Market expects SEC to narrow its disclosure proposal

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PHOENIX - Muni market participants expect the Securities and Exchange Commission to narrow its proposal to add new material event notice disclosures for bank loans and other alternatives to tax-exempt bonds after receiving many critical comments that it was too broad and would be overly burdensome.

The SEC proposed the amendments to its Rule SEC 15c2-12 in March and took public comments on them until mid-May.

The amendments are designed to achieve a goal most municipal participants generally support – helping rating agencies, analysts and others obtain information about the growing use of bank loans, private placements that can affect issuers' finances but fall outside Rule 15c2-12's disclosure requirements. However, many market participants were shocked that the proposal covered a very wide range of financial obligations and would require issuers to continuously make decisions about whether these obligations would be materially important to investors. As a result, there is a sense among stakeholders that the SEC is likely to more narrowly redefine some of its terms in response.

The proposal would require an issuer or borrower to file an event notice if they incur a financial obligation that is material or a financial obligation has an agreement to covenants, events of default, remedies, priority rights or similar terms "any of which affect securities holders, if material."

It defines financial obligations as "a debt obligation, lease, guarantee, derivative instrument or a monetary obligation resulting from a judicial, administrative or arbitration proceeding." That struck many industry commenters as overly broad and requiring an enormous amount of work for issuers. Market participants have also raised concerns at the murky meaning of “materiality,” which courts have held to mean information that a reasonable investor would consider important when making an investment decision. The SEC has historically refused to provide bright line guidance on the subject.

The proposal also would require an event notice to be filed for certain actions or events related to the financial obligation that "reflect financial difficulties" such as a default, event of acceleration, termination event, or modification of terms. Underwriters would have to reasonably determine that an issuer or borrower has agreed to provide notice of such events in its continuing disclosure agreement.

Rebecca Olsen, acting director of the SEC’s Office of Municipal Securities, didn’t tip her hand when questioned by lawyers meeting in Chicago earlier this month about the SEC’s thinking on possible changes to the proposal. But lawyers have noted that the SEC has a history of narrowing its proposals in response to industry comments, such as it did with the rollout of its Municipal Advisor Registration Rule several years ago. The market seems to expect that to happen again.

Lisa Washburn, a managing director at Municipal Market Analytics, said she expects the SEC to tailor the rule more narrowly based on her reading of the more than 90 comments the commission received on the proposal. Washburn said that, while it's probably too late for the SEC to back down from its efforts to push bank loans and direct placements into the light, the SEC could very well redefine “financial obligations” to more specifically target bank loans, private placements, and certain similar instruments having parity with publicly-offered bonds. Washburn added, however, that she hopes the SEC would not make its definition so narrow as to potentially exclude important types of debt that might be invented in the future.

“I hope that whatever does get reproposed and finalized covers not just bank loans and private placements but anything like that that should come in the future,” she said.

Bill Oliver, industry and media liaison at the National Federation of Municipal Analysts, said he has heard that the SEC may be amenable to some of the issuer-friendly changes. The NFMA, of which Washburn is a member and current industry practices and procedures chair, was largely supportive of the tack the SEC took in defining “financial obligation.” Oliver said he believes the SEC might find that its easiest path is to narrow that definition to not include operating leases, but he was adamant that the main goal of the proposal should be achieved.

“There isn’t a good argument against the bank loans, [direct] purchases, private placements and derivatives,” Oliver said.

John McNally, a partner at Hawkins Delafield & Wood, said he believes the proposal will go in a manner outlined by Hunton & Williams attorney Drew Kintzinger at the NABL meeting earlier this month. Kintzinger said that the comments on the rules suggest “a potential common ground” for an alternative proposal, under which issuers would agree to disclose on EMMA the primary documents for bank loans, direct purchases and private placements. Confidential financial terms could be redacted.

“There is agreement among issuers, counsel, and the SEC for the need to provide timely disclosure regarding bank loans and other debt instruments or borrowings that are on a parity with outstanding bonds,” McNally said.

The SEC could choose to finalize the proposal as is, repropose a modified version of it and ask for more comments, or finalize an alternative proposal without further comments.

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Securities law Municipal disclosure SEC NFMA NABL Washington DC