I. MUNICIPAL SECURITIES DISCLOSURE
The Commission is adopting amendments to Rule 15c2-12 under the Securities Exchange Act Of 1934. The purpose of the amendments is to further deter fraud and manipulation in the municipal securities market by prohibiting the underwriting and subsequent recommendation of securities for which adequate information is not available. As a result of the amendments, purchasers of municipal securities in the secondary market will have the benefit of substantially the same type of information enjoyed by purchasers in primary offerings,
The amendments were proposed on March 9, 1994. Over 390 comment letters were received on the proposals.
The principal amendments are as follows:
Underwriting of Primary Offerings of Securities
The Commission is amending Rule 15c2-12 to prohibit a broker, dealer, or municipal securities dealer from purchasing or selling municipal securities in connection with a primary offering of municipal securities with an aggregate principal amount of $1,000,000 or more, unless it has determined that an issuer or an obligated person has undertaken in a written agreement or contract for the benefit of the holders of such municipal securities to provide annual financial information and notices of material events.
The Commission is not adopting a proposal to require audited financial statements by all issuers and significant obligors, in response to comments regarding the need for flexibility in determining the type of information that should be provided regarding municipal securities. Instead, the amendments rely on the parties to the initial offering of the securities to establish which parties will provide ongoing secondary market disclosure, and what information is material to an understanding of the security being offered. Under the amendments, the key quantitative financial and operating information in the final official statement will determine the type of financial and operating data to be provided on an ongoing basis pursuant to the undertakings, and the persons about which that data will relate.
* This approach is designed to provide meaningful secondary market disclosure under standards that are flexible, yet enforceable. The approach is consistent with that traditionally followed by the Commission with respect to official statement disclosure, which relies upon market discipline and general antifraud considerations to ensure that the disclosure provided is meaningful.
* The proposed definition of "significant obligor" is not being adopted. Instead, parties must provide financial information and operating data in the official statement about those persons who are material to an offering. Annual financial information will be provided about those persons discussed in the offering statement who are obligated with respect to the repayment of the securities.
* The final official statement, as well as the annual information, could cross reference to information on file with a repository, the MSRB, or the SEC.
* The type of the financial information (such as full financial statements or summary financial information), would have to be of the same type as that provided in the offering statement. Audited annual financial statements will be provided when and if available.
* As with financial information, the operating data (such as attendance or utilization statistics), will be of the same type as that provided in the official statement.
As proposed, the amendments include 11 events affecting the security that must be disclosed if material. The failure to comply with the undertaking to provide annual financial information will be added as an event requiring immediate disclosure.
Recommendations Without Specified Information
Another provision of the proposed amendment would have prohibited any broker, dealer, or municipal securities dealer from recommending the purchase or sale of a municipal security unless such broker, dealer, or municipal securities dealer has reviewed the information the issuer of such municipal security has previously undertaken to provide. Commenters anticipated that such a prohibition would have a considerable negative impact on liquidity. Furthermore, brokers, dealers, and municipal securities dealers considered the proposed prohibition to be problematic from a compliance perspective.
This provision has been modified to prohibit the dealer from recommending a municipal security subject to a disclosure covenant unless the dealer has a system reasonably designed to notify the dealer of material event information regarding the security before the recommendation is made.
* For instance, a dealer could rely on a vendor system that electronically reported all material events to the dealer when they occurred, if these reports were made available to the staff responsible for the recommendations.
The restriction on recommendations will apply only with respect to municipal securities issued in an offering that is subject to an undertaking to provide material event notices.
* Although the amendments only create specific review obligations with respect to material event notices, annual financial information disseminated into the marketplace must be taken into account by brokers, dealers, and municipal securities dealers in making recommendations to investors in order to meet their obligations under the MSRB fair dealing and suitability rules.
Under the amendments, the undertakings must call for the annual financial information to be provided to all nationally recognized municipal securities information repositories ("NRMSIRs") and the appropriate state information depository, if one has been established for that state.
* Requiring the annual financial information to be sent to all NRMSIRs, rather than a single NIRMSIR, eliminates the need for an indexing system and will greatly facilitate access to the information, while not imposing any additional costs on issuers beyond mailing and duplication costs.
Event notices will be provided to all NRMSIRs or the Municipal Securities Rulemaking Board, as well as the appropriate state information depository, if one exists for that state. The adopting release discusses the standards the Commission will apply in considering requests for approval as a NRMSIR. It also discusses the role of state information depositories.
In addition to the exemptions already contained in the rule, the staff is recommending that the proposed exemption for small issuers with less than $10 million in securities outstanding following offering be adopted, with modifications. In lieu of a proposed condition that the issuer have issued less than $3 million in municipal securities in the prior 48 months, the small issuer exemption will be subject to a limited information undertaking (1) to provide on request or annually to a state information depository at least the annual financial information the issuer or obligated party customarily prepares and that is publicly available; and (2) to provide notices of material events to each NRMSIR or the MSRB, and to the state informaiton depository.
* While the small issuer exemption is conditioned on a undertaking to provide some type of financial information and operating data on request or to a state information depository, the condition to the exemption does not specify what type of information must be provided, other than: at a minimum, any information that is already customarily prepared and that's publicly available pursuant to public information laws or otherwise.
* These exempt issuers and obligors would not have to up-date the information provided in the official statement or release their audited financial statements, unless they otherwise make that information publicly available.
Offerings of securities with matutities of less than 18 months would be exempt from the requirement for an annual financial information undertaking, but not the material event notice and recommendation requirements.
Effective Dates and Phase-In
The amended role will be effective for all offerings occurring on or after July 1, 1995. The information covenant must encompass disclosure of any of the specified material events occurring after that date, but need not require annual financial information for fiscal years ending prior to January 1, 1996. Dealers need not have a system in place to review the notices until January 1, 1996. The limited information undertaking condition to the small issuer exemption will not take effect until January 1, 1996.
II. CONFIRMATION DISCLOSURE REQUIREMENTS
The Commission is adopting amendments to its confirmation rule, Rule 10b-10 under the Securities Exchange Act of 1934. That rule requires brokers and dealers to provide customers immediate written notification of information relevant to their transactions in securities (other than U.S. Savings Bonds and municipal securities).(1) For over 50 years the customer confirmation has served basic investor protection functions by conveying information allowing investors to verify the terms of their transactions; alerting investors to potential conflicts of interest with their broker-dealers; acting as a safeguard against fraud; and providing investors the means to evaluate the costs of their transactions and the quality of their broker-dealer's execution.
Consistent with the Commission's investor protection mandate and in keeping with innovations in securities products and markets, the amendments will require brokers and dealers to provide information concerning customer transaction costs in specified Nasdaq and exchange-listed securities, the status of certain unrated debt securities, the status of certain non-SIPC member broker-dealers, and the availability of information regarding asset-backed securities. The Commission is deferring action on its proposal to require disclosure of mark-ups in riskless principal transactions in debt securities to allow the industry time to develop enhanced price information in the markets for those securities.
On March 9, 1994, the Commission published for comment proposed amendments to Rule 10b-10 and new Rule 15c2-13 under the Securities Exchange Act of 1934 ("Exchange Act"),(2) to require disclosure of markups in riskless principal transactions in debt securities including municipal securities. Rule 10b- 10 requires broker-dealers to send an immediate confirmation to customers when effecting transactions in securities other than U.S. Savings Bonds and municipal securities. Rule 15c2-13 would have applied to transactions in municipal securities. The Commission also proposed amendments to Rule 10b-10 that would require brokerdealers to disclose (1) mark-ups in connection with transactions in certain Nasdaq and regional exchange-listed securities; (2) if they are not members of the Securities Investor Protection Corporation ("SIPC:); (3) information relevant to certain types of collateralized debt instruments; and (4) if a debt security has not been rated by a nationally recognized statistical rating organization ("NRSRO"). Proposed Rule 15c2-13 contained a similar provision requiring broker-dealers to disclose the unrated status of a municipal security.
Response to Commission Proposal of Mark-Up Disclosure
Since the Commission proposed riskless principal disclosure, municipal market participants have set forth proposals that would make publicly available pricing information for municipal securities. The Municipal Securities Rulemaking Board ("MSRB") and the Public Securities Association have proposed initiatives to enhance transparency in the municipal securities market. Notably, the MSRB proposal, when fully implemented, will provide close in time transaction reporting for virtually all municipal securities transactions. The proposals represent extensive movement by the municipal market to provide public dissemination of pricing information for municipal securities.
Deferral of Commission Action on Mark-Up Disclosure
In view of this progress, the Commission is deferring the riskless principal proposals for six months in order to allow for the implementation of price transparency. If fully implemented, price transparency will provide investors key pricing information prior to their transactions. In addition, price transparency enhances market integrity to the benefit of the market and all the market participants. Because the riskless principal mark-up proposals are not limited solely to the municipal securities markets, the Commission also expects the industry, during this time period, to examine means of providing price information for debt securities other than municipal securities. In addition, that portion of Rule 15c2-13 that would require disclosure if a municipal security was not rated by an NRSRO has been deferred and will be withdrawn if the MSRB acts to adopt similar amendments to its confirmation rule, G-15.
Amendments Adopted to Rule 10b-10
The Commission today is adopting amendments to Rule 10b-10 to require disclosure in the confirmation as follows.
* Require broker-dealers to disclose when a debt security is not rated by a NRSRO. This disclosure is not intended to suggest that an unrated security is inherently riskier than a rated security. Rather, the disclosure is intended to alert customers that they may wish to obtain further information or clarification from their brokerdealers. In most cases, this disclosure should verify information that was disclosed to the investor prior to the transaction.
* Require broker-dealers that are not members of SIPC to state affirmatively that they are not SIPC members (except, in limited circumstances, for transactions in mutual fund shares).
* Require broker-dealers to disclose the availability of information with respect to transactions in collateralized debt securities. While yield information is important to investors of CMOs, as well as all mortgage and asset-backed securities, these securities contain complexities that are difficult to explain using single figures in a confirmation. Accordingly, rather than require the disclosure in the confirmation of specific numbers identifying the estimated yield, weighted average life, and prepayment assumptions underlying the yield, the Commission is adopting a requirement that broker-dealers include on the confirmation a statement alerting investors that their yields are subject to fluctuation depending on the speed in which the underlying note or receivable prepays and that specific information is available upon written request of the customer.
* Require the disclosure of mark-ups and mark-downs in certain Nasdaq and regional exchange-listed securities that are subject to last sale reporting. This amendment covers securities that are subject to last sale reporting, but are not technically "reported securities" under Rule 11Aa3-1 of the Exchange Act. The purpose of the amendment is to consolidate disclosures already required under NASD rules. Because last sale information is available for regional exchange-listed securities, the Commission is extending the disclosure requirements to those securities also.
* Add a preliminary note clarifying that the confirmation disclosures required by Rule 10b-10 may not represent all the disclosure required under the antifraud provisions of the federal securities laws.
To allow firms the appropriate time to adapt their systems to accommodate these disclosure requirements, the proposals will become effective April 3, 1995.
(1) The confirmation currently requires, among other things, the disclosure of: the date, time, identity, and number of shares bought or sold; the capacity of the broker-dealer; the net dollar price and yield of a debt security; and, under specified circumstances, the amount of compensation paid to the broker-dealer and whether payment for order flow is received.
(2) Securities Exchange Act Release No. 33743 (March 9, 1994), 59 FR 12767 ["Proposing Release"].