HOUSTON -- The Securities and Exchange Commission's proposals on disclosure for municipal bond issues and dealer markups for so-called riskless principal transactions will jeopardize bond liquidity and drive up costs, according to industry officials.
At a Public Securities Association meeting last week in Houston, investment bankers and issuers expressed concern that the SEC plans to boost requirements for secondary disclosure information, and that dealer fees would discourage bond trading for several reasons. Those included regulations that dealers review an avalanche of paperwork that would cost money to store, access, and review.
"All this is adding up to a lot of cost and liquidity concerns," said Ruth Smith, senior vice president at Texas Commerce Bank and a member of the Municipal Securities Rule-making Board. "You are going to have to limit the credits you can trade."
Smith's remarks pertained to the proposed SEC rule that would bar dealers from underwriting an offering unless the issuer has agreed to provide annual financial and other operating information as well as notices of material events to a nationally recognized repository. The rule, which is open to comment until July 15, also would bar dealers from recommending a bond in the secondary market without having previously reviewed that information.
The amount of material that would need to be reviewed could be so excessive that dealers would be compelled to select only certain credits to study and sell, Smith said.
About 10 million documents could be submitted annually to a nationally recognized repository because most issuers will want to dump everything into the system to protect themselves from liability, Smith said. The additional paperwork would boost costs for issuers and dealers, she said.
Anne Schwartz, director of the Texas Public Finance Authority, also questioned how issuers would be able to determine what needed to be submitted to a repository to comply with SEC rules under antifraud provisions. The authority, which is one of the largest issuers in the country, could conceivably be required to provide statements on the budget made by elected officials from the governor to the comptroller.
If so, "we will have an official statement that goes on for a gazillion pages and reads like a tabloid," Schwartz told the more than 50 people attending the meeting.
Bob Estrada, chief executive officer for Estrada, Hinojosa & Co. and an attorney, advised the SEC not to encourage issuers to dump all information into the system for safety's sake.
In addition to concerns that dealers could stop selling some bonds because of paperwork, investment banking sources, and PSA officials said they would fight the SEC's proposed markup rule, partially from liquidity concerns.
Gary Lenhart, senior vice president at Rauscher Pierce Refsnes, said the SEC's proposal to have dealers disclose all markups on riskless principal transactions would not aid clients, but rather mislead some investors. The SEC's proposed rule defines a riskless principal transaction as one in which a dealer receives an order from an investor, locates a seller, buys the bonds for its own account, and then quickly sells them to an investor.
Lenhart said many customers would not understand that the yields obtained on the bonds are more important than the markups. In addition, he said dealers would hesitate to get involved in the transactions if the markup disclosure is required.
"The negative impact would be less liquidity and less access to market prices," he said.
Drew Masterson, senior vice president at Masterson Moreland Sauer Whisman, agreed that disclosing the markup takes attention off key issues, including yields.
"We are going to fight the markup [proposal] as hard as we can," he said.
Industry sources said they are concerned that regional firms that handle many of the riskless transactions could lose a substantial amount of business if the markup proposal is
passed.
The SEC has recommended such a proposal three times before, but it failed to get enough support for implementation. However, this time, it could stand a better chance for final approval, sources said.
"The last time it came up was 10 years ago. Now it's a different era," said Joseph Sack, vice president of membership initiatives for the PSA.
He said the PSA was opposed to the markup proposal. Although organization officials understood the SEC's desire for more price transparency in bond trading, they did not agree that markup disclosure was the appropriate vehicle.
He said the PSA would consider suggesting an alternative to markup when the organization makes its comments by the SEC's June 15 deadline.
Elizabeth MacGregor, SEC branch chief for the national market system, said the commission felt strongly about adopting the markup disclosure rule and eventually some sort of action would be taken.
"This is something the chairman [Arthur Levitt Jr.] is very concerned with," she said.
