LOS ANGELES — A California study into conduit borrowers' disclosure practices says the industry should try to make disclosure more consistent to allow investors to better evaluate investment alternatives.
The California Debt and Investment Advisory Commission report — sparked by complaints from a healthcare union — lobbed more strenuous criticism at the Securities and Exchange Commission for its lack of direction about the risk factors that issuers should include in bond documents.
The report, released last week, said that the SEC's lack of guidance made it impossible for CDIAC to advocate best practices or really assess the quality of disclosure, although it does report common disclosure practices and compare differences in reporting material event risks.
CDIAC, the educational arm of the State Treasurer's Office, began the study after Service Employees International Union-United Healthcare Workers West raised concerns in a February 2014 letter that nonprofit hospitals were not including enough information in bond disclosure documents about the impact of the Affordable Care Act.
The SEC provides a checklist guiding corporate bond issuers about what to disclose in public documents, but the same is not true for the more opaque municipal bond industry, two members of California Treasurer John Chiang's staff, who declined to be named, said in an interview.
SEC spokeswoman Judith Burns declined to comment.
"I do agree the way the SEC speaks to the municipal market is through its reports and the settlement agreements it enters into, but I don't think we assume the SEC isn't working on this issue," said Lisa Quateman, a bond attorney and managing partner in Polsinelli LLP's Los Angeles office. "I wouldn't be surprised if we do see more information emanating from the SEC."
Part of the challenge is that the SEC doesn't regulate issuers in the same way they do broker-dealers, Quateman said.
Though the National Federation of Municipal Analysts offers detailed guidance on financial and operational data that should be provided, the SEC "has neither affirmed nor disclaimed them as definitive guides of appropriate disclosure content," according to CDIAC's report. Instead, the report's authors looked to SEC enforcement actions against municipal issuers for violations of disclosure requirements for illumination.
CDIAC pointed to recent cases against Kansas, Miami, New Jersey and Victorville, Calif. as the best guidance to what the SEC wants to see disclosed.
"Recent actions reveal that an issuer's failure to disclose adequate financial information, particularly financial and operating information that may negatively affect the pricing of the bond issue, may expose it to liability for violating securities law," according to the report. "For instance, including misleading statements about solvency or failing to disclose liabilities in offering documents may constitute fraud."
CDIAC concluded, however, that neither the best practices publications nor the SEC enforcement actions provide much guidance on whether, and to what extent, industry risks should be disclosed.
The report is delivered in an academic tone and steps lightly in comparing the risks to investors that nonprofit hospitals disclosed in offering documents to the four other sectors surveyed for the report. The charts and information in the report demonstrate, however, that hospitals provided more extensive disclosure than higher education, K-12 education, housing or pollution control issuers. Pollution control issuers provided very little disclosure on material risks, according to the report.
Conduit bond issuers participated in the issuance of $18.7 billion for hospital and healthcare facilities in California from Jan. 1, 2009 through Sept. 30, 2014, according to CDIAC data. Of the 334 bonds issued during that time frame across the five sectors surveyed, CDIAC reviewed a random sampling of 275. The report's authors focused only on the offering statements for new money issuances saying that there was too much variance in risk disclosures in refundings.
The report looked at seven different factors: whether conduit issuers address bondholder risks; the extent to which documents focused on those risks in contrast to other topics; whether there are common inter-sector risks; the extent to which issuers in the different sectors addressed these inter-sector risks; whether there are sector-specific risks; how detailed sector specific risks were; and whether the level of detail of sector-specific risks changed over time.
Because authorities under the treasurer's office are conduit issuers, they cannot make value judgments on whether that disclosure is good or bad because then the conduit issuer becomes a principal of the transaction, which it cannot do, according to the treasurer office's staff.
The conduit's role is to say that the disclosure is there and addresses all things needed, and if so, say the borrower can proceed, the staff members said.
Providing more information does not necessarily mean providing more clarity on risk factors, Quateman said.
"I thought the report was interesting in the way CDIAC determined the metrics, such as how many pages were dedicated to the risks. I think the analysis from the security perspective needs to be qualitative as well," Quateman said. "I think the best practice is not necessarily dependent on word or page count, but on a thorough assessment of the credit, issuer and factors that could affect the ability of investors to receive a timely payment."
The treasurer's staff also said that better disclosure is not just a larger number of pages, but "a result of a clearly thought out process about what could pose a risk to repayment of the bonds on a timely basis."
The report also did look at the substance and quality of the disclosures, which Quateman said is really more important.
"I thought what CDIAC did was creative," she said. "And it reinforces its role as a leader in identifying issues and responding to marketplace concerns."
The report said that hospital issuers provided increasing clarity about such risk factors as the impact of the Affordable Care Act in documents as states provided more information about how the program would function. Nonprofit hospitals receive a large amount of funding through federal reimbursements so ACA represented a significant risk.
CDIAC's researchers were cautious about the perils of comparing the different sectors. Hospitals may provide more extensive information on risks, because threats to school district bonds are easier to describe than threats to a hospital's bonds, treasurer's staff said.
"Our position is that the best defense to not disclosing adequately is to develop a clear, thoughtful process and to disclose as clearly as you are able to over multiple processes," a treasurer's staff member said. "This office has a statutory mission to educate borrowers about how to do that."
Though other sectors were extensively reviewed, it was clear the thrust was evaluating nonprofit hospitals. All three of the 28-page report's appendixes focus on details of nonprofit hospital risk disclosures to the exclusion of the other categories, Quateman noted.
The report concludes by expressing the hope that it encourages discussion among issuers and finance professionals to identify opportunities to achieve greater uniformity in disclosing material events.
"Irregularities and variances between OS demonstrate the lack of established standards for disclosure content," according to CDIAC. "Without further guidance from the SEC, it is unclear whether such variance is appropriate. Thus, the risks and degree of specificity of financial impact that are provided to investors are often left to the judgment of bond and disclosure counsel."
Quateman said those decisions are really made by the issuer with the guidance of bond counsel, not by the attorneys.
The report found an improvement in disclosure of risk over the period studied.
CDIAC postulated that the reason for the improvement in disclosure of risk over the study period may be market-driven, or stem from regulatory changes, or a change in practices common to those preparing the offering statements.
CDIAC decided to "survey" the content of offering documents, rather than study unreported risks that may have warranted disclosure. As a result, the study authors wrote they cannot conclusively state whether the content of the offering statements was sufficient or not.
The report does recommend more uniformity in disclosure documents, however.