WASHINGTON — If dealers take advantage of disruption in the financial markets to manipulate prices of municipal securities, they will be violating federal law, the Municipal Securities Rulemaking Board warned Monday.
In addition, most issuers have a contractual obligation to submit material event notices to EMMA if their ratings change, the board said in a two-page statement posted on its website. The board also issued a two-page notice to members.
“Dealers cannot ever take advantage of investors and should be extra vigilant, especially during times of market disruption,” MSRB executive director Lynnette Hotchkiss said in a statement. “The prices of municipal securities transactions must be fair and reasonable, and dealers cannot trade at off-market prices.”
The board’s warning comes on the heels of a decision by Standard & Poor’s late Friday to reduce the sovereign debt rating of the United States to AA-plus from AAA. Moody’s Investors Service and Fitch Ratings have maintained the U.S. government’s bond rating at triple-A.
A spokesperson for the Securities and Exchange Commission, Kevin Callahan, declined immediate comment on the downgrade.
On Capitol Hill, the chairman of the Senate Banking Committee criticized the rating agency’s move, saying Treasury debt remained a “safe haven” during economic uncertainty.
“This irresponsible move by S&P may, however, have spillover effects that tax the American people by increasing interest rates on home loans, credit cards, and car loans, and by increasing the cost of finance for some state and local governments,” Sen. Tim Johnson, D-S.D., said in a statement.
The MSRB said in its member notice the board had observed “no unusual municipal market activity” to date. Rather, the board said, it issued a reminder about its investor protection rules due to “continuing uncertainty” about possible downgrades for state and local governments and “the potential impact of such ratings actions on the municipal securities market.”
Specifically, the board said, if it became aware of allegations that any dealer had attempted to take advantage of clients by trading munis at unfair or unreasonable prices, it would “notify the appropriate enforcement agencies and, if the allegations are true, recommend severe sanctions.”
Municipalities with a large population of federal employees or that rely significantly on federal government funding might be affected by the U.S. downgrade, the board noted.
Standard & Poor’s also said that pre-refunded munis may be affected as funds held in escrow to pay the principal and interest on such bonds are typically invested in Treasuries.
The MSRB lacks enforcement authority over its rules, including Rule G-17 on fair dealing. The Financial Industry Regulatory Authority handles enforcement of the board’s rules.
A market participant said it was fair for the board to remind dealers about their muni pricing obligations.
“But hopefully, people would know that stuff anyway,” said Robert Doty, president of American Governmental Financial Services Co. in Sacramento.
Bond lawyers, meanwhile, said market participants are grappling with the meaning of the Standard & Poor’s downgrade and how it might affect them.
“People are trying to figure out who’s heard what,” said William Hirata, a partner at Parker Poe Adams & Bernstein LLP in Charlotte.
Another bond attorney said some issuers are assessing their continuing disclosure obligations, in light of Standard & Poor’s move.
“I do think that some people were anticipating and were already considering the potential of this and preparing accordingly,” said Paul Maco, a partner at Vinson & Elkins LLP in Washington.
And the National Association of Bond Lawyers is working on advice to members, said John McNally, a partner at Hawkins, Delafield & Wood LLP in Washington.
In a one-page client advisory issued Monday, Hawkins said SEC Rule 15c2-12, as amended last year, requires state and local government issuers to file a material event notice with EMMA for any rating changes, without determining whether such a change is material. “The rule as amended deems such changes to be material,” the Hawkins advisory said.
A change in outlook without a rating change does not require a filing, the advisory said.