WASHINGTON - The Securities and Exchange Commission has issued new guidance that gives market participants more flexibility in the information they can withhold from preliminary official statements.
SEC Chief Counsel Robert Colby said in a letter to the Public Securities Association that information about credit enhancements and other features of deals that is not "reasonably ascertainable" before the securities have been priced generally does not need to be included.
Mr. Colby's letter comes in response to a request by the PSA for clarification on the content of preliminary official statements.
The SEC letter follows more than two years of controversy that began when New York bond lawyer Robert Ferdon wrote the agency in early 1990.
Mr. Ferdon had asked whether the identity of the credit enhancer and the maturities to be insured in a client's upcoming deal could be left out of the preliminary official statement if they have not yet been determined.
Mr. Ferdon, a partner with Mudge Rose Guthrie Alexander & Ferdon in New York City, reasoned that these features depend on the price of the securities and therefore would be exempt under the SEC's then year-old municipal disclosure Rule 15c2-l2.
Mr. Colby, in a letter that stunned the industry, wrote on April 4. 1990, that Mr. Ferdon's client would receive a special exemption, but that the SEC did not necessarily believe the material was generally allowed to be omitted.
Industry members had hoped the letter would state broadly that the document could exclude any information unavailable at the time of the preliminary official statement's distribution or not known in good faith - particularly if the information was linked to the price of the securities.
In industry meetings following the issuance of the letter, SEC staff members said they did not issue a broader interpretation because they worried that it would open the floodgates for underwriters to omit too much information from preliminary official statements. But they added that the response to Mr. Ferton was too narrow.
In his latest letter, Mr. Colby said: "The staff recognizes that ... certain information may not be available to the issuer or the participating, underwriter at an early stage in the offering process because the information cannot be known or reasonably ascertained until the securities have been preliminarily marketed and priced.
"At the same time, we do not believe that a participating underwriter is relieved of its obligation under Rule 15c2-l2 to obtain and review the requisite information solely because such information is not known with absolute certainty, or because information that is known concerns terms with respect to which more specific additional information may not be known until a later date," Mr. Colby said.
"In general, we believe that in the context of each offering, the issuer, the participating underwriter, and their respective counsel will be in the best position to determine whether information is in fact not known or reasonably ascertainable at the time the underwriter must obtain and review" a preliminary official statement under the SEC's disclosure rule, he said.
Throughout the letter, Mr. Colby refers to a preliminary official statement as a "deemed final official statement," referring to language in l5c2-l2.
Bond lawyer Stanley Keller, who has worked with the SEC as it developed its response, described the agency's letter as "hopeful."
"It takes a really flexible and somewhat expansive view of what can be omitted from the deemed final official statement," he said. "And it's an interpretation that's free to be relied on by everyone. It's really a good example of the SEC staff and industry groups really working together to come up with a sensible resolution."
Focusing on credit enhancements, Mr. Colby said that for certain offerings, decisions about who will provide a credit enhancement, the terms of the deal, and, in some cases, whether a credit enhancement will be obtained at all, is not made until the securities have been priced.
This may be the case, for example, because participants in a deal will solicit competing bids for credit enhancements from several sources, and the securities must be priced before the bids can be obtained, he said. Also, a decision to get a credit enhancement may hinge on an analysis of market conditions at the time of pricing, he added.
"In those cases, the information that is not known or reasonably ascertainable may be omitted from the deemed final official statement," he said.
Mr. Colby added, however, that this "would not justify the omission from a DFOS of information concerning credit enhancement, such as the fact that credit enhancement generally or of a certain type will be obtained, if that information is known or reasonably ascertainable as of the date of the DFOS.
"However, information concerning all potential credit enhancers would not necessarily need to be included in the DFOS if credit enhancement is expected to be obtained, but either the type or source has not been determined," he said.
Mr. Colby said the same principles apply to guaranteed investment contracts.
Regarding redemptions, Mr. Colby said that decisions about whether bonds will be subject to optional or mandatory redemption ordinarily are made before the date of the deemed final official statement and therefore should be reported in the document.
However, in negotiated offerings, more specific details like particular sinking fund dates, principal amounts per sinking fund redemption, periods of call protection, or premiums to be paid on each redemption date may not be fixed or reasonably ascertainable until pricing. In such circumstances, these items can be omitted from the deemed final official statement, the SEC said.
Other terms that cannot be determined until pricing and that also can be excluded from the deemed financial official statement could include the dollar amounts for specific line items regarding the use of proceeds or exact pro forma debt service amounts, Mr. Colby said.
Mr. Colby stressed that the examples in the letters are "illustrative" and not meant to exhaust all possibilities.
EDITORS NOTE: The following is the text of the Aug. 24 letter by Robert Colby, chief counsel market regulation at the Securities and Exchange Commission, to Public Securities Association Vice President George Brakatselos. Mr. Brakatselos wrote the SEC asking for a clarification of the agency's April 1990 letter on what information can be omitted from a "deemed final official statement" under the commission's municipal disclosure Rule 15c2-12. That SEC letter was addressed to Robert Ferdon, a partner with Mudge Rose Guthrie Alexander & Ferdon in New York.
In your letter of August 11, 1992, you inquired as to the application of paragraph (b)(1) of Rule 15c2-12 ("Rule") under the Securities Exchange Act of 1934 ("Exchange Act") with respect to the inclusion or omission of certain types of information from an official statement that is obtained and reviewed by an underwriter of a municipal securities offering that is subject to the Rule. You indicated that you wished to obtain clarification of certain issues that were raised in a letter previously issued by the staff.(1)
Rule 15c2-12(b)(1) generally requires that an underwriter participating in a primary offering, as defined in the Rule, of municipal securities ("Participating Underwriter") must, prior to the underwriter's first bid, purchase, offer, or sale of the securities, obtain and review an official statement. The official statement (sometimes referred to as a "deemed final official statement" and hereinafter referred to as a "DFOS") must be deemed final by the issuer as of its date, except for the omission of certain specified information, including:
the offering price(s), interest rate(s), selling compensation,
aggregate principal amount, principal amount per maturity,
deliver dates, any other terms or provisions required by an issuer
of such securities to be specified in a competitive bid, ratings,
other terms of the securities depending on such matters,
and the identity of the underwriter(s).
It is our understanding that, in the context of particular offerings of municipal securities, certain terms or provisions often are determined immediately after, or in connection with, the pricing of the securities. Accordingly, this information may not be available to an issuer or Participating Underwriter at the time the Participating Underwriter must obtain and review the DFOS pursuant to the Rule. You have asked for the staff's views with respect to the application of paragraph (b)(1) of the Rule in these circumstances.
In its interpretation of municipal underwriter responsibilities (the "Interpretation") contained in the release proposing Rule 15c2-12,(2) the Commission reaffirmed the principle that, under the general antifraud provisions of the federal securities laws, a broker-dealer recommending securities to investors makes an implied representation that it has a reasonable basis for the recommendation.(3) In addition, by participating in an underwriting, an underwriter makes an implied recommendation about the securities sold in the offering. This representation in turn implies that the underwriter has a reasonable basis for believing in the accuracy and completeness of key representations made in disclosure documents.(4)
Paragraph (b)(1) of the Rule is designed to ensure that underwriters of municipal securities obtain information that is sufficient to determine whether changes or additions are required before the underwriter becomes obligated to purchase the securities. By ensuring that Participating Underwriters obtain this information before undertaken this obligation, this provision is meant to assist Participating Underwriters in complying with the reasonable basis obligation described above.(5) The Rule is not meant to govern the content of offering documents used in municipal securities offerings.(6) Further, recognizing that disclosure is a dynamic process, the requirement that a Participating Underwriter obtain and review a DFOS is not intended to preclude changes to disclosure documents prior to sale.(7)
In order for an underwriter to satisfy its obligation to have a reasonable basis for recommending the purchase of securities by its customers, it must endeavor to consider the information related to those securities that is necessary to support that recommendation. Viewed within the context of an underwriter's reasonable basis obligation and the purposes of the Rule, each Participating Underwriter must obtain and that obligation that is known or reasonably ascertainable.
The staff recognizes that, in the context of certain offerings and in accordance with responsible industry practice, certain information may not be available to the issuer or the Participating Underwriter at an early stage in the offering process because the information cannot be known or reasonably ascertained until the securities have been preliminarily marketed and priced. At the same time, we do not believe that a Participating Underwriter is relieved of its obligation under the Rule to obtain and review the requisite information solely because such information is not known with absolute certainty, or because information that is known concerns terms with respect to which more specific additional information may not be known until a later date.
The following examples illustrate the application of these principles with respect to matters identified in your letter.
* Credit Enhancement
It is our understanding that, in the context of certain offerings, the determination as to the party that will provide credit enhancement with respect to the offering, terms of the credit enhancement, or in some cases whether any form of credit enhancement will be obtained, is not made and is not reasonably ascertainable until the securities have been priced.(8) This may be the case, for example, because competing bids for credit enhancement will be solicited from several sources and the securities must be priced before the bids can be obtained. Also, the determination as to whether credit enhancement will be obtained may require an analysis, based on market conditions at the time of pricing, of the cost of the credit enhancement compared to the interest savings to the issuer if credit enhancement is obtained. In those cases, the information that is not known or reasonably ascertainable may be omitted from the DFOS.
The foregoing analysis would not justify the omission from a DFOS of information concerning credit enhancement, such as the fact that credit enhancement generally or of a certain type will be obtained, if that information is known or reasonably ascertainable as of the date of the DFOS. However, information concerning all potential credit enhancers would not necessarily need to be included in the DFOS is credit enhancement is expected to be obtained but either the type or source of credit enhancement has not been determined. Further, if credit enhancement is not reasonably expected to be obtained as of the date of the DFOS, it would not be necessary to include in the DFOS information about credit enhancement generally solely because credit enhancement is a possibility.
The principles stated above also can be illustrated in the context of guaranteed investment contracts ("GICs"). The terms of certain municipal securities provide for the investment of part or all of the proceeds of the offering in GIC that is designed to serve as a primary source of payment or security. In the context of a negotiated offering, several potential providers of the GIC may exist, and the selection of a provider or specific terms of the GIC may depend on the determination of the price and other terms of the securities. The information that is not ascertainable based on these factors need not be contained in the DFOS. However, where applicable, other information that is known, such as the fact that the GIC provider will be required to meet certain specified credit or other requirements, should be reflected.
* Optional or Mandatory Redemption Terms
The determination that securities will be subject to optional or mandatory redemption ordinarily will be made prior to the date of the DFOS, and, if such is the case, these facts, including any other basic terms concerning these matters that are known or reasonably ascertainable at that time, should be contained in the document or documents comprising the DFOS. However, in negotiated offerings,(9) more specific matters such as particular sinking fund redemption dates, principal amounts per sinking fund redemption, periods of call protection, or premiums to be paid on each redemption date, may not be fixed or known or reasonably ascertainable until pricing. In such circumstances, these specific items need not be contained in the DFOS.
* Other Terms Dependent on Pricing
Various other terms that cannot be determined until pricing, or until the determination of the amount of underwriter compensation and offering expenses, would not need to be contained in the DFOS. This category of information could include, for example, matters such as dollar amounts for specific line items concerning the use of proceeds or exact pro forma debt service amounts. General information concerning such matters that is known or reasonably ascertainable, such as the types of purposes for which proceeds will be used, should be included.
The examples provided above are illustrative and are not meant to be exhaustive of situations in which information may be omitted from a DFOS based on the principles enunciated above. In general, we believe that, in the context of each offering, the issuer, the Participating Underwriter, and their information is in fact not known or reasonably ascertainable at the time the Participating Underwriter must obtain and review a DFOS pursuant to the Rule.
Our position relates solely to information that may be omitted from a DFOS under paragraph (b)(1) of the Rule and is based in part on our understanding of marketing practices and other factors that are unique to municipal securities offerings. In particular, our position does not apply to information to be contained in prospectuses or other documents pursuant to the requirements of the Securities Act of 1933 ("Securities Act") or the Investment Company Act of 1940 and the rules and regulations promulgated thereunder.(10)
In addition, in adopting the position described above, we assume that each Participating Underwriter will obtain and review any omitted information prior to the time that it purchases securities from an issuer or sells securities to investors and that information will be contained in the final statement delivered to Participating Underwriter under paragraph (b)(3) of the Rule. Further, as noted above, the Rule is not meant to govern disclosure content in connection with municipal securities offerings. Accordingly, the Rule does not affect the disclosure obligations of municipal securities issuers and underwriters under the general antifraud provisions. Disclosure is a dynamic process and a continuing obligation of persons offering securities for sale, and "even substantial changes to the document required by paragraph (b)(1) may be necessary to comply with the federal securities laws at the time of sale to investors."(11) The fact that certain information may, in some circumstances, be omitted from a DFOS does not limit the obligation of a Participating Underwriter to provide such information, if material, in an effective manner to investors prior to the time that a final investment decision is made.
(1) Robert E. Ferdon Esq. [1990-1991] Fed. Sec. L. Rep. (CCH) (paragraph) 79,650 (April 4, 1990).
(2) Securities Exchange Act Release No. 26100 (September 22, 1988), 53 FR37778 ("Proposing Release"). The interpretation was modified in certain respects in the Rule 15c2-12 adopting release, Securities Exchange Act Release No. 26985 (June 28,1989), 54 FR 28799 ("Adopting Release").
(3) In the Interpretation, the Commission discussed the obligations of underwriters and securities salesmen generally and quoted the following language from Hanly v.S.E.C., 415 F.2d 589, 597 (2d Cir. 1969), affirming Richard J. Buck & Co., 43 S.E.C. 998 (1968), quoted at 53 FR 37787:
In summary, the standards by which the actions of each [salesman] must be judged are strict. He cannot recommend a security unless there is an adequate and reasonable basis for such recommendation. He must disclose facts which he knows and those which are reasonably ascertainable. By his recommendation, he implies that a reasonable investigation has been made and that his recommendation rests on the conclusions based on such investigation.
(5) Adopting Release, 54 FR 28803.
(6) Id. n. 31. However, by requiring Participating underwriters to obtain sufficient information on a timely basis, the Rule may have the effect of influencing the process by which municipal issuers prepare disclosure documents. In the Proposing Release, the Commissions stated that "[i]n order to allow the underwriter to meet [its reasonable basis] obligation, issuers will have to begin drafting disclosure documents earlier and perhaps with greater care than in the past." 53 FR 37790.
(7) Adopting Release, 54 FR 28803.
(8) Such Credit enhancement may take the form of letters of credit, bond insurance, guaranteed investment contracts, and other types of guarantees.
(9) In competitive offerings, when these items are terms to be specified in the bid, they are explicitly permitted to be omitted by paragraph (b)(1) of the Rule.
(10) See, e.g., Rule 430 under the Securities Act, concerning information to be contained in a prospectus meeting the requirements of Section 10 of the Securities Act prior to the effective date of the registration statement.
(11) Adopting Release, 54 FR 28803.