Congress should repeal the Tower Amendment and other securities law exemptions for municipal issuers so that the Securities and Exchange Commission can require them to comply with certain disclosure requirements as well as with generally accepted governmental accounting standards, SEC commissioner Elisse Walter said Wednesday night.
According to an advance copy of her remarks, Walter also called for lawmakers to give the SEC regulatory authority over all financial intermediaries in the municipal market and to “seriously consider” combining muni market rulemaking and enforcement authority into one self-regulatory organization.
Currently, the Municipal Securities Rulemaking Board writes rules for dealers and the Financial Industry Regulatory Authority enforces them. But maintaining a separate “regulatory function” from the “enforcement and examination functions” leads to “coordination and communication problems,” Walter said.
Walter, a former FINRA senior executive vice president, did not say if the MSRB should be merged with FINRA or given enforcement authority, which former MSRB chairman Ron Stack asked Congress for during a Senate Banking Committee hearing earlier this year.
Congressional action is necessary on all of these fronts, Walter said, because despite the enormous size and increasing complexity and interconnectedness of the $2.8 trillion muni market, the SEC is unable to impose mandatory disclosure requirements directly on issuers or mandate that they all use the same accounting standards. While there are some steps the SEC could still take under its existing authority, its options are extremely limited without legislation, she said.
Walter’s remarks closely echo those made over the years by other commission officials, and come a day after SEC chairman Mary Schapiro said the agency will likely seek legislation next year to give it more oversight over the muni market because it has exhausted its existing authority.
But Walter — who stressed she was speaking for herself and not the SEC — expressed dismay that lawmakers and other regulators have all but ignored calls for reform of the municipal market as they consider other financial regulatory reforms.
“SEC chairmen ranging from David Ruder and Arthur Levitt to Christopher Cox and Mary Schapiro have advocated taking a hard look at this area,” she said. “But this topic has not received serious consideration in recent regulatory reform discussions.”
Walter tempered her calls for boosting municipal disclosure standards by cautioning against a “one-size-fits-all” approach to muni regulation. Municipal issuers should not necessarily be required to receive pre-approval for their offerings from the SEC, Walter said.
She added that the commission would implement “tailored rulemaking” to provide “appropriate exemptions” in certain cases, possibly for small issuances and private placements, as currently exist for corporate securities.
“One possibility worth considering is a tranched approach to issuer obligations,” Walter said. “The largest issuers could be required to provide disclosures similar to public companies, while smaller issuers would be subject to a less rigorous disclosure regime.”
Though she called for the repeal of Tower — an amendment added in 1975 to the Securities Exchange Act of 1934 that prohibits the SEC and MSRB from collecting disclosures prior to bond sales — she indicated that her primary concern was with timely secondary-market disclosures rather than those in the primary market.
“Complete, timely, and accurate disclosure is essential for the proper functioning of the municipal securities markets, in particular for efficient pricing,” Walter said.
“Timeliness is a particular concern,” she added. “With the appropriate authority, the commission could mandate that municipal disclosures be issued in a time period that makes critical information available when investment decisions are made.”
As part of these reforms, she called for Congress to provide an “independent funding mechanism” for the Governmental Accounting Standards Board, as well as SEC oversight of GASB, as is now provided for the Financial Accounting Standards Board under the Sarbanes-Oxley Act.
Currently, GASB is funded by voluntary payments and contributions from state and local governments and the financial community, as well as sales of its publications.
“This funding mechanism is not adequate to ensure that GASB is a truly independent standard setter,” Walter said.
She also called for mandating that credit rating agencies use a single scale for rating corporate and municipal bonds, which she said makes sense “given that the corporate and municipal markets are increasingly interconnected.”
“However, we do not want to lose the level of granularity that currently exists within the rating scale for municipal issuers,” Walter said. “At a minimum, though, if municipal issuers want to have their bonds rated on the same scale as corporate bonds, then I believe they should be prepared to provide the same level of timely and accurate disclosure as corporate issuers. It is only fair to investors.”
Walter said most of the arguments for maintaining the existing exemptions for municipal issuers are “no longer compelling.” For instance, while some claim there is not much abuse in the muni market, she said the SEC has brought dozens of enforcement actions in recent years “that highlight the continued disclosure weaknesses” in the market and raise concerns about governmental accounting,
There have been “numerous bid-rigging, price-fixing, pay-to-play and other scandals in the market,” Walters said. In addition, municipalities can and sometimes do default on their bonds, she said.
Another rationale for exempting municipal securities — that the muni market is sophisticated and mostly institutional — “is clearly no longer valid today,” she said. There is “extensive retail participation” that “is probably only going to increase as baby-boomer senior investors increasingly include fixed-income and tax-free offerings in their retirement portfolios,” she said.
Walter conceded that it is more difficult to dismiss a third rationale for exempting munis — so-called intergovernmental comity — but noted that this is not a federalism issue under the 10th Amendment to the Constitution.
“Rather, intergovernmental comity is a matter of balancing the respect due to the local interests of municipalities and their citizens, on the one hand, and the federal interest in maintaining the integrity of the national market system for the benefit of investors, on the other,” she said.
It is a “little misleading” to make a “simple contrast” between state and local interests and federal interests, given that municipalities are populated by taxpayers who also are frequently investors, sometimes in the bonds issued by their own states and localities, Walter said.
“Indeed, the concerns of a citizen qua taxpayer and the same citizen qua investor have something very important in common,” she said, using the Latin term meaning “in the capacity or character of.”
“Just as an investor wants to understand the true financial health of an entity whose debt it purchases, a taxpayer has an interest in understanding the true fiscal health of the state or local municipality in which he or she lives,” Walter said. “So the call for greater federal regulation of the municipal securities market could have benefits for both taxpayers and investors alike.”
