If the SEC proceeds with its secondary market disclosure rule as proposed, the municipal market will dissolve into a "multi-tiered market" in which many bonds are illiquid, warned top industry officials yesterday.
"If the Securities and Exchange Commission's rule becomes effective, I feel the market at least in the short term, and personally I believe in the long term, will suffer a tremendous decrease in liquidity," said Terry L. Atkinson, vice chairman of the Public Securities Association's municipal securities division.
"You will certainly have virtually zero liquidity for issuers that do not provide secondary market disclosure," said Atkinson, who appeared on a PSA-sponsored panel in New York City that was debating the proposed amendments aimed at tightening the agency's disclosure Rule 15c2-12.
The SEC rule, proposed March 9, would bar dealers from underwriting bonds unless the issuer has pledged in writing to provide ongoing disclosure to a nationally recognized repository. Dealers are particularly concerned about a provision that would bar them from recommending bonds to customers unless they have reviewed an issuer's financial statements.
"You could be busted for failing to read the last annual report," Atkinson said. "That's a very onerous statement. In the absense [of the Documents], you can't recommend.
"I think we will potentially create a marketplace [with] as many as three tiers," said Atkinson, who is director of the municipal securities group at PaineWebber Inc.
One tier would be bonds that are issued before the new rule takes effect and therefore do not have to meet the SEC's research requirement, Atkinson said. Dealers could sell those bonds as long as they have a reasonable basis for recommending them.
The second tier would be issuers that provide the information on a timely, professional basis in response to the new research requirement, he said.
The third would be the "illiquid issuer" that does not provide the information on a timely or adequate basis, Atkinson said.
"This isn't going to create three tiers or four tiers. This is going to create 96 tiers," said Ronald S. Plaine, president of Comerica Securities, a major underwriter of Michigan bonds, who offered the regional dealers' perspective on the the SEC's proposed rule. This is going to create a bureaucracy big enough to "choke a horse," he said.
"How am I going to be able to look a long-term customer in the face and say 'I can't bid your bonds?' Anything I say to him he isn't going" to accept, Plaine said. He is going to tell people that he bought some bonds from this broker, and now he cannot sell them, Plaine said.
Meanwhile, SEC Commissioner Richard Y. Roberts signaled Tuesday that the agency may bend to the industry's concern about the controversial provision.
"The criticisms are valid," Roberts said in a telephone interview. "There are a lot of mechanical problems [with the proposal]. There is no repository up and running. If you are a national broker-dealer, how can you review thousands of issues? Does this mean they have to keep a file on each issue? There could be thousands.
"But there does need to be some sort of secondary market brokerdealer prohibition to give the secondary market disclosure initiatives some teeth." Roberts said. "Until all the comments are in, it's too early to say" what the SEC will do. said Roberts.
Atkinson said that the SEC could Atkinson said. "Issuers will come, the investors will come, and the broker-dealers will come. Build it, and the industry will be more active than you can imagine."
"You will see a quantum leap forward on secondary market disclosure if you build an effective system that can collect data on an ongoing basis, index it so you know where it is, and disseminate it to the market on a timely, cost-effective basis. The system will work. You won't have a problem of going to one repository and finding that that one doesn't have the information, but the third one on the right does."
Asked yesterday whether the SEC would seriously consider such a plan, Elizabeth MacGregor, SEC branch chief for the national market system and a panelist, said, "Absolutely."
Atkinson predicted major changes at PaineWebber if the SEC does not revise the proposed rule.
"If Rule 15c2-12 happens in present form, I think I would probably fire half my traders and I would increase the number of research types to search and evaluate the information," he said. "I would probably limit the number of issues we would bid On."
Atkinson said the firm would probably keep a current database of roughly 300 to 400 issues. The database would focus on frequent issuers and large infrequent issuers with sophisticated professional staffs "that I can count on to provide the type of information required," Atkinson said. He said the firm gradually would expand the number of issues to 1,000 at most.
"We would have to bring someone in to develop a system for tracking and proving that" the firm reviewed the bonds, Atkinson said. "I take the SEC at its word that it intends to vigorously enforce all these provisions."
He said the overall impact of such procedures on market liquidity will be that fewer issues will be followed industrywide. "You'd be limited by your ability to search out and review issues on a timely basis. A relatively small number of issues would be covered in depth. The overwhelming number of issuers will be handled on a time-available basis."
Atkinson said that the immediate impact would be higher costs for everyone in the market.
"The cost of doing business, staying in business. and protecting employees are going to go up." he said. "There will be added expenses [for] research, document analysis, and preparation of reports. You are going to have to validate that you did the activities and have some paper trail. The trustee fee is going to increase and communicating with repositories" will have a cost. he said.
Panelists implored firms to file comments on the disclosure rules. "This is an area which the commission feels very strongly about," the SEC's MacGregor said. "There will be some action. What the details will be is up in the air. But please understand that something will happen. I encourage you to write a letter."
"SEC Chairman Arthur Levitt and other members of the commission are dead serious about this," said R. Fenn Putman. PSA chairman and managing director of Lehman Brothers. "This is the train leaving the station. The train is going whether we like it or not. So we must direct it" the right direction. "We want to make it an opportunity, not a killer or show stopper.
