MINNEAPOLIS — State and local officials are worried that small issuers of municipal bonds will be disproportionately exposed to the risk of enforcement action under the Securities and Exchange Commission's continuing self-reporting program on disclosure failures, and plan to pressure the commission to extend the initiative's deadline beyond its current Sept. 10 date and offer more guidance.
The Government Finance Officers Association's debt management committee discussed the SEC's Municipalities Continuing Disclosure Cooperation initiative at length during a meeting at the GFOA's annual conference here on May 17. The MCDC, announced on March 10, allows issuers and underwriters to get favorable settlement terms if they voluntarily report, by Sept. 10, any time they offered bonds without disclosing failures to meet their continuing disclosure obligations. Under a provision of the SEC's Rule 15c2-12 on disclosure, an official statement must disclose anytime within the last five years that the issuer failed to meet its annual financial and operating information filing requirement.
Ben Watkins, the GFOA committee's chairman and Florida's bond finance director, told panel members that underwriters will be, or are already, putting together lists of all deals that may have omitted disclosure failures from their official statements.
Watkins has been critical of the MCDC since its inception, and told the debt committee that the SEC's enforcement division is attempting to "regulate through fear and anxiety." He warned other issuer officials that dealers have a big incentive to over-report potential failings to the SEC because they can effectively shield themselves from further enforcement action for relatively cheap: a maximum fine of $500,000 and much less than that for small deals.
The SEC has said the program creates a "modified prisoner's dilemma" by creating an incentive for both issuers and underwriters to effectively turn one another in or risk being turned in alone. If dealers send the SEC expansive lists of transactions they have underwritten and do not let the issuers involved know about it quickly enough, that could expose issuers to the risk of enforcement action worse than the reduced settlement terms available under the MCDC. If issuers know their underwriters plan to report a deal they did together, both can participate in the MCDC.
"You may be on the list," Watkins told his colleagues.
But while dealers and many larger issuers have a high-level of training and sophistication and can put together these comprehensive reviews of their recent activities, smaller issuers need help, debt committee members said.
Laura Lockwood-McCall, director of the debt management division in the Oregon State Treasury, was among those who expressed concern that smaller issuers will be exposed by dealers participating in the MCDC. There may be few staff and/or a lot turnover at many small governmental issuers, and the officials who presided over bond issuances five years ago may be long gone. Lockwood-McCall's office provides small issuers in Oregon technical assistance on the basics of filing continuing disclosures on EMMA, and she said many might be unprepared to do the kind of detailed review the dealers might do.
"After several years of effort, we're still reaching out to Oregon local government finance staff on what EMMA is, and what a CUSIP number is," she said. "That's the reality for small local governments."
Those issuers need guidance on what to do, she told the committee. Philadelphia treasurer Nancy Winkler said dealers will be looking out for their own interests and not those of potentially unaware issuers when deciding whether and what to report to the SEC.
"Their interests are not aligned," Winkler said.
The committee generally agreed that issuers should make it a point to have good communications with underwriters they have done business with to avoid the danger of being turned in unawares.
"We need to hammer home to the dealer community: 'You better not file a list without talking to your issuer first,'" Watkins said.
The SEC has suggested that MCDC participants could essentially file two different types of reports: those on deals they feel might have contained a material disclosure failure and those in which the failure was not material in the issuer or underwriter's opinion. Watkins urged committee members not to overreact and recommend sweeping reviews of five years' worth of bond issuances to make sure every single event notice may have been filed before a sale.
"I'm not going to go back and prove that I filed," Watkins said. "Not gonna do it."
Watkins also said he was disturbed by the idea that Elaine Greenberg, who helmed the SEC's muni enforcement division until September, is now essentially benefiting from the potential glut of securities fraud clients the MCDC could create in her new job as a partner at Orrick, Herrington & Sutcliffe in Washington.
Municipal Securities Rulemaking Board chairman Dan Heimowitz told the committee that the SEC and the MSRB remain in close contact generally, but that there has been no formal communication from the commission about the MCDC. The MSRB has nothing to do with enforcement of municipal securities rules or laws, but its EMMA website is the gateway for continuing disclosure where issuers can file their annual financials and material event notices.
MSRB executive director Lynnette Kelly told the committee that the SEC is free to act unilaterally where it chooses. "The SEC is not obliged to seek our advice," she said.
Most debt committee members said the program's six-month life is simply too short to allow them to properly participate, especially in light of the commission's decision not to offer any initial guidance on what sort of disclosure failure it might consider "material" for the purpose of the MCDC. Several committee members said the program should be extended to at least the end of 2014, and perhaps beyond. Watkins said GFOA has received support for this idea from both the Securities Industry and Financial Markets Association and the National Association of Bond Lawyers. He told his colleagues that they should lean on the SEC to provide the guidance issuers need, and if the SEC fails they should simply work with NABL to create their own.
Issuers will have the opportunity to seek more answers during the final day of the conference, May 21, when DC Water & Sewer Authority chief financial officer Mark Kim will moderate an enforcement panel featuring the SEC's Peter Chan, a regional director in the Chicago office who has been a leading commission voice on the MCDC.
