LOS ANGELES - With regulators coming down on disclosure practices among municipal issuers, industry experts at The Bond Buyer’s California Public Finance Conference discussed the importance of due diligence and how to comply with their obligations Friday.
“This is not a new requirement, this is something that’s been in existence for some time,” said Katie Koster, managing director at Piper Jaffray. “It’s just that the light is shining a little brighter both on the underwriters and their obligations, and also on the issuer.”
Recent enforcement actions by the Securities and Exchange Commission against municipal bond issuers, including Harrisburg, Pa. and West Clark Community Schools in Clark County, Ind., found that issuers were not complying with their continuing disclosure agreements.
Under SEC’s Rule 15c2-12, muni broker-dealers are not supposed to underwrite muni bonds unless the issuers have contractually agreed to disclose annual financial and operating information and material events as they occur.
Brian Forbath, a shareholder at law firm Stradling Yocca Carlson & Rauth, said the rule was designed to enhance disclosure and prevent fraudulent practices. He said underwriters must ensure that they have proper policies and procedures in place and internal controls to make sure that they establish a basis to believe that there will be proper compliance from the issuer.
The Financial Industry Regulatory Authority is also examining whether dealers have checked issuers’ continuing disclosure compliance before selling their bonds.
Such probes have spurred firms to start looking at their practices and whether they have policies in place to track issuer disclosure filings and compliance.
“From my discussion with investors, that’s probably a good thing,” Koster said. “It’s a frustration they’ve had for some time that continuing disclosure, in particular, is not adequate, and not timely enough, so this is something that’s been coming for a long time.”
She added that most underwriters have had policies and processes in place for some time, but now they have an opportunity to really get down to the nuts and bolts of these practices.
Koster also discussed the nature and scope of the underwriter’s responsibility in the due diligence process, noting that it will depend on the circumstances of the specific transaction.
The highest obligation occurs when the bank is the sole underwriter or senior manager on a transaction, she said. That doesn’t mean that co-managers should rely solely on the senior manager. In fact, they should also be present for all of the disclosure discussions, bringing up any red flags that the senior manager has not brought up, she said.
A selling group member may not be considered an underwriter, but their reputation is at stake, so they should be involved in the process, Koster said. A placement agent and a remarketing agent also have disclosure obligations.
The disclosure process is a team effort, and includes bankers who understand the issuer and background of the transaction, as well as other internal resources that can provide due diligent research.
“It’s quite an undertaking and most underwriters would say that current fees don’t pay for the additional research you have to do to make sure all your T’s are crossed and I’s are dotted,” Koster said. “But we have to do it, and we’re going to do it regardless. But it takes a village.”
Matthew Reining, a director at Standard & Poor’s, said there can be various ratings implications relating to disclosure problems. If an issuer fails to meet disclosure requirements, the rating agency could suspend the rating or put the rating on credit watch.
Before taking action, the rating agency will generally reach out multiple times to the issuer. Reining said that communication is important in the process.
“We appreciate when they give us a call, when they’re posting on [Electronic Municipal Market Access, or EMMA], for example, and there’s a real dialogue there,” Reining said. “I think that’s what we strive for.”
Sources used in the diligence process include offering documents, budgets, news, unaudited figures, past records, third party providers, and discussions with the issuers, panelists said.
The Municipal Securities Rulemaking Board has launched tools on its website to provide issuers and investors disclosure resources, according to the board’s executive director Lynette Kelly.
“Our vision is to make it as user friendly and serve the needs of issuers and stakeholders as much as we can,” she said Friday during the panel.
Such tools include e-mail alerts reminding issuers when disclosure is due, a “toolkit” to help users learn about the issuance process and using EMMA, and educational resources to provide an understanding of disclosure obligations.
