On March 1, the Securities Exchange Commission voted to propose amendments to Rule 15c2-12 under the Securities Exchange Act of 1934, adding two event notices to the current fourteen required in continuing disclosure agreements of issuers and obligated persons issuing municipal bonds and bring the total to sixteen, as well as the addition of a defined term key to application of the two events.

The Rule proposal presents a positive response to suggestions from many market participants regarding disclosure of so-called bank loan transactions. It does so without wandering into the potential morass of what is and is not a security. However, it does not use the rule-making opportunity to remove anachronisms left over from the Rule's creation in a world of paper-based disclosure, as suggested by market participants, to more effectively interface with modernized EMMA system, or otherwise simplify compliance. Nor does it provide interpretive guidance many hoped for following MCDC.

The additional events proposed are:

(15) Incurrence of a financial obligation of the obligated person, if material, or agreement to covenants, events of default, remedies, priority rights, or other similar terms of a financial obligation of the obligated person, any of which affect security holders, if material; and

(16) Default, event of acceleration, termination event, modification of terms, or other similar events under the terms of the financial obligation of the obligated person, any of which reflect financial difficulties.

The proposed amendments also add a definition of "financial obligation" to the Rule, as "a (i) debt obligation, (ii) lease, (iii) guarantee, (iv) derivative instrument, or (v) monetary obligation resulting from a judicial, administrative, or arbitration proceeding. The term financial obligation shall not include municipal securities as to which a final official statement has been provided to the Municipal Securities Rulemaking Board consistent with this rule."

While the text of the SEC's press release announcing the proposed rule change and the proposing release itself from time to time uses the phrase "issuer or obligated person," the proposed additional events use only "obligated person." This is consistent with the definition of "obligated person," defined in the current Rule as "any person, including an issuer of municipal securities …" and consistent with the usage in the existing notice events under the Rule.

The stated goal of the amendments is to improve financial transparency of municipal bond issuers in an area where the Commission otherwise lacks the statutory authority to do so. The proposed changes aim to reduce the "information asymmetry among market participants and to increase transparency to the municipal securities market by improving investor and market participant access to timely information relating to a municipal issuer's financial obligations," explained Acting Chairman Michael S. Piwowar. Commissioner Kara M. Stein said that this proposal represents a step toward increased transparency and will create efficiency for issuers and investors alike.

The extent of reporting under the first proposed event notice hinges upon the gatekeeping term "materiality" and under the second proposed event notice upon the phrase "reflect financial difficulties." Issuers and obligated persons would need to apply these terms in determining whether an obligation is material and therefore reportable, and if so, which of its terms are material and reportable as well, under continuing disclosure agreements dated after the effective date of the amendments. They would likewise need to assess whether events relating to financial obligations "reflect financial difficulties" and trigger reporting.

The proposal states "the preliminary belief" of the Commission "that including a materiality determination would strike an appropriate balance" in determining what issuers and obligated persons should report, and provides this illustration:

As proposed, the materiality determination applies to the incurrence of a financial obligation and each of the agreed upon terms listed (i.e., covenants, events of default, remedies, priority rights, or other similar terms). For example, an issuer or obligated person may incur a financial obligation for an amount that, absent other circumstances, would not raise the concerns the proposed amendments are intended to address. On the other hand, if an issuer or obligated person agrees to provide a counterparty to a financial obligation with a senior position in the debt payment priority structure, and that agreement affects existing security holders, the event likely does rise to the level of importance that it should be disclosed to investors and other market participants.

The proposal also states the preliminary belief of the Commission that the qualifier "reflect financial difficulties," likewise "strike[s] an appropriate balance" as a reporting trigger and provides this illustration:

As proposed, the term "any of which reflect financial difficulties" applies to all of the events listed in the proposed event notice (i.e., a default, event of acceleration, termination event, modification of terms, or other similar events). For example, an issuer or obligated person may covenant to provide the counterparty with notice of change in its address and may not promptly comply with the covenant. A failure to comply with such a covenant may not reflect financial difficulties; therefore, absent other circumstances, this event likely does not raise the concerns the proposed amendments are intended to address. On the other hand an issuer or obligated person could agree to replenish a debt service reserve fund if draws have been made on such fund. In this example, if an issuer or obligated person fails to comply with such covenant, then such an event likely should be disclosed to investors and other market participants.

The proposal also points out "[t]he concept of "reflecting financial difficulties" has been used since the adoption of Rule 15c2-12 in paragraph (b)(5)(i)(C)(3) and in paragraph (b)(5)(i)(C)(4), and, as such, market participants should be familiar with the concept as it relates to the operation of Rule 15c2-12." The Commission requests comments on its proposal.

The prism through which issuers, obligated persons and underwriters will likely view compliance with these proposed additions is the MCDC experience, in particular the Commission's treatment of materiality in regard to official statement descriptions of prior non-compliance. Many market participants view the often granular application of materiality displayed in the 71 issuer settlements announced last August as inconsistent with the application of materiality anticipated by experienced municipal finance lawyers, as illustrated by NABL's August 2014 MCDC Initiative Whitepaper Considerations for Analysis by Issuers of Materiality and Self-Reporting and may question how the term will be applied in an enforcement context.

Similarly, the absence of transparency on the part of the issuers with respect to their financial obligations, which was the motivating factor behind the addition of the two notice events, may pose challenges to underwriters when forming a reasonable basis for belief in the accuracy of statements in issuer or obligated person offering documents as to compliance with disclosure undertakings including the two events. The MCDC Initiative provided many issuers, obligated persons, and underwriters with real-world metrics to compare with the Commission's assumptions under the Paperwork Reduction Act, Economic Analysis, Small Business Regulatory Enforcement Fairness Act, and Regulatory Flexibility Certification Sections, that compliance with the Rule as amended would result in certain costs, benefits, and burdens, on which the Commission also requests comment.

The comment period, running 60 days following publication of the proposal in the Federal Register, will provide municipal market participants and other interested parties with an opportunity to express views on these matters and others. The Commission and the municipal market will benefit from thoughtful comments from municipal market participants and all interested in its functioning in a fair and efficient manner.


Paul S.   Maco

Paul S. Maco

Paul S. Maco, a partner in Bracewell LLP’s Washington, D.C. office and a former senior official at the U.S. Securities and Exchange Commission, defends municipal bond issuers, underwriters, municipal advisors, lawyers, rating agencies, companies and their employees in government enforcement matters as well as advises on regulatory and compliance matters. He can be reached at paul.maco@bracewell.com.