SEC Committee Makes Recommendations On Municipal Securities Disclosure Practices

Public Finance Alert | February.20.2020

On February 10, 2020, an SEC advisory committee called the Fixed Income Market Structure Advisory Committee (FIMSAC) met and adopted a series of recommendations on the topic “Timeliness of Financial Disclosures in the Municipal Securities Market.”   This Alert provides a summary of the FIMSAC recommendations followed by some comments on these recommendations.  It must be noted at the outset that the FIMSAC recommendations are not official SEC policy, but will be submitted to the full Commission for whatever action the members may choose to take, if any.

The background for FIMSAC’s interest in this topic has been a steady stream of requests, especially from institutional investors in the municipal market, and repeated public comments by SEC Chairman Jay Clayton, for more timely disclosure of issuers’ financial information, and for more dissemination of interim financial information given the frequently long time period between the end of an issuer’s fiscal year and the release of its CAFR or annual financial report/audited financial statements pursuant to its Rule 15c2-12 continuing disclosure obligations.   FIMSAC tasked a subcommittee to review this topic, which developed five recommendations, discussed below, and which the full committee adopted with two dissenting votes.  At the February 10 meeting, a panel of five municipal market experts – two representing issuers, two representing investors, and a former SEC Commissioner, Elisse Walter – discussed the recommendations.  Not surprisingly, the issuer representatives had concerns with some of them, the investor representatives were all in favor, and former Commissioner Walter felt the recommendations were not strong enough.

The five recommendations adopted by FIMSAC were as follows:

1.     Enact legislation to provide the SEC with authority to provide a mechanism to enforce compliance with continuing disclosure agreements (CDA’s) and other obligations.  Currently, since CDA’s are only a contract between an issuer and its bondholders, mediated by an underwriter, the SEC cannot directly enforce any perceived failure of an issuer to comply with a CDA.   As we know, the SEC found a clever way to address this problem without seeking new legislation through the 2014 Municipalities Continuing Disclosure Cooperation Initiative  (MCDC), which relied on findings  that issuers had made false or misleading statements or omissions in official statements, thus coming under the SEC’s power to enforce securities fraud violations.  Given the heightened attention to this issue from underwriters and issuers since MCDC, it would be interesting to see  how much noncompliance or late compliance with CDAs is still a problem in the industry.  Is the heavy lift which a change in law would entail worth the effort for this one topic?  (As noted at the end of this Alert, this recommendation had originally been made in 2012, before MCDC.)

2.     Enact legislation to give the SEC authority to provide a safe harbor from private liability for forward-looking statements for municipal issuers, which meet certain conditions.  This would mirror rules applicable to corporate issuers.  Notably this recommendation does not include any safe harbor for dissemination of unaudited, interim financial information, which is the most contentious issue presently.   Although there is no regulatory basis currently for disclaimers about “forward-looking statements” in municipal disclosure documents, such language is commonly used.  Moreover, this recommendation only relates to private suits, not SEC enforcement actions, so its value may be limited, given the relative scarcity of private suits in the municipal market, as compared to the corporate equity market.

3.     Explore ways to make disclosure deadlines for annual financial information and audited financial statements more certain and predictable.  In making this recommendation  the Subcommittee noted that current practices for the delivery of annual filings under CDAs  are inconsistent and sometimes include dates that could vary from year to year or have contingent language.  This recommendation seems appropriate, and it would seem the SEC or its staff could address such practices by issuing a public statement or release, perhaps in a FAQ format, that sets out acceptable language contrasted with disapproved disclosure deadlines that do not comply with Rule 15c2-12.

4.     Consider whether to seek legislation to authorize the SEC to enact rules governing the content and timing of municipal financial reports.  Before seeking such legislation, and recognizing that any such regulatory action could significantly impact both investors and issuers’ access to capital markets, the recommendation asks the SEC to first seek wide-ranging input and public comment.  One possible approach could be a tiered set of timeframe obligations based on the nature, size and complexity of the municipal entity.  This would certainly be the most radical change if it were pursued.

5.     The Subcommittee noted  that at present there is no difference between the yields demanded by investors based on the length of time an issuer takes to release its financial statements or whether or not it provides robust interim financial information, but that this condition may change in the future;  as a result, the SEC should explore ways to raise awareness of the potential consequences of providing less timely or less robust financial information.   Certainly ongoing education of market participants, particularly smaller and less frequent issuers, is always desirable.  For now the supply-demand imbalance in the municipal market makes it unlikely that investor demands will meaningfully impact continuing disclosure practices at large.  Investor members on the panel did indicate that poor disclosure history could cause a large fund to decline to participate in a particular offering.

As a final observation, we recognize that recommendations 1, 2 and 4 (in part) are taken directly from the SEC’s 2012 Report on the Municipal Securities Market, of which a prime sponsor was then-Commissioner Walter.  Like the 2012 Report, these recommendations do not change the current securities law exemptions under the 1933 Act or the Tower Amendment limitations on SEC powers contained in the 1934 Act.  Given that none of the legislative recommendations made in the 2012 Report have moved forward (although some of its regulatory recommendations have), it will be interesting to see whether the Commission will take any action in 2020.