A high-ranking Securities and Exchange Commission enforcement official warned Wednesday that issuers risk running afoul of the federal securities laws if they hide materially important information deep within bond-offering documents.
Mark Zehner, deputy director of the SEC’s new municipal and public pension fund enforcement unit, also warned that disclosures should be clearly written because many retail and foreign investors who may look at the offering documents may not understand legalese.
“I see a lot of people who literally hide things in 500-page official statements on page 400,” Zehner said, speaking on a disclosure panel at a conference sponsored by Bloomberg Cities and Debt Briefing in New York City. Courts have found that deliberately hiding material information in an obscure location may put it in a different context and could affect whether the statement is misleading, he added.
The warnings came after Thomas Metzold, co-director of municipal investments and portfolio manager at Eaton Vance Management in Boston, urged a bond lawyer on an enforcement panel to push bond counsel to release more information to analysts.
Metzold, whose remarks were addressed to John McNally, a partner at Hawkins Delafield & Wood LLP and president-elect of the National Association of Bond Lawyers, maintained that issuers routinely withhold important information from investors because they are urged by their bond counsel not to release it.
“Stop deciding yourself whether or not it’s a material event,” Metzold said. “Let the investing community decide whether or not it’s material and just tell us what’s going on.”
Though Metzold said NABL has not done enough to encourage such disclosures, McNally sharply disagreed. He said concerns about selective disclosure regarding corporate securities do not apply in the municipal market and that NABL has repeatedly encouraged its members to communicate openly with investors. Such guidance was formally included in a white paper NABL wrote for its members earlier in this decade, he stressed.
Further, McNally warned that failing to determine which information would be material to a reasonable investor risks burying investors under a mountain of disclosures, most of which would not be material.
Zehner agreed, but warned against hiding information and called for the use of clear language given the diversity of the market.
Referring to pension disclosures, Zehner said: “Some states have constitutional protections for compensation of public employees. Some don’t. Some are fully funded. Some are not. Some use actuarial discount figures on the order of eight. Some use seven and a half.
“That’s all fine and good for those of us in this room, but do you really think that the German investor is going to know the difference between California, North Carolina, and New Jersey? No way, unless you explain it to them in a full and fair fashion within the four corners of the document.”
During the same panel, former SEC chairman Arthur Levitt warned that there are enormous abuses in the municipal market that are “worse today than it’s ever been in many ways.” He faulted the commission for not taking enough interest in the market.
Levitt called for the repeal of so-called Tower Amendment, which was added in 1975 to the Securities Exchange Act of 1934 and restricts the SEC and Municipal Securities Rulemaking Board from collecting offering documents prior to bond sales.
Zehner and McNally countered Levitt, arguing that the SEC has significantly boosted its focus on munis. They cited, among other actions, the planned field hearings that start next week in San Francisco and that are expected to lead to specific recommendations for regulatory and legislative changes, as well as industry “best practices” documents. In response, Levitt conceded that SEC chairman Mary Schapiro has made munis one of her key priorities. He said in an interview that she is doing far more on munis than any of her predecessors.
The focus of Wednesday’s conference revolved largely around the unfunded municipal pension liabilities, with panelists offering various estimates of their value, ranging from $500 billion to $3 trillion.
Robert Kurtter, managing director for state and regional ratings at Moody’s Investors Service, said on an earlier panel that while state and local unfunded pension levels have been part of the agency’s rating methodology “for quite some time,” they are playing an increasingly important role as the liabilities have “soared” in size.
However, he said the rating agency must weigh both the absolute numerical burden of the pensions against the relative pension funding levels of other sovereigns, such as European countries like Germany, that have enormous pension liabilities that are entirely unfunded. But some participants warned that rating agencies need to do a lot more to incorporate pension liabilities into their ratings.
Metzold, who spoke on yet another panel, warned that several highly rated states have “very different” pension funding levels, and that there ought to be more disparities in their ratings if their pension liabilities comprise a significant ratings component.
He also noted that Eaton Vance holds few bonds issued by some of the most underfunded states, such as Illinois and California.
George Friedlander, managing director and senior municipal strategist at Citi, agreed that rating agencies have not incorporated pensions “in the way I would like to see,” stressing he was speaking only for himself and not his firm.
“We’re in the very, very early stages of incorporating pension issues into pricing of muni debt,” Friedlander said.
He estimated that the total unfunded pension liability for states is $1.5 trillion. Adding the pension obligations of local governments as well as retiree health care obligations for both states and localities, the liabilities are “significantly more than” the $2.8 trillion in outstanding muni bonds, he said.
Turning to credit enhancers, Howard Cure, managing director and director of municipal research for Evercore Wealth Management LLC, suggested there are opportunities for new entrants to the bond insurance market but said it is unlikely that insurers will regain a significant share of the new-issue market. Before the financial crisis, insurers backed roughly half of new-issue deals.
New insurers would need to raise significant levels of capital to enter the market at a time when capital is “tight,” Cure said, “so I just don’t think we’re going to see [insurance] make a comeback.”
Currently, there is only one insurer writing new business — Assured Guaranty — and potential entrants into the market have been forced to mothball their attempts to launch new businesses.
Richard Ciccarone, managing director and chief research officer at McDonnell Investment Management LLC, said that insurance levels usually rebound after economic crises and there would be benefits to investors if that occurred now. He noted several court cases in which insurers have aggressively asserted the legal rights of bondholders, drawing on legal resources that retail investors generally do not have.
Matt Fabian, managing director at Municipal Market Advisors, said new entrants would have trouble securing investments from private-equity firms spooked by “wretched” muni disclosure practices, alarming news headlines about states and localities, as well as ominous warnings from Berkshire Hathaway’s Warren Buffett about a “terrible problem” looming for the muni market.
However, Fabian said retail investors are less likely to buy uninsured munis because they do not have the resources to perform extensive research on the underlying credits.
