.

"This quite possibly indicates growing [issuer] indifference toward filing disclosure materials," the study stated. "It also supports the view that obligors for bonds issued in more recent years are more inclined to disregard their continuing disclosure covenants."

The upturn since 2004 is significant because that year marks the establishment of the Central Post Office, which was devised by the Muni Council, a group of 18 muni market groups working to improve secondary market disclosure, to both provide issuers with a voluntary, one-stop filing place for secondary market disclosure documents, and eliminate the inconsistencies in the way the NRMSIRs obtained and filed the documents.

Asked about the CPO's establishment that year, Schmitt said the upturn is "one of the big surprises in the data" and that he does not fully understand why it had occurred.

"The CPO really should have taken away the excuse that it's too cumbersome to file with four repositories and maybe a [state information depository]," he said. "The ease of filing should have been a tremendous possibility for increasing compliance, but it didn't and I can't explain why."

Data showing that the CPO was ineffective at improving compliance could suggest that EMMA also will be ineffective, sources said.

But issuer groups, which have expressed support for the system, dismissed that idea yesterday.

"A multiple NRMSIR system is inefficient for both investors and issuers," said Susan Gaffney, director of the Government Finance Officers Association's federal liaison center here. "Creating a central repository will allow for the process to be streamlined and is a concept the GFOA has supported for many years."

Some market participants warned that if the DPC Data is accurate, it means that voluntary compliance with disclosure regulations does not work.

"Delinquencies to the scale that DPC talks about are unacceptable and an indication that voluntary compliance doesn't work," said Richard Ciccarone, a managing director and chief research officer at McDonnell Investment Management LLC, who stressed that there are "a large number of issuers that do comply with the spirit of disclosure and there are exceptional cases where compliance is above and beyond what one might expect."

Ciccarone, who is also president of Merritt Research Services, which maintains a large database of information on municipal credits, said delinquency figures from a sample of 3,200 of Merritt's "core" credits, which include larger revenue bonds and state general obligation debt, was less alarming than DPC Data's study.

For instance, about 79% of the time Merritt received annual financial information for its core credits within nine months of the close of issuers' fiscal years, while only about 3.5% of the annual information is never received despite repeated requests, he said.

But outside of Merritt's core credits - which includes smaller issuers, less frequent borrowers and many privately secured municipal bonds - delinquencies are closer to the results of the DPC study, he said.

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