WASHINGTON -- The Securities and Exchange Commission approved secondary market disclosure requirements yesterday and endorsed municipal industry initiatives to improve price transparency, in what SEC chairman Arthur Levitt called "an historic event."
"I am not aware of any rulemaking initiative by this commission that has been conducted in a more cooperative manner," Levitt said at the commission meeting.
The new municipal bond market requirements and initiatives are "the culmination of an extraordinary dialogue" that has taken place between the SEC, state and local issuers, municipal securities dealers, and investors over the past year, Levitt said.
The SEC chairman praised the issuer and dealer communities for "their considerable efforts to help address the needs of investors." He also lavished praise on SEC commissioner Richard Roberts, who he said played a major role in the process.
But Levitt said that while the increased secondary market disclosure and improved price transparency that will result from these requirements and initiatives is "a very important step in the right direction," further action may be needed.
"Hopefully together we can look back a year or two from now and recognize that this was but one step and that greater progress is anticipated and is indeed expected," he said.
SEC commissioner Steven Wallman echoed Levitt's comments when he said the new requirements and initiatives should create "a sea change" in the municipal securities business. At the same time, however, he said if price transparency is not improved he will call for the commission to consider requiring dealers to disclose markups in most bond transactions, not just those done on a riskless-principal basis as the SEC initially proposed and then deferred.
At the meeting, the SEC staff outlined new details about the secondary market disclosure requirements they had recommended, which the commissioners adopted in whole, during a briefing with commissioners and reporters.
Under one of two key requirements, dealers would be barred from underwriting bonds as of July 3, 1995, unless they had "reasonably determined" that the issuer or obligor had agreed in writing to provide ongoing disclosure of annual financial information and notices of material events.
Annual financial information would include updates of key financial and operating data from the official statement for the primary offering and, if they are prepared, audited financial statements.
SEC staff officials told reporters that they envision the issuer or obligor typically putting the commitment to provide ongoing disclosure in the bond indenture document.
The staff told commissioners and reporters that issuers and obligors making such a written commitment should include specific information, including: each party for which annual financial information and notices of material events are to be provided; the type of annual financial information to be provided, and whether it will include audited financial statements; the accounting principals to be used; and the date on which the annual financial information will be provided and whether it will be given to a state depository.
In conduit financings, the borrower rather than the issuer would be obligated for ongoing disclosure, they said.
Unless they are exempted from such a requirement, an issuer or obligor's failure to provide annual financial information would be considered a material event for which a notice would have to be filed, the staff told commissioners.
The staff officials said that the requirement for issuers or obligors to agree to provide ongoing disclosure has teeth because if they fail to follow through on their agreement they will have broken a contract with the investors.
"We have created a contractual relationship between the issuer and obligor and bondholders," said David Sirignano, the senior legal adviser to the director of the SEC's corporation finance division.
Sirignano said issuers or obligors could also spell out, in the bond indenture, what penalties they would be subject to if they failed to meet their commitment to provide ongoing disclosure.
The other key requirement is for broker-dealers to have in place by Jan. 1, 1996, the systems and procedures to monitor material events that could affect the bonds they recommend to investors.
"We believe that existing law requires dealers to use the information disseminated to the marketplace in forming a reasonable basis for recommending securities to investors," said Janet Russell-Hunter, an attorney in the SEC's division of market regulation.
Levitt asked about the secondary market disclosure requirements' effects on small issuers, some of which would be exempted.
"For governmental issuers, the townships, the school districts, this won't be a problem," said Sirignano. "They all prepare some type of annual information."
But Sirignano said the requirements "might be a little bit of a bite for some of the corporate [industrial development bond] type issuances" which involve small borrowers that are reluctant to provide information to the market.
"They provide it to their trustees, to the agencies that finance their borrowings, they just may be reluctant to give it out" publicly, Sirignano said. He said, however, that under these requirements, "They must be willing to tell the market what they will be willing to provide [because] that's a small cost for entering public markets."
Robert Colby, the deputy director of the SEC's division of market regulation, said "the states can play a very valuable role" in the new disclosure program by setting up depositories to collect and disseminate information about bond issues within their jurisdiction.
Most market participants praised the requirements.
"I think the commission deserves some praise for trying to be accommodating both to the needs of market participants and to the needs of investors," said Gerald Laporte, a lawyer with Patton, Boggs & Blow here.
The requirements will be tough for some small issuers and borrowers, but the delayed effective dates should help, said Laporte, who is also vice chairman of the National Association of Bond Lawyers' securities law and disclosure committee.
"I was very pleased. I think they satisfy the needs of the analyst community," said Katherine Bateman, an assistant vice president at John Nuveen & Co. in Chicago and past chairman of the National Federation of Municipal Analysts.
Catherine L. Spain, director of the Government Finance Officers Association's federal liaison center, said the revised disclosure requirements more closely track proposals originally made by municipal bond issuers.
In making its March proposal the SEC staff had used the industry's ideas as a template, but had added requirements such as disclosure of information about "significant obligors" that would have been unworkable, said Spain.
"That's where they got into trouble" with the March proposal, Spain said. "Now, what they have done is they have gone back and corrected it, they have brought it back to the original proposals" made by market participants.
David Clapp, the previous chairman of the Municipal Securities Rulemaking Board, said the changes made by the staff in their earlier proposals reflect their acknowledgement that parts of the proposals had been unworkable, particularly the idea of barring broker-dealers from recommending bonds unless they had first reviewed the financial information disclosed by the issuer.
By removing that part of the proposal, the SEC "has taken off the table the requirement that you do something that I think was going to be very nearly impossible to do," Clapp said. "That's where the liquidity problem might have started to show."
The changes to the disclosure requirements show that the SEC staff made a strong effort to learn the way the bond market operates, Clapp said. "I think all of the changes really are in the area of operation of the marketplace," Clapp said. "The staff pretty much now by its own admission did not understand the way the market operates, and what really happened -- and this is the great thing about it -- is that they went out and they found out" by consulting with the market, he said.
"None of us have all agreed with each other on every point, but you can't beat the level of communication, and I think everybody was moving in the same direction," said Christopher Taylor, the executive director of the MSRB. "It was a really cooperative effort."
Spain agreed. "In all the years I've been working with various regulatory agencies, it was the most consultative and cooperative effort." Spain said issuers have proposed "that we continue to have this consultative relationship, that there be ongoing dialogue, and that there be cooperation in getting the message out, and I hope that continues."
Levitt's comments during the meeting made it clear the commission has not stopped examining the municipal market, Spain said.
"I heard that message very loudly and very clearly: 'Okay, market, we're not done,'" Spain said.
Joan Pryde contributed to this article.