Opinions Divided Over Disclosure

SANTA ANA PUEBLO, N.M. — Even as the major municipal market groups have pledged to work to improve continuing-disclosure practices, voluntary improvements to their timeliness and quality remains elusive after years of debate, some analysts say.

They expressed skepticism at the National Federation of Municipal Analysts’ annual conference, meeting here this week, that any widespread improvements could come about without the legislation the Securities and Exchange Commission is seeking to give it direct authority over the market.

Though the analysts conceded the Municipal Securities Rulemaking Board’s Electronic Municipal Market Access, or EMMA, site is a step forward for improving access to disclosures, they complained that the SEC’s existing Rule 15c2-12 on disclosure, under which the commission regulates issuers indirectly through dealers, is essentially toothless.

The criticism comes despite recent pledges from the NFMA, the Government Finance Officers Association, and the National Association of Bond Lawyers to work together to improve the quality of derivatives disclosures and work toward the more timely release of financial information. NFMA board members stressed they believe these new initiatives will bear fruit.

But speaking from the audience during a market roundtable at the conference Wednesday, Tom Weyl, director of municipal research at Eaton Vance Management in Boston, expressed  frustration that more improvements have not been made to secondary market disclosure during the last decade.

“It’s a sad state of the market that we’re having the same conversation 12 years into our efforts on recommended best practices,” said Weyl, a former NFMA chairman who is no longer a member of the group’s board. “We keep coming back to the same market discussions, but we’re not moving forward much.”

Weyl conceded that one of the roundtable panelists, Ken Artin, a shareholder at Bryant Miller & Olive in Orlando and a member of NABL’s board, has some thoughtful ideas, such as tailoring continuing disclosure agreements to the type of security. But these ideas have already been incorporated by the NFMA into its white papers and best practices documents, Weyl said.

Specifically, Artin suggested that for dedicated tax securities, issuers should consider how to quickly make their monthly sales-tax reports publicly available on EMMA.

Artin also said that for general obligation credits, there is no reason why annual tax assessor reports used to determine localities’ budgets for the coming year could not be released on an expedited basis through EMMA.

But the release of such documents typically is held up in the audit for the prior fiscal year and they are not made available to investors on EMMA until up to 12 months after the close of that fiscal year.

“What you wind up having is the data that was really necessary getting stale, sitting there waiting for the annual reports,” Artin said. “I’m [seeing] a bit of a bottleneck issue here with respect to information. There’s no reason why that county tax collector’s report made available to the county for the budgetary process can’t be pushed through to EMMA and made available at that point in time.”

While Weyl said these kinds of ideas are welcome, he added, “We’ve done everything [Artin] said, and it really hasn’t gotten us anywhere.”

“It’s very frustrating, especially for the buy-side analysts in the audience, as we talk about these same things every year,” he said.

Martha Mahan Haines, the SEC’s municipal securities chief and one of the panelists, told analysts it is “extremely important” that they tell the issuer and underwriter when their concerns about disclosure deficiencies in a particular deal lead them not to buy the bonds. Such market discipline would lead to improvements without legislation, she suggested.

But Weyl said there can be no market discipline in a market that is now comprised one-third of retail investors and another third as proxies for retail. He criticized Haines and The Bond Buyer for giving the market discipline argument too much credence.

“If anybody turns down a deal, somebody else buys it — there’s enough buyers out there,” Weyl said. He added that it is “those kinds of market forces that caused Congress to decide to make equities and corporate bonds subject to disclosure rules and securities laws back in the ’40s that don’t exist in our market now.”

Though Artin noted that there are heightened quarterly disclosures in certain market segments, notably health care, Weyl said this is only because there is a limited market for health care bonds, “so you can have market power.”

Turning to perceived weaknesses with 15c2-12, Weyl said he was recently at a meeting where a bond insurer representative said the insurer had made four principal and interest payments on bonds it was wrapping, yet no material event notices were published.

“That’s a default … and to me clearly it’s an issue of 15c2-12 not working when market participants — trustees or someone else — don’t do their jobs under the rules,” Weyl said.

Though Weyl seemed to push Haines for a comment on the failure of the issuer or trustee to file an event notice, she only said that the SEC would “love to have more authority” to address the problems.

Under 15c2-12, dealers cannot underwrite most muni securities of $1 million or more unless the issuer has entered into a written continuing-disclosure agreement with bondholders to disclose annual financial and operating information as well as material events when they occur.

Guidance issued by the SEC lists at least 11 events that could be material, including unscheduled draws on credit enhancements that reflect financial difficulties. But the guidance currently leaves it up to the issuer and other market participants to determine whether any of the 11 events are material. Under case law, information generally is deemed to be material if an investor would want to know about it prior to making an investment decision.

Proposed changes to 15c2-12 to expand the quantity and timeliness of continuing disclosures would remove a materiality determination from several categories of events, including unscheduled draws on credit enhancement. Haines said the SEC is still scheduled to consider the proposed changes to the rule sometime before the end of the second quarter.

While Artin agreed with Weyl that improvements to disclosure have been a constant refrain for the past 20 years and that it is difficult to have market discipline when there is always another buyer, he was much more optimistic about possible improvements. “We can only hope that there is so much change in the market right now that maybe if we redouble our efforts and make an effort again this time, that maybe we’ll accomplish something,” Artin said. “We can’t give up.”

Those remarks were echoed by another panelist, Bob Scott, the chief financial officer of Carrollton, Tex., and a member of the GFOA’s executive board, who said that historically, issuers may not have seen “tremendous rewards” for going above and beyond their disclosure obligations. But that has changed with the collapse of most bond insurers, he said, adding: “I think there will be more willingness to dialogue with you on what you need.” 

MSRB executive director Lynnette Hotchkiss, who also spoke on the panel, said she hopes EMMA, which became the sole repository for continuing disclosures last summer, will facilitate disclosure improvements.

EMMA already has cleaned up the previous decentralized and incomplete system of multiple disclosure repositories and houses a transparency system for short-term securities that no other fixed-income market has, she noted.

Hotchkiss said the board has a proposal before the SEC to give a special designation to issuers that voluntarily agree to several undertakings, such as providing annual audited financial information within 120 or 150 days of the end of their fiscal years. The proposal has been pushed by the SEC to give issuers incentives to improve the timeliness and quality of their disclosures.

“I’m hopeful that the EMMA system and the transparency that that system provides will up the ante in terms of the quantity and quality of disclosure,” she said. “We’re going to need to have to go through a year or year-and-a-half cycle to actually see if there’s any evidence of that, but I’m optimistic. I think we’re going to be in a better situation this time next year.”

Emphasizing the possibility of rewards for issuers that elect to provide more timely disclosures, John Hallacy, head muni strategist at Bank of America Merrill Lynch, said from the audience that many crossover investors of taxable Build America Bonds are “somewhat aghast” at the status of real-time information they get for municipal credits.

While they understand they are unlikely to receive quarterly disclosures as in the corporate market, investors are concerned about how infrequent the financials are reported. Hallacy said that in many cases, they either will choose not to purchase munis if there are other vehicles to select from, or less risk-averse investors will buy the bonds but insist on more spread or higher yield.

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