WASHINGTON — The Securities and Exchange Commission's new program allowing issuers and underwriters to "self-report" disclosure failures could be a game changer, according to some market participants. However, it's unclear how popular the initiative will be and whether the costs for self-reporters will outweigh the benefits, others said.
The SEC's Municipalities Continuing Disclosure Cooperation initiative, announced on March 10, would allow issuers and underwriters to get favorable settlement terms if they voluntarily report, by Sept. 10, any time they offered bonds without disclosing failures to meet their continuing disclosure obligations.
The program is primarily aimed at getting issuers and underwriters to fess up about issuers failing to file annual financial and operating documents within their self-required dates. Under a provision of the SEC's Rule 15c2-12 on disclosure, an official statement must disclose anytime within the last five years that the issuer failed to meet its annual financial and operating information filing requirement.
But the self-reporting initiative also covers failures to file material event notices when warranted.
SEC officials have emphasized that the program provides "take it to the bank" assurance of lesser penalties — negligence charges and no financial penalties for an issuer, with a $500,000 cap on the financial penalties for an underwriter.
But market participants are divided about the workability of the MCDC initiative.
Robert Doty, president and proprietor of consulting firm AGFS in Annapolis, Md., said the program reflects valid concerns on the part of the SEC and should not cause anxiety for either issuers or underwriters who choose to come forward.
"It is an interesting approach," Doty said. "Given the low levels of penalties it contemplates, including relatively low financial penalties for underwriters, I see little reason for excessive concern for parties who 'confess.' The more significant concerns would be for parties that do not come forward."
SEC enforcement officials have acknowledged that the initiative creates a "modified prisoner's dilemma," referencing the theoretical scenario of two prisoners who are separately interrogated by the authorities and must decide whether to confess to get more lenient treatment or hold together and say nothing. Either an underwriter or an issuer could essentially be "turned in" by the other or other participants on the deal. In the alternative, they would have to decide together whether to enter into the program in order to avoid possible enforcement action.
Doty pointed out that the consequences in some cases could be severe for parties who are not eligible to participate. The SEC has said specifically that individuals are not able to shield themselves from culpability.
"One important consideration I do not see discussed is what happens in offerings in the future," Doty continued. "I would imagine, given the threat of more severe penalties, the program is somewhat of a game changer in terms of the pressures it brings on all parties to be more diligent about continuing disclosure going forward. The future risks of noncompliance are being raised substantially."
National Federation of Municipal Analysts industry liaison William Oliver said that while the NFMA has no formal position on it, the MCDC initiative is "really positive for the market" in his view. The NFMA has always placed a priority on encouraging the highest disclosure standards, and the MCDC could help facilitate that, Oliver said. He added that, although it is not clear how large a problem this 15c2-12 violation is for the market, the SEC approach is imaginative and has some promise.
"It's a pretty innovative way of addressing the problems," Oliver said.
The Bond Dealers of America has so far decided not to take any action or make any recommendations to its members about the MCDC, said Susan Collet, BDA's senior vice president for government relations.
"This is something that each member firm is considering," Collet said. "This is uncharted territory."
The Securities Industry and Financial Markets Association declined to comment on whether it is offering guidance to member firms on the issue.
A broker-dealer executive who asked not to be identified said that his firm has not spoken to any of the issuers they've done business with about the initiative, because the firm is confident it has not recently underwritten any bonds in which the OS fails to properly note the issuers' continuing disclosure failures within a five-year time period.
The executive said the MCDC creates "interesting conflicts," and that he wonders whether the Financial Industry Regulatory Authority would "pile on" and impose its own fines and other penalties on a dealer firm that chooses to participate in the MCDC.
"The SEC could say 'fine, thank you very much,' and then FINRA could turn around and fine you," the executive worried.
FINRA associate vice president and chief counsel for enforcement James Day said last month at a bond lawyers' meeting in Boston that is unclear whether the self-regulator would take enforcement action. FINRA failed to respond to a recent request for clarification and follow-up questions.
A securities lawyer who also asked to remain unnamed said he initially wondered "who would be dumb enough" to participate in the MCDC, but said law firms will probably push their clients to at least consider it.
"I think the law firms are pretty incentivized to get people thinking about this and scared about this," the lawyer said.
Although much of the industry's concern about MCDC revolves around issuers landing underwriters in hot water by coming forward, he said, issuers may be less likely than underwriters to participate because they are less likely to know about the program.
The SEC has warned that violators who do not come forward will face much harsher penalties, but the lawyer said most unreported violations are likely to slip through the cracks because the SEC probably does not have the time or resources to find and process more than a fraction of them, especially for older deals where continuing disclosure data may not be as readily available.
The law firm of Hawkins Delafield & Wood published an advisory for clients about the MCDC earlier this month. The advisory explains the program and says that issuers and underwriters have to determine whether they may be exposed to liability and then make a careful determination about whether to participate in the MCDC. The advisory disputes some of the SEC's rationale behind encouraging participation, and suggests that the commission release further guidance.
"The ramifications for a public issuer and its officials in admitting violations of the federal securities laws are quite different than for a registered company, whose considerations may be limited to the financial impact of such an admission on shareholders and other financial factors," the advisory notes. Negative media attention and political backlash could make a cease and desist order from the SEC a much less appealing settlement for a municipal government than for a broker-dealer, it added.
The SEC could help by providing guidance on what level of material omission warrants a self-report, the Hawkins advisory concludes.
"Such guidance could address common occurrences, such as, for example, those instances of(i) incorrect CUSIP numbers for a few maturities of bonds, and (ii) failures to file notices of rating changes during the financial crisis when rating changes occurred rapidly without notice to the issuer."
SEC officials haven't said whether more guidance about the program will be forthcoming. The Hawkins advisory notes that the commission has been historically hesitant to offer specifics about what it considers "material" for the purposes of federal antifraud provisions.
