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Securities Law

SEC Could Tighten Underwriters Oversight or Form 3-Strike System for Issuers

WASHINGTON — The Securities and Exchange Commission could tighten its oversight of muni underwriters or adopt a “three-strike system” for issuers if it does not get legislative authority to set disclosure standards for issuers, a top regulator said Friday.

In remarks at the The Bond Buyer’s California Public Finance Conference in San Francisco, SEC Commissioner Elisse Walter said “she is ready right now” to consider initiatives to improve municipal market disclosure.

They included taking a stricter interpretation of Rule 15c2-12’s requirements for  muni underwriters or “codifying” into the rule a system that would prohibit dealers from underwriting bonds if an issuer had failed three times to meet its continuing disclosure obligations.

“In the absence of legislation, we need to think about whether to place even greater burdens on the market intermediaries we regulate to address the significant source of investor harm,” Walter said at the conference. Even without congressional action, there is “more to do,” she said.

Walter noted that Rule 15c2-12 currently requires an underwriter, before recommending munis to an investor, to have a reasonable basis for believing the issuer will meet its continuing-disclosure obligations. The SEC has made clear that it is unlikely an underwriter could form a reasonable basis for recommending munis “if the municipality had a history of persistent and material nondisclosures,” she said.

“Unfortunately, even after repeated disclosure delinquencies, underwriting continues, and that appears more the rule than the exception,” she said.

Among other initiatives the SEC could take to enhance disclosure, Walter said, is an update of its 1994 anti-fraud interpretive guidance on the disclosure obligations of issuers and others. The SEC, starting next spring, could also hold the first of a series of annual conferences for market participants, regulators and academics. The conference would allow for open dialogue about market issues, she said.

Walter told attendees that while issuers’ disclosures have improved in recent years, muni investors remain “second-class citizens.” The SEC is hamstrung by laws preventing it from instituting fundamental disclosure reform, leaving the agency with “only limited authority to protect” muni bond investors, she said.

The commission currently regulates issuers’ muni disclosures through back-door rules that apply to dealers, which cannot underwrite bonds unless issuers agree to provide ongoing disclosures. The agency does not have authority over issuers or the content or timing of their disclosures.

Walter noted that the SEC can charge issuers with violations of antifraud laws, but those enforcement cases only happen after disclosure failures occurred and investors are possibly harmed.

She lauded efforts by market participants to improve disclosure, but said “voluntary disclosure regimes won’t fix the problem.” Municipalities with budget shortfalls could cut voluntary disclosure programs to save money, she said, adding: “The situation has to change.”

Walter’s speech comes nearly three months after the SEC released its long-anticipated report on the muni market. The report outlined a number of legislative recommendations for improving disclosure, including a request that Congress grant the regulator authority to set the content and timing of disclosures and financial statements.

Walter said she doubts Congress will act on the SEC’s disclosure recommendations this year, but she “remains hopeful ... that early next year we will be able to engage in a robust dialogue in these matters.”

The report also outlined steps the SEC could take without congressional action, and it made “market structure” recommendations aimed at improving price transparency. On Friday, Walter focused primarily on disclosure, telling market participants to read the speech she gave at a Securities Industry and Financial Markets meeting earlier this month if they want to learn more about the market structure recommendations.

Walter said the SEC’s recent muni report “tells the story” of the muni market from participants’ viewpoints. It highlights recent improvements in disclosure, which Walter attributed to new regulations, industry efforts and improvements to the Municipal Securities Rulemaking Board’s online EMMA disclosure system.

But the report shows problems persist. Many issuers’ disclosures are outdated and incomplete, or are missing information related to material events, outstanding debt and bank loans, Walter said.

Walter also shared a list of top disclosure “dos and don’ts.” She said issuers must make sure their disclosures include the most current financial information and should update any outdated information.

“Your support for these efforts is critical. Whatever we do, it will be done better if we have” your support, Walter told attendees.

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