WASHINGTON — The Securities and Exchange Commission is preparing to issue a report, as soon as Thursday, proposing legislative and regulatory changes that would improve disclosure and price transparency in the $3.7 trillion municipal bond market.
SEC officials and a spokesman declined to comment on the report, which has been approved by all five commissioners. But market sources said it will recommend, among other things, corporate-style registration and disclosure for conduit bonds, which state and local governmental authorities issue for corporate borrowers.
The report also is expected to propose requiring state and local government issuers to comply with the Governmental Accounting Standards Board’s generally accepted accounting principles if they want to issue muni bonds.
To improve price transparency, the SEC is expected to recommend that the Municipal Securities Rulemaking Board require dealers to disclose markups and markdowns for riskless principal transactions, which make up a significant percentage of muni trades, and occur when a dealer buys and sells bonds almost simultaneously to fill an order without holding them in inventory so there is little risk of loss from market changes.
The SEC also is likely to urge the MSRB to adopt a best execution rule, similar to one that exists for corporate securities that requires brokers to always execute orders for clients at the best possible prices available.
The report is the culmination of more than two years of work presided over by SEC commissioner Elisse Walter, who in May 2010 launched a nationwide inquiry in the muni market with the goal of issuing a final report and recommendations.
Walter initiated the inquiry after being criticized by issuer officials for a landmark speech she gave in October 2009 at Fordham University School of Law entitled, “Regulation of the Municipal Securities Markets: Investors Are Not Second-Class Citizens.”
In that speech, Walter called for several muni market reforms, many of which were incorporated into the Dodd-Frank Act. Among these were that the MSRB have a majority-public board and be given authority over swap and other municipal advisors. She also called for an independent funding source for GASB.
Walter irked muni issuers by calling for the repeal of the Tower Amendment and other exemptions for muni securities in the federal securities laws. The Tower Amendment, added in 1975 to the Securities Exchange Act of 1934, prohibits the SEC and MSRB from requiring issuers to file documents with them before issuing securities.
Issuers complained Walter didn’t understand the muni market, so she launched the inquiry. The SEC held a series of public hearings around the country, met with dozens of muni market participants and collected written comments from them.
Since then, Walter has said, and the Government Accountability Office is expected to conclude, that it is not necessary to repeal the Tower Amendment or securities law exemptions for munis to implement market reforms such as the ones the SEC is proposing.
Several of the recommendations expected to be in the SEC report are not new. Former SEC chairman Christopher Cox, a Republican, sent a 12-page white paper to members of Congress in July 2007 asking them to require corporate-style disclosure and registration for conduit bonds and to require muni issuers to use GAAP. The SEC adopted a conduit bond registration rule in 1968, but it was overturned by Congress a year later as it pertained to muni issuers. Former SEC chairman Arthur Levitt also urged lawmakers to draft and approve legislation requiring registration of corporate conduit borrowers.
In 1994, the SEC, under Levitt, considered requiring brokers to disclose markups for riskless principal transactions in the muni market, but shelved the idea after the dealer community proposed a price transparency program as an alternative. That was long before the MSRB’s EMMA system began collecting and making available issuers’ primary and secondary disclosure documents and near-real time prices for muni bonds.
The SEC’s proposals are likely to be embraced by a number of lawmakers and the MSRB, sources said.
Rep. Mike Quigley, D-Ill., a member of the House Oversight and Government Reform Committee, working with Rep. Patrick McHenry, R-N.C., a subcommittee chairman, last year drafted the Municipal Securities Transparency Act of 2011, which would have required corporate conduit borrowers to register with the SEC and meet its corporate disclosure requirements. The draft would also have authorized the SEC to dictate the content and timing of muni issuers’ disclosure documents.
While the SEC does not regulate muni issuers, it has tried to indirectly impose disclosure requirements on issuers through broker-dealers. The SEC’s Rule 15c2-12 on muni disclosure, for example, prohibits dealers from underwriting most municipal securities unless issuers have entered into written agreements to disclose annual financial and operating information, as well as notices of events such as principal and interest payment delinquencies or bankruptcy filings, when they occur.
