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The Burden of 15c2-12

MIAMI BEACH - It is unreasonable to expect state and local governments to file material event notices when the ratings on their bonds are downgraded because the ratings of the insurers that backed their bonds are lowered, Frank Hoadley, chairman of the Government Finance Officers Association's debt management committee, said here yesterday.

Speaking at the annual conference of the National Federation of Municipal Analysts, Hoadley, Wisconsin's capital finance director, argued that the requirements of the Securities and Exchange Commission's Rule 15c2-12 on disclosure places an impossible burden on issuers in such circumstances.

Under the rule, a dealer may not underwrite munis unless the issuer of the bonds has contractually agreed to disclose to nationally recognized repositories financial and operating information at least annually, as well as the occurrence of any of 11 specified material events, such as rating changes, bond calls, and adverse tax opinions, or events affecting the tax-exempt status of the bonds.

But Hoadley said he does not know of a single issuer that has been formally notified by either a credit rating agency or an insurer that its bonds have been downgraded because the rating on the insurer wrapping the bonds has been lowered. Further, it is unclear what an issuer facing such circumstances would disclose, since most continuing disclosure notices normally include a document such as a letter from a rating agency, or a new revenue estimate, he said.

"We have an obligation to report under the 11 'deadly sins' - those facts which we know, and those facts usually are in the form of a document," said Hoadley. But he added that "with regard to the downgrades that have happened because of the insurance downgrades, I don't believe one single issuer has been told that there has been an insurance downgrade."

Even though rating agencies have online lists of the securities that have been affected by the downgrades, Hoadley said that the act of citing "something that you heard about or saw on a third-party Web site is hearsay," because neither the rating agency nor the insurer has formally written the issuer to notify them that their bonds have been downgraded.

"It's not a fact that is known to the issuer at this point," he said.

Hoadley's remarks were seconded by J. Foster Clark, president of the National Association of Bond Lawyers, who also spoke on the panel. Clark, a partner at Balch & Bingham LLP in Birmingham, said that he did not know until the ratings of bond insurers were downgraded earlier this year that an issuer could have bonds wrapped by the downgraded insurer and not be informed that its debt had subsequently been downgraded.

The remarks come after the SEC distributed two pieces of guidance to bond attorneys earlier this year meant to clarify issuers' roles amid the rating downgrades of insurers. The first, which the commission informally sent to NABL on Jan. 18, said issuers did not need to file material event notices notifying investors of the initial Fitch Ratings' downgrade of Ambac Assurance Corp. to double-A from triple-A because "press coverage had been so widespread and extensive."

But in a Feb. 6 clarification, which some attorneys saw as a reversal, the SEC stated that the Jan. 18 notice only applied to the reporting of the rating downgrades to the insurers and not to the wrapped securities that were downgraded as a result.

Frank Chin, the chairman of the Municipal Securities Rulemaking Board, who was also on the panel, said that the MSRB is aware of the difficulty issuers are having with this issue and is working to create a system in which insurers can file with the board the Cusip numbers of the securities affected by a change to their rating.

Chin said he is hopeful that the system will be part of the board's Electronic Municipal Market Access, or EMMA system, the free central repository that the board is developing and hopes to operate as a primary and secondary market disclosure site by the end of the year.

But the filing system for insurers would only be voluntary because the MSRB does not have oversight over bond insurers and because continuing disclosure agreements are only binding between issuers and the holders of their bonds.

The board launched EMMA in a pilot format at the end of March, the first of four phases in the project. So far EMMA has had 21,000 separate visitors from 22 countries, MSRB officials said yesterday after the panel session.

 

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