LOS ANGELES — Congress should clarify the disclosure responsibilities of issuer officials, underwriters, bond counsel, and other participants in municipal securities transactions, Securities and Exchange Commission chairman Christopher Cox said yesterday.
“Properly done, this could reduce the cost — to taxpayers, issuers, and their professional consultants — that arises because of today’s uncertain liability environment,” Cox said in a speech before Town Hall Los Angeles, a group of business leaders that sponsor public forums. “There is a job for legislation to do,” he said. “It is needed to establish a limited regulatory regime designed expressly for the needs of the municipal market.”
Cox explicitly said that new regulations should not include the full registration and review requirements that apply to private companies, but rather should focus on improving the disclosure available to investors.
“Today’s investors in municipal securities, in many respects, get second-class treatment under current law,” he said. Cox also said the SEC is using its established authority to conduct a thorough review of broker-dealer compliance with the Municipal Securities Rulemaking Board’s Rule G-37, which is designed to prevent firms and muni finance professionals from engaging in pay-to-play practices, as well as a review of the four nationally recognized municipal securities information repositories that collect issuers’ secondary market disclosure documents.
“In particular, we’ll look at the role these entities are playing in making municipal disclosures available to investors and brokers,” he said.
Under the Tower Amendment that was added in 1975 to the Securities Exchange Act of 1934, the SEC and MSRB are prohibited from directly or indirectly requiring issuers to file municipal securities documents with them before the securities are sold.
As a result, the commission places disclosure requirements and burdens on the underwriters of municipal bonds, as opposed to issuers. Today’s rules are inadequate for what has become a large, sophisticated market with a high proportion of individual investors, who hold bonds either directly or through mutual funds, according to Cox.
The SEC chairman also said Congress should require issuers to follow generally accepted accounting principles, and ensure that funding for the Governmental Accounting Standards Board is not dependent on the state and local governments that must follow its standards.
Recent legislation in Connecticut and Texas designed to allow governments to opt out of GASB standards threatens the integrity of the municipal market, as do efforts by governmental associations to do away with GASB in favor of Financial Accounting Standards Board oversight, Cox said.
“These efforts are a clear and present danger to investors in municipal securities,” he said. Legislation should require the offering documents and follow-up reports of muni issuers to provide investors with information similar to what investors see for other securities, Cox said.
Congress should also require more disclosure from private entities that use conduit issuers to borrow on a tax-exempt basis, and make disclosure information more accessible in a timelier manner through a free, Internet-based system similar to the SEC’s EDGAR system, Cox said.
In many SEC enforcement actions, it has become clear that many issuer officials have paid little heed to their disclosure responsibilities, according to the SEC chairman. Large, complex, and frequent issuers of municipal securities should have policies and procedures for disclosure that are “appropriate to its circumstances.”
Cox didn’t say what he meant by “appropriate,” but later in the speech hailed the SEC’s securities fraud sanction settlement with San Diego last year.
That settlement required the city to implement new disclosure procedures. They included the creation of a disclosure practices working group of senior officials across city government charged with reviewing disclosure materials.
In addition, San Diego’s mayor and attorney must now personally certify to the City Council as to the accuracy of the city’s financial statements and the city auditor must annually evaluate internal financial controls and report the results to the council.
San Diego was sanctioned by the SEC after failing to disclose to investors the extent to which it had underfunded its employee pension systems.
“It is my opinion that keeping markets free of fraud reduces costs,” Cox told reporters after the speech. While the SEC has issued sanctions when problems arise as they did with San Diego, the after-the-fact approach isn’t effective, he said.
“It’s not enough to punish fraud; we’ve got to work to prevent it,” Cox told the business leaders. Much of what Cox talked about yesterday will depend on Congress. “I’m engaged in very preliminary discussions with my former colleagues on Capitol Hill,” the former congressman told reporters.
“What I hope to ignite is new discussion and new focus on this area.”
In response to an audience question, Cox said the MSRB should continue to have a major role in overseeing the muni bond arena. “As with GASB, the idea is to sustain and support the institutions we have,” he said.
Cox said the SEC’s focus on municipal securities disclosure is not based on any concern over potential municipal defaults. “Default is surely a risk but it is not the only risk,” Cox said. He said investors in munis deserve timely, accurate information to determine if they should buy, hold, or sell bonds, just as they do with other securities.
Cox’s speech follows a six-month internal SEC review of municipal securities regulation.
In March, Cox told The Bond Buyer the commission had launched an initiative to step up enforcement and improve disclosure and accounting in the muni market. He said his interest was in part triggered by the SEC’s investigation into San Diego and its failure to disclose to investors the underfunding of its pension system, which eventually triggered SEC sanctions last year. Cox’s interest in municipal bond disclosure predates his tenure at the SEC.
He represented Orange County, Calif., in the U.S. House in 1994, when the county declared Chapter 9 bankruptcy after it suffered sudden losses from risky investments.
