WASHINGTON — The Securities and Exchange Commission could address muni market sectors with the most defaults if Congress gives it authority to enhance municipal issuers’ disclosure practices, SEC commissioner Elisse Walter said in a recent interview.
“Those deals ... would be subject to the disclosure standards that the commission has asked for authority to establish,” Walter said.
“Whether it’s a conduit deal, a [general obligation] deal, a revenue bond deal, a dirt bond deal, whatever it is. ... What we are doing is seeking to establish disclosure standards across the board for all of those different kinds of municipal offerings,” she added.
Walter made the remarks after an Aug. 21 article in The Bond Buyer quoted market participants saying recommendations in the SEC’s July 31 report on the municipal bond market would not improve disclosure for bonds with the highest default rates.
The market participants noted that the SEC’s call for legislative authority to subject corporate conduit borrowers to corporate-style registration and disclosure requirements would not cover land-based bonds, which are not sold through conduit deals, or many nursing home and hospital bonds, which would retain a federal securities law exemption for nonprofits.
Market studies indicate that those deals are most likely to default.
Between 2007 and 2010, land-secured bonds accounted for 33% of defaults, and bonds for nonprofit hospitals and long-term care facilities like nursing homes accounted for 18% of defaults, according to data cited in the “Bloomberg Visual Guide to Municipal Bonds,” a book by Robert Doty, a California-based municipal advisor and president of consulting firm AGFS, which was published this year.
Walter defended the SEC’s report, saying that the conduit-related recommendation specifically addresses disclosure loopholes afforded to private companies. They should not be able to avoid registration and disclosure “simply because” they borrow money through a municipal entity, she said.
As for nonprofit conduit borrowers and land-based bonds, Walter said the SEC could target disclosure related to those deals if lawmakers act on the first, over-arching recommendation in the report: that Congress grant the commission authority to regulate the content and timing of issuers’ official statements and continuing disclosures.
This is “one of the most critical aspects of the report,” she said.
But equally critical, Walter said, are the pricing-related recommendations, among them that the SEC consider amending its “ATS Regulation” to require alternative trading systems — the electronic marketplaces where dealers buy and sell munis — to publicly distribute the best offers and best bids submitted by dealers.
Executives at some alternative trading system firms have raised concerns about new disclosure requirements, warning that disclosing bids and offers could tighten dealers’ spreads and force some dealers out of the muni trading business, which could further restrict market liquidity and efficiency.
But Walter maintained that transparency nearly always benefits capital markets. She added that dealers expressed similar, and ultimately unfounded, concerns about being required to report post-trade pricing information to the Municipal Securities Rulemaking Board and the Financial Industry Regulatory Authority.
When asked if the SEC is actively working on proposed changes to ATS rules, Walter said only, “The staff will now move forward with the items laid out in the report.”
Walter also discussed the importance of the SEC’s proposal for its improved collaboration with the Internal Revenue Service.
The commission said in its report that its investigations of municipal bond abuses have been hampered by tax laws that prohibit the IRS from sharing taxpayer information with the SEC for muni enforcement cases.
The IRS regards municipal issuers as taxpayers.
The SEC said the prohibition delayed its probe of the Neshannock Township School District in Pennsylvania and hindered its investigations of alleged bid-rigging of muni bond-related investment and derivatives contracts.
The report asked Congress to permit the IRS to share information related to its tax audits and examinations in instances of suspected securities fraud.
“We are both parts of the federal government. We should be able to help each other,” Walter said. “In any case where someone is claiming the municipal securities exemption, and they are not entitled to it, the tax issue and the securities-law issue are very closely tied together.”
Tax laws generally prohibit the IRS from sharing any taxpayer information with the SEC for its enforcement of federal securities laws, the SEC said in its report. The IRS cannot disclose to the commission the names of issuers whose bonds it determines are taxable or any details from audits of those bonds.
The SEC report noted, however, that tax-law exemptions permit the IRS to share tax information with others in certain situations, such as in connection with criminal investigations.
The IRS can disclose taxpayer information to state tax officials, state law enforcement agencies, congressional committees, the president, White House officials, the Justice Department, the Treasury Department and other federal agencies, according to the commission.
Access to tax information and information related to IRS investigations could make the SEC’s civil enforcement actions more consistent and comprehensive, the report said.
The Neshannock Township School District agreed in 2004 to pay $28,904 to settle fraud charges, but only after it paid $150,000 to the IRS, which had determined that a $9.6 million, three-year note sold in 2003 was taxable.
According to the SEC, although offering and disclosure documents said most of the note proceeds would be used to fund capital improvements, the district invested the money in U.S. Treasury bills, and expected to spend only $225,000 — the investment return — on improvements.
The investigations of bid-rigging schemes, which occurred between 1997 and 2005, have resulted in criminal indictments and convictions.
Bankers, guaranteed-investment contract brokers, and other brokers have pleaded guilty to conspiracy and fraud charges, and five financial firms have paid more than $745 million in global settlements with the SEC, Justice Department, other federal regulators and state attorneys general.
“Had the IRS been able to communicate with the commission, these investigations could have been conducted in a more efficient and timely fashion,” the report said.
Walter called the SEC’s muni office, which currently has only three dedicated staffers and no director, “a work in progress.”
The Dodd-Frank Act requires the office to be independent and to report directly to the commission’s chairman.
The muni office was created as an independent division in 1995, when then-chairman Arthur Levitt said one of his priorities was to initiate reforms for the muni market. But the office lost its independent stature and has been housed in the SEC’s division of trading and markets since 2001.
The commission announced recently that John Cross, associate tax legislative counsel at the Treasury Department, will become director of the muni office in September.
Walter said the muni office has historically worked on muni bond issues with the division of corporation finance, which regulates financial disclosures, and in particular with Amy Starr, that division’s senior special counsel.
Walter said the office will remain “relatively small” and continue to “interact very closely with those people who deal with market issues and with disclosures issues” in the trading and markets and corporation finance divisions.
