WASHINGTON -- Orange County, Calif.'s financial troubles will make issuers more aware of their disclosure obligations, but new disclosure rules or legislation aren't called for, F. Fenn Putman, the outgoing chairman of the Public Securities Association, said last week.
Legislation requiring issuers to register their bond offerings with the Securities and Exchange Commission would be disastrous for the municipal market, Putman, a managing director at Lehman Brothers who will step down as PSA chairman next week, said in a series of recent interviews.
Putman said the municipal bond market faces at least three major challenges in the new year:
* Implementing the SEC's new secondary market disclosure rules.
* Moving to a three-day clearance and settlement period.
* Dealing with the new Republican leaders in Congress, whose views about tax-exempt bonds are still largely unknown.
He also said that there should be "a level playing field" on campaign contributions so that bond lawyers, financial advisers, and other municipal market participants are subject to some of the same restrictions as broker-dealers.
Putman said the Orange County controversy "should sensitize people to the types of things that have to be disclosed that people in the past did not think were very important."
"It may be painful. It may be expensive. But it's a very good lesson that kind of dovetails with the rules" on secondary market disclosure that were adopted last month by the SEC, he said.
Putman said the SEC's disclosure rules, along with previously issued SEC disclosure guidelines and ongoing industry initiatives on price transparency, should be sufficient to deal with most of the disclosure issues being raised in connection with Orange County.
The county filed for bankruptcy earlier this month after suffering derivatives and leveraged investment-related losses and liquidity problems with its multibillion dollar investment pool.
Putman said the SEC's investigations of Orange County may show that county officials failed to follow some of the disclosure practices that the SEC recommended issuers employ to avoid running afoul of the securities laws' antifraud provisions. The commission made those recommendations in an interpretative release it issued last March.
Contract With America Cited
Both Rep. Christopher Cox, a Republican representing Orange County, and Rep. Jim Leach, R-Iowa, the incoming House Banking Committee chairman, have said the county treasurer's risky investment strategies should have been disclosed and that they plan to introduce legislation calling for municipal bond issuers to be subject to the same disclosure requirements as corporate issuers, possibly including registration.
But Putman said last week, "I don't think legislation is needed."
"The [House] Republicans' Contract With America is for less, not more, regulations," he said.
"Forced registration would be a terrible mistake" and would be costly for both issuers and the SEC, he said.
Registration statements for only about 3,500 corporate issues were filed with the SEC last year, while state and local governments issued roughly 14,000 municipal bond issues, Putman said.
"You don't have to be a genius to figure out how the SEC would handle this under their current budget squeeze," he said.
Putman said that while the SEC's disclosure rules and guidelines do not specify the form and content of the disclosures that issuers should make, they "in essence mirror what the SEC has asked corporations to do." The rules become effective beginning next July.
The Orange County controversy already has led some issuers to disclose information about their investments and to begin marking to market their portfolios on a periodic basis, Putman said.
Unresolved Issues Over SEC Rules
In an earlier interview, Putman said that while the SEC's new secondary market disclosure rules are "very workable," there are still some "open issues" about how they will be implemented by market participants.
The rules bar broker-dealers from underwriting bonds as of July 3, 1995, unless they have "reasonably determined" that the issuer has agreed in writing to provide ongoing disclosure of annual financial information and notices of material events that could affect their bonds.
Under the rules, issuers must annually update the key financial and operating information that appears in the official statements for their primary offerings. If an issuer prepares an audited financial statement, it will also have to be submitted to a nationally recognized information repository.
One open issue, Putman said, is how far municipal issuers will go to satisfy the requirements to disclose annual financial information and notice of material events.
For general obligation bonds, issuers should be able to satisfy the annual financial information requirement by disclosing their annual financial report, he said. For revenue bonds or more complex financings, they may only need to supplement that report with some additional information, he said.
"I think there's going to be a lot of time and motion and energy gnawing over the nits and grits here, but I think some of it is going to be unnecessary," he said.
Putman predicted that the rules will spawn a whole new sector of the industry whose mission will be to research, analyze, and abstract issuers' annual financial reports. He envisions a future in which broker-dealers not only routinely call up these abstracts electronically, but also provide them to investors.
"That's the whole concept behind the rules. If someone now has the data, we're going to have a larger responsibility to understand it and to access it," he said. "It's pretty clear that we, as business people, should take a very hard look at how we operate under these rules, particularly now that we'll have the information available."
Putman is worried that some issuers may overload the system with notices of events that are not really material to their bond issues.
"There obviously will be some debate on material events," he said.
The fact that New York State is running a budget deficit may be material, but every little change in that deficit might not be, he said.
"I don't think every time they have a hiccup in Albany, it means they have to file all kinds of documents," he said.
Repository Overkill Feared
Putman is also concerned that too many nationally recognized municipal securities information repositories (NRMSIRs) may be established under the rules and that broker-dealers will be expected to pay for all of them.
The rules require broker-dealers to have in place by Jan. 1, 1996, the systems and procedures needed to monitor material events that could affect the bonds they recommend to investors.
Issuers must send notices of material events either to each of the NRMSIRs or the Municipal Securities Rulemaking Board as well as to any depository set up in that state. They must send annual financial information to each NRMSIR and to any depository in their state.
"If you've got 20 NRMSIRs taking in 50,000 documents, that's a rather redundant system," he said.
Practically speaking and from an economic standpoint, it does not make sense to have more than five or six repositories under the rules, he said.
Putman said that people should remember that while taxpayers pay for EDGAR -- the SEC's Electronic Data Gathering Analysis and Retrieval system, which is used to receive corporate filings electronically -- brokerdealers will be paying for the NRMSIRs with their fees.
Putman said that some press reports suggesting that the SEC's new disclosure rules were forced upon the industry are "backwards."
"We have been pushing for this," he said. "The PSA has been on record saying for some time that we do need more information or at least the ability to access information without being steamrolled."
Putman said he believes that the PSA and MSRB initiatives to make bond prices and other information publicly available will eventually lead newspapers across the country to routinely publish the prices of municipal bonds that are sold or traded on a daily basis.
On the issue of political contributions, Putman said that while most broker-dealers are supportive of the MSRB rule aimed at banning pay-to-play practices, there are still some issues to be resolved with regard to the rule.
The rule, which took effect on April 25, bars broker-dealers who make political contributions to issuer-clients from doing business with those clients for two years afterwards.
One unresolved issue is whether an official of a municipal securities firm should be allowed to be part of the transition team of a newly elected local official without triggering the rule's restrictions.
"It's an in-kind contribution. Whether you give dollars or your time it's still in a sense a contribution," said Putman. "But does that mean that politicians can consult with everybody else except the financial community when they come into the office? That doesn't make sense."
Asked about bond attorneys who say lawyers should not be subjected to the same constraints on political contributions as broker-dealers because they help state and local lawmakers write laws, Putman joked that those lawyers must see "a deeper philosophical difference between the lawyers and the dealers" and must feel that "they're professionals and we're just out to get money."
"I think we have to have a level playing field," he said.
At a minimum, bond lawyers, financial advisers, and other market participants should disclose their political contributions and refrain from making any contributions to obtain bond business, he said.
"The bigger problem with all of this, however, that nobody likes to focus on, is the whole issue of campaign finance reform," Putman said. "It's gotten out of hand."
Politicians have to raise huge amounts of money, Putman said, and much of that money goes for political consultants and advertising. "We've built a whole new infrastructure that has a vested interest" in political contributions, he said.
Big Changes From T Plus 3
Putman said the move from a fiveto a three-day clearance and settlement period will be a "dramatic" change for the municipal bond market, particularly for regional or small bond firms that are used to accepting checks from individual investors buying bonds.
Under the so-called T plus 3 system, which takes effect next June, investors are going to have to have cash management accounts with broker-dealers or some means of transferring money electronically, he said.
An increase in cash management accounts, however, could cause problems for monetarists because M1 and M2, the two key measures of the money supply, do not pick up the money in those accounts, he said.
Republicans' Agenda Unclear
Asked about the new Republicanled Congress, Putman said, "There's still a great unknown here as to what their specific policies will be."
Before the election, Rep. Edward Markey, D-Mass., the chairman of the House Energy and Commerce Committee's subcommittee on telecommunications and finance, had said one of his priorities for the coming year would be to hold hearings on municipal bonds and to introduce legislation requiring the registration of conduit bonds.
Putman said he told Markey, who will become ranking minority member of the subcommittee in January, that registration would be a death knell for some conduit bond issues.
"I reminded the congressman that in Massachusetts there's some $20 billion worth of conduit issuers including hospitals and universities, for which Massachusetts is known, and that perhaps before he put those folks out of business he should talk to his local constituents," Putman said.
Rep. Jack Fields, R-Tex., who will now chair the subcommittee with jurisdiction over securities, "is going to have a lot on his plate" in trying to implement his part of the Republican leadership's Contract With America, and municipal bonds may be less of a priority, he said.
The Republicans have talked about putting more responsibilities on the states and reducing the capital gains tax, both of which would be good for municipal bonds, Putman said.
The PSA would like any legislation aimed at reducing the capital gains tax to include a measure to overturn a recently enacted tax bill provision that treats the discount from bonds sold at a market discount after April 30, 1993, as ordinary income rather than as capital gains, he said.
But it is not yet clear what will happen to infrastructure and other initiatives launched by the Clinton Administration before the election, Putman said.
Turning to the business side of the bond market, Putman said that while the huge drop in municipal bond volume this year may result in some downsizing and some reductions in bonuses at firms, it should not result in a major retrenchment of municipal bond departments.
"I don't see any wholesale withdrawal from the business," he said. "People learned some pretty good lessons in the 1980s and didn't bulk up" in the early 1990s when volume was rising.
Putman sees municipal bond volume increasing steadily over the next few years to over $200 billion in the year 2000. There is some pent-up demand for new issues, because a lot of issuers were focused on refundings last year, as well as ongoing infrastructure needs, he said.
Summing up the past year, Putman said the SEC's new disclosure rules, the MSRB's political contributions rule, the ongoing industry price transparency programs, and other initiatives have created a huge "sea change" in the municipal market.
"I'd say 1994 was as big a year in terms of changing the industry as the year they created the MSRB" in 1975, he said.
These new initiatives will have to be digested and they may have to be fine-tuned, "but in essence everything is in place" for a strong, well-regulated market that serves investor needs, Putman said.
