WASHINGTON - Federal regulators do not support wholesale removal of the Tower Amendment or exemptions from federal securities laws for municipal securities to improve municipal bond disclosure, the General Accountability Office said in a report issued Thursday.
Instead, Securities and Exchange Commission and Municipal Securities Rulemaking Board staff told the GAO that Congress may need to either give them authority, or amend the securities law exemptions for munis, to allow them to establish disclosure requirements on muni issuers, the report said.
The GAO report, called Options for Improving Continuing Disclosure, was mandated by the Dodd-Frank Act. The act called for the GAO to write a report within two years of enactment of Dodd-Frank, that compares muni and corporate disclosure requirements and recommends whether the Tower Amendment should be repealed.
The Tower Amendment, which was added in 1975 to the Securities Exchange Act of 1934, prohibits the SEC and MSRB from requiring issuers to file any information with them prior to the sale of munis. In addition, the MSRB cannot require issuers to provide it or investors with any information after the sale of munis under Tower.
The release of the GAO report comes as the SEC is preparing to issue its own report, either Friday or early next week, recommending legislation and regulatory changes to improve disclosure and price transparency in the muni market. The SEC report is expected to be approved by the five commissioners, who are currently reviewing and tweaking it.
In its report, GAO said that seven of 21 muni securities experts they interviewed recommended repealing the Tower Amendment.
But both the SEC and MSRB staff told the GAO that removing the Tower Amendment would not accomplish anything because munis are exempted from federal securities laws imposing registration and other requirements on securities. Further, they said, it would not be appropriate for the SEC or MSRB to set up a marketwide registration scheme for muni securities similar to the one that exists for the corporate market because this would require too many resources and would be beyond their capabilities. The muni market has about 50,000 issuers and 1.3 million separate outstanding securities, GAO noted.
The SEC and MSRB staff also recognized that broad-based or marketwide standardized disclosure might not work in the municipal market because munis are not standardized, according to the report. The SEC staff said that any disclosure requirements should be principles-based, under which key objectives of good reporting would be established and guidance and examples would be used to explain each objective.
Staff from both agencies also said federal regulation of muni disclosure should be flexible, adaptable and should balance the need for investor protection with "intergovernmental comity." Comity is defined by the dictionary as meaning courtesy or harmony.
GAO discussed options for improving disclosure that was recommended by market participants, as well as the regulators.
The report said five of 21 muni disclosure experts interviewed said the SEC should be given authority to require muni issuers to meet generally accepted accounting principles or other uniform accounting standards. The SEC is expected to recommend this in its muni report, sources have said.
Four experts and four market groups told GAO that federal regulators should require issuers to submit annual financial and operating information on a more timely basis. Three market groups said the regulators should require issuers to disclose unaudited financial information on a quarterly basis to the MSRB's EMMA system. However issuers argued that might be costly.
Four experts and one market group said the SEC should impose corporate registration and disclosure requirements on conduit borrowers because they are responsible for most of the defaults in the market. But GAO noted in a footnote that no one suppported registration for nonprofit conduit borrowers. The SEC is also expected to recommend registration for corporate conduit borrowers.
Three market groups and one expert said the SEC should use its existing antifraud authority to take enforcement actions against issuers that are not complying with their secondary market disclosure obligations.
The SEC's Rule 15c2-12 lacks any enforcement mechanism, disclosure experts have pointed out. The rule prohibits dealers from underwriting munis unless they are reasonably sure the issuer has agreed in writing to disclose annual financial and operating information and notices of events as they occur. The rule leaves it up to the issuers to decide how soon they will disclose financial information after the close of their fiscal years.
But if the issuer violates its own agreement and fails to file financial information, there is essentially no way to sanction the issuer. Under the rule, issuers' continuing or secondary market disclosure agreements are considered to be contracts with bondholders. The bondholders would have to enforce the contract, but from a practical standpoint, it is unlikely that bondholders would know who each other is or would have the resources to challenge an issuer that violated its contract.
The SEC, however, can take enforcement action under its antifraud rules against an issuer for misrepresenting or omitting key information in its muni-related financial disclosures that investors would want to know before making an investment decision about the munis.
Michael Decker, co-head of the municipal securities division at the Securities Industry and Financial Markets Association, said, “The GAO has identified some important issues related to municipal issuer disclosure. In particular, our members are concerned that so much of the current regulatory model covering disclosure is effected indirectly through dealers. We hope the GAO report will spark a renewed discussion about practical ways to improve the timeliness and quality of issuer disclosure while respecting the unique features of the municipal market.”
Mike Nicholas, chief executive officer of Bond Dealers of America, said, “The BDA agrees with the GAO report calling for better disclosure in the municipal market for the benefit of both investors and issuers but we also believe it should be done by enhancing EMMA while reducing the regulatory burden on small dealers who serve the needs of small, infrequent issuers and their corresponding investors. At the same time, we look forward to the SEC's soon to be released report on the muni market where we anticipate hard recommendations on ways to enhance disclosure in the muni market.”
