WASHINGTON - Federal regulators are calling for broad new rules and legislation to regulate the municipal securities market, including standards governing ongoing disclosure, political contributions, price information, sales practices, and audit trails.
The recommendations were included in three separate reports sent late Friday to Congress by the Securities and Exchange Commission, the Municipal Securities Rule-making Board, and the National Association of Securities Dealers outlining changes that the groups feel are needed.
The SEC staff, in particular, came out swinging, saying Congress needs to enact comprehensive legislation to reform market disclosure, including a measure requiring registration of conduit bonds.
If Congress does not propose reform legislation, the SEC staff said it would recommend that the SEC issue a legal interpretation making clear that the antifraud provisions of the federal securities laws require issuers to provide ongoing disclosure to the market.
The staff also will recommend that the agency issue rules barring dealers from recommending bonds to investors unless the issuer has pledged to make available ongoing information about the financial condition of the issuer.
Only two things would keep the SEC staff from making those recommendations. One would be congressional legislation giving the agency direct authority to require continuing financial disclosure by issuers. The other would be legislation rescinding the current exemption municipal bonds have from SEC registration and reporting requirements, the SEC staff said.
But observers said Congress is unlikely to try to enact such legislation.
The three reports, which were released to the press yesterday, came after Rep. John Dingell, D-Mich., chairman of the House Energy and Commerce Committee, and Rep. Edward Markey, D-Mass., chairman of the panel's subcommittee on telecommunications and finance, sent letters to the regulators in May. The letters ask them to conduct a comprehensive review of the adequacy of current laws and regulations governing the issuance and sale of municipal bonds.
Top officials of the groups are scheduled at 9:30 a.m. tomorrow to discuss their findings at a hearing on the municipal securities market by Markey's subcommittee. Scheduled to testify are SEC Chairman Arthur Levitt Jr., MSRB Chairman Charles W. Fish, and NASD Vice President John E. Pinto.
The MSRB has agreed with the SEC that voluntary secondary market disclosure efforts have failed to trigger comprehensive ongoing disclosure by issuers. But the MSRB said in its report that before advocating additional reforms it wants to see if a disclosure rule it plans to propose this fall will prompt adequate reform.
The board announced on Aug. 4 that its proposal would require dealers to alert investors in writing at the time of a bond sale whether an issuer intends to provide secondary market disclosure. In addition, dealers would be required to alert investors that the lack of secondary market disclosure could affect the price and liquidity of their investments.
All three regulators said that new rules, rather than legislative changes, are the best way to curb abuses involving political contributions made by dealers to issuers. The three backed a rule proposed by the MSRB on Aug. 30 that would prohibit dealers from making contributions designed to capture or keep an issuer's bond business. The rule also would require dealers to disclose over a four-year period all political gifts made to issuers with whom they have done business.
"Preliminarily, the SEC staff believes that the MSRB's proposal represents a positive first step to address the misuse of political contributions." the commission's report says.
The MSRB also indicated that it may adopt rules aimed at cracking do%a,n on undisclosed fee splitting between municipal underwriters and financial advisers.
Both the SEC and the MSRB said existing rules already bar some of the alleged influence peddling reported widely in the press that involves questionable deals in New Jersey, Louisiana, and Massachusetts.
The SEC noted that it currently is reviewing the political contributions practices of a number of brokers and dealers, "including possible improper payments to financial advisers and other third parties.
"The staff is unable at this time to draw conclusions regarding the extent of political contributions by underwriters and other influence seeking activities, or the federal securities provisions that may be implicated by such activities, though it expects to be able to make a further report after fully analyzing all of the information it will eventually receive."
All three regulators supported improvements in the public's access to market price and quotation information.
The SEC recommended that real time quotations and trade reports in actively traded municipal securities be made available. It urged that the municipal securities industry's exemption from the federal "national market system" be lifted.
Sponsored by the NASD, the national market system makes comprehensive information available to investors about the securities that trade on the system. The MSRB and the NASD called for more limited steps aimed at improving public access to price and volume information.
The SEC also called for better disclosure of the markups that dealers make in the prices of municipal securities so that it is easier for regulators to detect excessive price hikes.
The agency called for better disclosure on confirmations of "riskless principal transactions, " meaning transactions in which a broker-dealer trades with a customer from or for his own inventory and charges a markup when the customer buys the bond or a markdown when the customer sells.
All three regulators agreed that no major changes are needed in the current structure for implementing and enforcing municipal securities rules. Currently, the MSRB and the SEC can write rules for municipal broker-dealers, and the SEC, the NASD, and bank regulators can inspect firms and take enforcement action against bank dealers.
But the SEC said regulators need to improve the coordination of their activities and increase enforcement of municipal dealers.
The SEC said that a "central flaw," in the current regulatory system for municipal bonds is the lack of an "audit trail" similar to the type that exists in the stock and options markets. The agency called for regulators to work together to create a cost-effective system for municipal bonds and improved surveillance for all segments of the tax-exempt market.
The term "audit trail" refers to a process that generates time-sequenced reports showing when a security is bought or sold and at what price. Audit trails allow enforcement officials to reconstruct trades.
"If [the SEC is] doing an investigation, that can be quite important," "said a Markey aide. "There is not a full audit trail system in municipals like that in the equities market. It would be a significant reform."
Markey said in a press release yesterday, "In recent months considerable attention has been focused on questionable practices relating to the underwriting and sale of municipal securities. With these reports, the regulators have now weighed in with a comprehensive package of suggested regulatory and legislative solutions to the key problem areas currently affecting this market. I welcome these recommendations for reforms as this subcommittee considers how best to preserve public confidence in the integrity and fairness of the $1 trillion municipal market."
Officials from the Public Securities Association and Government Finance Officers Association could not be contacted yesterday because publication of the reports was embargoed until this morning.
