Municipal Bond Disclosure

Introduction

It is with great pride that municipalities promote their communities. However, when it comes to offering bonds or other municipal securities you are required to disclose all material facts whether the facts are favorable or negative, i.e., issuers must provide all information that enables investors to make informed investment decisions.

Historical Overview of Municipal Disclosure Practices

Following congressional hearings into allegations of corporate fraud in the early 1930s, Congress passed the Securities Act of 1933 with the objective of providing investors full disclosure of material facts about securities offered and sold. In 1934 Congress passed the Securities Exchange Act of 1934 that created the Securities and Exchange Commission (SEC) and empowered the SEC with broad authority over all aspects of the securities industry.

Both the Securities Act of 1933 and the Securities and Exchange Act of 1934 were enacted with broad exemptions for municipal securities. Municipal securities received special exemptions based on considerations of federal-state comity. In addition, at the time of enactment, there was a lack of perceived abuse in the municipal securities market as compared with the corporate market. Furthermore, the typical purchasers of municipal securities were institutional investors with financial expertise.

Principle to minimize federal interference and disruption of states' jurisdiction in order to avoid friction.

Although municipal securities are exempt from the registration and reporting requirements of the Securities Acts, issuers are subject to liability under the anti-fraud provisions of the Securities Acts of 1933 and 1934 (principally Rule 10b-5 of the Securities Exchange Act of 1934). Rule 10b-5 requires the disclosure of all material facts and prohibits the omission of facts necessary to make statements not misleading. The Securities Acts do not detail the extent of liability nor the information an issuer must disclose. Courts, however, have consistently held that an omitted fact is "material" if there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision.

In spite of Rule 10b-5, full disclosure was not frequently practiced. Prior to the 1960s, the majority of tax-exempt issues were general obligation bonds. Due to the full faith and credit pledge, predominance of institutional investors, and consistent terms, municipal bonds were sold without difficulty even when disclosure was limited to a notice of sale.

After the 1960s, dramatic changes began occurring in the municipal bond market. Revenue bonds became more prevalent, new types of bonds were introduced, such as advance refunding, industrial revenue, and housing bonds, and innovative structures such as zero coupon, variable rate and credit enhanced issues were created. Diversity of security types necessitated greater disclosure. A major thrust to change disclosure requirements and practices occurred during the 1970s as a result of bond defaults. Prior to the default by the City of New York in 1975, tax-exempt securities were thought to be "risk free." To address the growing need for disclosure, in 1976 the Municipal Finance Officers Association (now the Government Finance Officers Association) completed disclosure guidelines.(1) The guidelines were not intended to be legally binding, but rather to encourage improved disclosure and greater standardization of disclosure practices. The guidelines set forth information the Association believed municipal issuers should disclose to potential investors.

Changes in investor composition after the 1970s also triggered a demand for increased disclosure. While the historical buyers of bonds; banks, insurance companies and individuals, remained the same, the demand for municipal securities among them changed dramatically. Brought about principally by revisions in the tax code, banks were no longer the primary buyers of tax-exempt bonds. Since the mid 1980s, the public sector, comprised of individuals and trusts, have accounted for more than 50% of the purchases of new issues. In contrast to institutional investors, which are staffed with professional analysts and have resources and access to a variety of informational sources, individual investors are likely to depend upon an official statement as the primary source of information.

Public sentiment for increased disclosure reached new heights in 1983 when the Washington Public Power Supply System defaulted on $2.45 billion in tax-exempt revenue bonds. Congress requested that the SEC investigate whether Federal Securities Laws had been violated. On September 22, 1988, the SEC released to Congress the results of its extensive investigation. At the same time, the SEC published a Release requesting comment on several initiatives that were designed to improve the quality, timing, and dissemination of disclosure in the municipal securities markets. The Release proposed adoption of Rule 15c2-12 under the Securities Act of 1934. While the Rule was adopted in the wake of the Washington Public Power Supply System default, it also was in response to a widely held belief that there were problems in the timeliness of and access to official statements.

On January 1, 1990, Rule 15c2-12 went into effect. Although the SEC is prohibited from imposing disclosure rules on municipal government entities, the SEC did so indirectly through the requirements that Rule 15c2-12 placed on broker-dealers.

A securities firm that is engaged in buying and selling securities.

Summary of Rule 15c2-12 for Primary Offerings

Rule 15c2-12 obligates underwriters participating in primary (new) offerings of municipal securities of $1,000,000 or more to obtain, review, and distribute to investors copies of the issuer's official statement. The official statement preparation and dissemination requirements of the Rule are as follows:

(1) Prior to bidding on or purchasing an issue, the underwriter is required to "obtain and review" an official statement that is deemed final by the issuer as of its date, except for the omission of certain information that is not known until the time of the sale. The information which may be omitted includes the offering price, interest rates, selling compensation, aggregate principal amount, principal amount per maturity, delivery dates, ratings, other provisions required to be specified in a competitive bid, other terms of the securities depending on such matters, and the name of the underwriter.

(2) In a negotiated underwriting, the underwriter must distribute preliminary official statements, if one has been prepared by the issuer, not later than the next business day, to potential customers upon request.

(3) The underwriter must contract with the issuer or its agents to receive a sufficient number of copies of a final official statement to enable compliance with the delivery requirements of the Rule and the rules of the Municipal Securities Rulemaking Board (see MSRB Rule G-32). The issuer must provide copies of the final official statement not later than seven business days after entering into a contract for the sale of securities.

(4) The underwriter must provide a copy of the final official statement, upon request, to any potential customer for designated time periods following an underwriting of a new issue.

The rule does not apply to certain private placements or short-term issues if the securities are in denominations of $100,000 or more and if such securities:

(1) Are sold to no more than thirty-five persons which the underwriter believes: (a) have knowledge and experience in financial and business matters and are capable of evaluating the merits and risks of the prospective investment; and (b) is not purchasing for more than one account or with the view to distribute the securities; or

(2) Have a maturity of nine months or less; or

(3) Such securities may be tendered to the issuer or its agent for redemption or purchase at par at least as frequently as every nine months.

Secondary Market Disclosure

While the quality of disclosure for primary offerings significantly improved with the passage of Rule 15c2-12, there was a continuing concern with the adequacy of disclosure in the secondary market. Contributing to the concerns were highly publicized defaults, growing ownership of municipal securities by individual investors, and the increasing volume and complexity of new issues. In 1993, the SEC's Division of Market Regulation conducted a comprehensive review of many aspects of the municipal securities market, including secondary market disclosure. The findings were set forth in the September, 1993 Staff Report on the Municipal Securities Market. The Staff Report indicated that the growing participation of individual investors, who may not be sophisticated in financial matters, as well as the proliferation of complex derivative municipal securities, underscored the need for improved disclosure practices in both the primary and secondary municipal securities markets.(2)

On November 10, 1994 the Securities and Exchange Commission amended rule 15c2-12. Under the amended rules, broker-dealers are barred from buying municipal securities sold on and after July 3, 1995 (January 1, 1996 for bonds of small issuers) unless the issuer has agreed, in writing, to provide ongoing disclosure. Although the SEC can not regulate municipalities, it once again effectively did so indirectly by the rules imposed on broker-dealers. With certain exceptions, described below, the rule requires bond issuers to prepare and disseminate to Nationally Recognized Municipal Securities Information Repositories ("NRMSIRs") "Annual Financial Information" and notices of material events.(3)

The issuer's written agreement to provide ongoing disclosure may take the form of a covenant in the trust indenture, bond ordinance or bond resolution or there may be a separate written agreement. Although the agreement may be executed at the time of the bond closing, the underwriter may not enter into a contract for the purchase of the security unless the underwriter has made a reasonable determination that there will be continuing disclosure at the time the bond purchase agreement is executed. A reasonable determination may be made by including an obligating provision in the bond purchase agreement or, in the case of a competitively bid offering, such assurances could be contained in a notice of sale.

The term Annual Financial Information means financial information or operating data, provided at least annually. In its Release No. 34-34961 the SEC indicated that Annual Financial Information is to "mirror" the type of quantitative financial information and operating data contained in the final official statement. Annual financial information may be presented through any disclosure document or set of disclosure documents. The SEC warned that the fact that the amended Rule relies on the final official statement to set the standard for ongoing disclosure should not serve as an incentive for issuers to reduce existing disclosure practices in the preparation of official statements. The SEC stated that it encourages market participants to continue to refer to voluntary guidelines (such as the guidelines prepared by the Government Finance Officers Association) and the SEC's Interpretive Release in preparing official statements. If audited financial statements are prepared, such audited financial statements must also be submitted to NRMSIRs.

At the time bonds are offered, the issuer must outline the type of Annual Financial Information it will provide annually and the terms of its continuing disclosure agreement. The contract must include and the official statement must describe (i) the type of information to be provided as part of the Annual Financial Information, (ii) the accounting principles used to prepare the financial statements and the timing of such statements, (iii) the date in each year by which the Annual Financial Information will be provided and to whom, and (iv) who will be providing the information - the issuer, an "obligated person," an indenture trustee or a designated agent. The official statement must also indicate any instances in the previous five years in which there has been a failure to provide the continuing disclosure for which the issuer is contractually bound.

Any party legally committed to support payment of all or part of an issue of municipal securities, other than certain unrelated providers of credit enhancement.

Issuers are required to provide to each NRMSIR or the Municipal Securities Rulemaking Board a notice, in a timely manner, of the following "material events" that normally reflect the credit supporting municipal securities.(4)

The eleven events are as follows:

1.   Principal and interest payment delinquencies;
2.   Non-payment related defaults;
3.   Unscheduled draws on debt service reserves;
4.   Unscheduled draws on credit enhancement;
5.   Substitution of credit or liquidity providers, or their failure to perform;
6.   Adverse tax opinions or events affecting the tax-exempt status of the security;
7.   Modifications to rights of security holders;
8.   Bond calls;
9.   Defeasances;
10. Release, substitution, or sale of property securing repayment of the securities; and
11. Rating changes.

Notice must also be given on any other information which the issuer has agreed to provide.

The SEC included the eleven events in the rules for "guidance." According to SEC attorneys, issuers' disclosure obligations under the securities fraud laws go beyond the SEC's list and cover anything that could materially affect their bonds.(5) Issuers will have to determine if a notice of other material events must be provided to repositories.

Issuers with less than an aggregate of $10 million in outstanding securities are exempt from the Annual Financial Information requirement if they make a "limited undertaking" specifying the type of financial information and operating data they will make available, on a request basis at least annually. Financial information and operating data that are customarily prepared and publicly available satisfy this limited undertaking. Small issuers must also provide material events disclosure as described hereinbefore. The $10,000,000 exemption takes into account all types of the issuers' outstanding tax-exempt debt. General obligation bonds, revenue bonds, lease obligations and notes are all aggregated in the $10,000,000 limit.

Primary issues that are exempt from Rule 15c2-12 are also exempt for purposes of secondary market disclosure. In addition, issues which are outstanding 18 months or shorter are exempt from secondary market disclosure.

Failure to Comply With Secondary Market Disclosure

A failure to comply with the undertaking would be a breach of contract. The rule however, does not specify the consequences of an issuer's breach of its undertakings to provide secondary market disclosure.

In the SEC Release No. 34-34961 the SEC stated that:

"The amendments do not prohibit Participating Underwriters from underwriting an Offering of municipal securities if an issuer or obligated person has failed to comply with previous undertakings to provide secondary market disclosure. However, if a failure to comply with such previous undertakings has not been remedied as of the start of the Offering, or if the party has a history of persistent and material breaches, it is doubtful whether a Participating Underwriter could form a reasonable basis for relying on the accuracy of the issuer's or obligated person's ongoing disclosure representations."

Disclosure Goes Electronic

Technological advancements have led to numerous changes in the municipal bond industry including rules relating to disclosure.

Under the MSRB's Rule G-32, the managing or sole underwriter of municipal securities is required to send paper copies of the official statement to all broker-dealers that purchase the new issue. On August 25, 2005 the Securities and Exchange Commission approved amendments to Rule G-32 that permit the distribution of electronic official statements. Under the amendment, if the requesting dealer consents, the managing or sole underwriter is permitted to provide dealers with a printable electronic official statement in lieu of the paper copies.

Another recent development is the establishment of DisclosureUSA by the Muni Council, a group of more than 20 municipal market participants. DisclosureUSA is a central post office created to simplify secondary market disclosure by making it possible for issues to file documents electronically in a single location rather than with several NRMSIRs. On September 7, 2004, the SEC issued an Interpretative Letter expressing the view that an issuer may satisfy the continuing disclosure filings under Rule 15c2-12 electronically at a single location through the use of the Web site or "central post office" created for this purpose at www.DisclosureUSA.org.

The Spirit of the Law

Several organizations including the Government Finance Officers Association and the National Association of Municipal Analysts have long urged municipalities to provide secondary market disclosure and have suggested going beyond the requirements of Rule 15c2-12. Continuing disclosure improves relations with investors and analysts. At the 2001 National Association of State Auditors, Comptrollers and Treasurers annual conference, Stephen J. Wenstein from the Office of Municipal Securities of the Securities and Exchange Commission stated "The provisions of Rule 15c2-12 set a floor, not a ceiling. Common-sense approaches to disclosure also serve ethical considerations and the issuers' self-interests, in keeping their investors and constituents alike current and fully informed."

Recent Amendments

On December 8, 2008, the Securities and Exchange Commission (SEC) approved amendments to Rule 15c2-12 that become effective on July 1, 2009 and will change the annual disclosure requirements for virtually all municipal bond issuers.

Under the rule, the Municipal Securities Rulemaking Board�s Electronic Municipal Market Access system (�EMMA�) has been designated as the central repository for continuing disclosure documents. Issuers will be required to provide continuing disclosure documents to EMMA rather than to each Nationally Recognized Municipal Securities Information Repository (�NRMSIR�) or the current central repository known as DisclosureUSA.

Rule 15c2-12 previously provided an exemption to certain small issuers or borrowers who have $10 million or less of debt outstanding. Small issuers entered into a limited continuing disclosure undertaking whereby financial information or data that is customarily prepared and publicly available was made available upon request to bondholders. Under the amendments to Rule 15c2-12 small issuers will be required to submit the financial information and data to EMMA (except with respect to issues less than $1,000,000 and certain private placements).

The amendments also require all disclosure documents to be submitted in electronic format (PDF Files). Beginning January 1, 2010, PDF files submitted to EMMA must be word searchable.

The SEC indicated that issuers can submit continuing disclosure documents to EMMA or can do so indirectly through an indenture trustee or a designated agent.

Secondary Market Disclosure Services

To assist government entities in fulfilling their secondary market disclosure requirements, WM Financial Strategies, offers continuing disclosure services. WM Financial Strategies collects and compiles data and prepares an Annual Financial Information Report that meets the requirements as well as the spirit of Rule15c2-12. When the document is completed, WM Financial Strategies serves as the Dissemination Agent in filing the document with the NRMSIRs or DisclosureUSA, as determined most appropriate, and any other parties named in the continuing disclosure undertaking.

Beginning in July 2009, WM Financial Strategies will expand its services to act as a designated agent to small issuers. These services will include advising on the content of the disclosure document, compiling and formatting the content into an appropriate electronically formatted document, and submitting the continuing disclosure document and financial statements to EMMA.

For further information contact: Joy A. Howard at 314-423-2122.
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(1)	To reflect changes in the tax exempt market, the Government Finance Officers Association has periodically drafted new disclosure guidelines.
(2)	Exchange Act Release No. 34961. November 10, 1994.
(3)	The list of NRMSIRs is available at the SEC website.
(4)	On September 8, 2005 the MSRB submitted a petition to the SEC to amend rule 15c2-12 end eliminate filings with the MSRB.
(5)	The Bond Buyer, January 31, 1995. Reporting on comments made at the practicing Law Institute's 13th Annual Institute on Municipal Finance by SEC attorneys Paul Maco and Amy M. Starr.