WASHINGTON -- The Securities and Exchange Commission's proposed disclosure rule and legal interpretation would have a major impact on the municipal market and should be eased, anxious market participants told the commission Friday.
"I have become convinced that the proposed changes will have a profound [effect] on the municipal market place," California Treasurer Kathleen Brown said in a five-page letter filed as the SECs deadline for comments expired Friday.
"The likelihood is that issuers will be required to spend millions of dollars annually to bring their reporting systems and practices into compliance with the proposed rule," Brown said.
"The costs borne by underwriters, brokers, dealers, and investors are also likely to be passed onto public agencies in the form of higher issuance costs or reduced prices for municipal bonds," she said.
Brown said that she believes the SEC's plan for improving secondary market disclosure ultimately will enhance market "integrity." But she said its success hinges on how sensitive the commission is to confronting the costs, technical problems, and other problems posed by the proposals.
The National Association of Bond Lawyers said the SEC should not proceed with its proposed rule on disclosure until it does a more detailed cost-benefit analysis.
Regulators could "enhance" existing rules that require firms to sell only suitable bonds to customers "to emphasize the importance of secondary market disclosure," the association said in an 82-page letter signed by John M. Gardner, chairman of the group's committee on securities law and disclosure, and John S. Overdorff, chairman of the group's special task force on federal securities regulation.
Lawyers said the Municipal Securities Rulemaking Board should adopt a rule that would require dealers to disclose to investors when an issuer has failed to commit to providing ongoing disclosure and the consequences for investors. And the SEC should adopt a legal interpretation that explains how the absence of continuing disclosure information can affect the suitability of investments.
The association also urged the commission to clarify provisions of its interpretive release that accompanied the proposed disclosure rule, including distinguishing between recommended and required practices.
Brown and the bond lawyers are among the first market participants to file what eventually may be hundreds of comments on the proposed rule and interpretative release that were published for comment by the SEC March 16.
The proposed rule would bar dealers from underwriting bonds unless the issuer has pledged in writing to provide annual financial statements and material events to a nationally recognized repository. Also, dealers could not recommend bonds to customers unless they have reviewed a municipal bond issuer's financial statements.
The interpretive release, which the agency says is in effect, outlines a number of areas where improvement is needed in primary and secondary market disclosure and lists 11 items that, at a minimum, should be disclosed when they are considered material.
The Public Securities Association, as expected, said Friday that it opposes the provision in the proposed rule that would bar dealers from recommending a bond until they have reviewed current disclosure. But the group said it agrees with the "basic outline" of the rule, which would require issuers to promise to disseminate both annual financial statements and material events to the market while their bonds are outstanding.
The PSA made the statement in a two-page press release that said the will send an in-depth comment the SEC after a group of trade groups hammers out a joint comment letter to the SEC. The 12 groups, which include the PSA, are scheduled to meet today in Washington. All were co-signers of a landmark December 1993 joint statement that called on the SEC to develop new rules requiring continuing disclosure by issuers. Most of the signers have agreed not to file their individual comments until the joint letter is filed.
The proposed rule would require that financial and operating information on "significant obligors" of an issuer be provided in the final official statement and in annual financial documents. The rule defines a significant obligor as one that is the source of 20% or more of the cash flow servicing the obligations on the bonds.
Brown said the SEC's definition will have a "chilling effect" on economic development in California and urged the agency to defer the provision until it has better examined the issue.
"This requirement will place many public agencies in an extremely difficult position if the private borrower is unable or unwilling to provide such information on an ongoing basis," Brown said. "If the SEC believes that the information from private borrowers is vital, the requirement should fall on those borrowers, not public agencies."
Brown also said she hopes the SEC does not interpret the term "significant obligor" to include land-secured financings such as special assessment and Mello-Roos bonds. Ownership in these financings frequently changes, she said. And the information could be misleading because only the property, not the overall assets of the parties, is at risk in these transactions:
In other comments, Brown said the SEC should not require issuers; to provide audited financial statements or any other specific document because it places the SEC in the role of dictating the form and content of the information. She said the SECs recommendation that issuers be required to make available audited financial statements within six months after the end of their fiscal years may be too restrictive for a large state such as California, given the extensive number of individual state accounts and funds that must be reconciled.
She said California issuers are willing to provide reasonable disclosure to all interested parties, but they do not want to have to file with any more than one central repository.
The California treasurer, like the PSA, opposed the SECs plan to bar dealers from recommending bonds if they have not reviewed the issuer's disclosure information. She said she would support a delay or phase-in of the rule or regulators' simply relying on an existing requirement that dealers sell only suitable bonds to customers.
The SEC staff is drafting legislation to send to Capitol Hill that would re- move the exemption from registration for the corporate entity underlying certain conduit bonds. The SEC's legal interpretation said that pending those amendments, conduit corpo~ rate borrowers should provide not only standard municipal disclosure but the more extensive disclosure required for corporate offerings.
But Brown said she opposes efforts to apply corporate-like registration to underlying obligors of conduit bonds.
In other comments, the bond lawyers said that if regulators intend to apply the antifraud statutes to the public statements of state and local government officials, then they need to clarify the difference between "vigorous political dialogue" and "intended financial disclosure."
"The law is not as clear as the commission suggests" on this issue, lawyers said.
The group said it agrees with the SEC that political contributions and other arrangements that reflect material conflicts of interest should be disclosed. But it said it disagrees with the "implication" in the legal interpretation that political contributions by participants in an offering should regularly be considered material.
