Securities Law

Cross: MA Definition Could Come Early Next Year

WASHINGTON — The Securities and Exchange Commission hopes to finalize its definition of municipal advisor early next year, according to the new director of the SEC's municipal securities office.

In his first interview since joining the SEC, John Cross, 56, who became head of the office on Sept. 24, called the final MA definition and registration rules "a first, immediate priority of his office."

Cross, a former associate tax legislative counsel at the Treasury Department, discussed a host of other challenges facing the muni market and urged issuers to take steps to improve the quality and timeliness of their disclosure filings.

He said better disclosure could boost the market's vibrancy and attract more institutional investors.

"You've got to look at the future and see the need for ... better and more timely information to the investor community to facilitate maximum access to this market," Cross said.

The SEC has not set a deadline for finishing its MA definition and registration rules, but the goal is to "try to bring to the commission a final rule package for consideration early next year," Cross said.

The commission has been under heat from market participants to complete its definition of municipal adviser, which was proposed in late 2010 but criticized by market participants for being overly broad.

Since then, MAs have been required to register with the SEC under temporary registration rules.

In September the SEC extended the temporary rules for the second time until September 2013.

"The intent was not to signal that it would take another year for us to finalize those rules. We expect to do considerably better than that," Cross said.

A measure passed by the House of Representatives in September "complicates" the SEC's efforts to finalize its rules, he said.

Sponsored by Rep. Robert Dold, R-Ill., that bill is designed to fix many of the perceived problems with the SEC's initial definition.

It would define MAs as those engaged in muni advisory activities for compensation and would create exceptions for underwriters, bankers and swap dealers, as well as those who provide advice related to those activities.

Some market participants have called the bill, which has been referred to the Senate Banking Committee, a "message bill" designed to encourage the SEC to complete its definition.

Cross said he would prefer if Congress delayed action on the bill until the commission completes its rulemaking, noting that the regulator hopes to address many industry concerns in final rules, Cross said.
If the bill were to become law, further delays would ensue because the SEC would then need to repropose its rule, Cross said.

"I would argue that it would be a better process if the SEC were allowed to complete its rulemaking in consideration of public comments, and after that, if Congress sees fit to revisit the area, that certainly is their prerogative," he said.

Cross also expressed concern that the exceptions in Dold's bill could dilute the Dodd-Frank Act's intent.

"While I think the SEC is fully appreciative of the theme of trying to provide clear lines on the scope of municipal advisor registration ... some of the language potentially could be interpreted to broaden exceptions in a way that may swallow the rules," he said.

Another goal of the muni office, Cross said, is to update the SEC's 1994 interpretive guidance to Rule 15c2-12 on the disclosure obligations of issuers and other market participants.

The update "maybe could take some steps that are incremental and at the margins to improve disclosure standards" by taking into account shortcomings highlighted by enforcement cases and changes in market practices since 1994, he said. It will also address current topics like pension issues, financial stresses and derivatives risks, he added.

Cross said he became interested in the SEC post partly because of the Dodd Frank Act, which required that the office operate independently and report directly to the chairman. That stressed the importance of the roughly $4 trillion muni market, he said.

While at the Treasury Department, Cross said he observed "structural stresses" in the muni market that "have not fully shaken out" and that illustrate the need for improvements in muni disclosure practices.

He noted that in 2007 and 2008, 60% of muni bonds were backed by municipal bond insurance. Today, only 5% to 10% of bonds have insurance.

That change, brought on by the financial downturn, bolsters the need for better disclosure by issuers and more uniform financial statements.

"You can no longer just assume that the municipal bond insurer will do all the scrutiny of the credit characteristics of an issuer," Cross said.

Another change was the introduction of Build America Bonds into the muni market by the American Recovery and Reinvestment Act. Issuers of these taxable bonds receive subsidy payments from the Treasury equal to 35% of their interest costs.

BABs were primarily purchased by institutional investors, which typically demand better disclosure and have stark views "about how slow disclosure is in the municipal securities area," according to Cross.

He also said that more investment in municipal bonds by institutional investors would create "more depth to the market, better pricing, and more long-term investment."

Cross noted that half of munis are currently owned directly by retail investors and 25% are owned by individuals through mutual funds.

He pointed out that all five of the SEC's commissioners endorsed the report on the municipal market that was released in July - what he took to be a clear signal that they support improvements to muni disclosure.

Among the report's recommendations was for Congress to grant the commission authority to regulate the timing and content of issuers' disclosures.

That recommendation has been opposed by some issuers, which claim that diversity among muni issuers make regulation impractical.

But Cross said that SEC seeks to establish standards, not to create corporate-style disclosure requirements. And he urged issuers to be open to taking steps to improve disclosure.

"Forever we have heard the litany [of claims] that municipal securities involve standards of speed and scope of disclosure that don't compare with the rest of the market," Cross said. "It does have a Groundhog's Day flavor to it."

"I think it would be nice if there were at least some aspiration towards improvements in disclosure and timeliness," he added.

A recent report by Merritt Research Services found that less than 10% of general obligation bond issuers make annual financial disclosures within 120 days after the end of their fiscal years.

Some issuers, including Municipal Securities Rulemaking Board chairman Jay Goldstone, who also serves as chief financial officer and chief operating officer of San Diego, have called 150 days a more realistic goal, noting that issues typically must wait for data from other units, like pensions.

Cross said issuers should look to New York City and New York State, which typically complete their annual financial reports in 120 days, as role models for the process.

"You can't find more complex units than New York City and New York state in terms of all of their affiliated entities," he said.

Cross doesn't envision the SEC wielding "a big stick" to encourage disclosure improvements.

"I just think it's in the best interest of state and local governments and the market," he said.

"Above all else, I'd like to see a thriving, sustainable municipal securities market and I think more timely disclosure will improve liquidity in this market," Cross added.



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