On September 13, 2017, the Municipal Securities Rulemaking Board (the “MSRB”) published a market advisory on selective disclosure (the “Notice”). The stated purpose of the Notice is to “increase awareness” of selective disclosure as a “market fairness” concern.  Although the Notice acknowledges that selective disclosure by issuers of, or conduit obligors on, municipal securities is not prohibited or “inherently problematic”, the Notice cautions issuers and obligors in the municipal market not to selectively disclose material nonpublic information.

The Notice’s bottom line is to urge that issuers of and obligors on municipal securities voluntarily disclose to the broader marketplace information that is potentially material and is being disclosed or has been disclosed to a subset of actual or potential bondholders “by a method or combination of methods that is reasonably designed to effect broad, non-exclusionary distribution of the information to the public”, including, for example, by posting the relevant information on the MSRB’s EMMA website.

The Notice addresses the practice of certain municipal securities issuers and obligors of making selective disclosure, which occurs when certain classes of investors (the Notice singles out investment bankers, investment advisers and institutional investors as “typical” recipients) are given access to information but other investors are not. Selective disclosure may occur when the issuer presents information relating to an issue to current or prospective investors, for example, during road shows, investor conferences and one-on-one investor calls or meetings. The Notice states that “these events are not inherently problematic, but they can become so when the information conveyed is nonpublic and material”.

The Notice addresses selective disclosure in both the primary and secondary markets. As an example, the MSRB notes that investor conferences and investor calls often include question-and-answer sessions, which may place the issuer at risk of discussing nonpublic material information, such as information that is not included in the preliminary official statement. As to secondary market selective disclosure, the MSRB uses the example of when an issuer might provide new nonpublic material information, which is not required to be disclosed pursuant to Rule 15c2-12 under the Securities Exchange Act of 1934 (“Exchange Act”) or any other rule, to select investors or analysts.

As an example from other markets, the Notice outlines some of the requirements of the Securities and Exchange Commission’s (SEC) Regulation Fair Disclosure, more commonly known as Regulation FD, adopted in 2000 to address, in part, selective disclosure by public companies. The regulation provides that, when an issuer discloses material nonpublic information to certain persons (e.g., brokers, dealers, investment advisers and investment companies), it must publicly disclose that information. If the selective disclosure was intentional, the issuer must make the public disclosure simultaneously; if it was unintentional, the issuer must make the public disclosure promptly.

The Notice acknowledges that Regulation FD does not apply to municipal issuers (or to obligors on municipal securities that are not public issuers of non-municipal securities), as municipal issuers are exempt from regulation by the SEC (other than antifraud provisions). Similarly, while the Exchange Act provides the MSRB with broad authority to write rules governing the activities of brokers, dealers, municipal securities dealers and municipal advisors, it does not provide the MSRB with authority to write rules governing the activities of issuers.

The Notice also acknowledges that selective disclosure, even of material nonpublic information, does not in and of itself constitute inside information for purposes of “insider trading” prohibitions, as such prohibitions generally have been construed as applicable only where the disclosure is made in breach of a duty to the issuer. However, the Notice appears to promote reducing selective disclosure by highlighting the risk that selective disclosure of nonpublic and material information might be indicative of material omissions or misstatements in offering documents or result in transactions that might be considered insider trading.

The Notice suggests that issuers and conduit obligors may wish to develop and follow guidelines for disclosure in a manner that disseminates all potentially material nonpublic information to all market participants. This is not unlike the push a few years ago by the Internal Revenue Service for issuers to establish post-issuance compliance guidelines.  The Notice further suggests that issuers consider adopting, on a voluntary basis, the dissemination principles set forth in Regulation FD.

The MSRB claims that the purpose of the Notice “is not to discourage direct communications between issuers and investors and/or analysts, as road shows, investor conferences and other similar communications are legitimate market practices that are not inherently problematic.” Although the Notice is measured in tone and does not communicate any new legal requirements, it may prompt some issuers to decide that it is overly burdensome to sort through what good faith nonpublic communications might be deemed “unfair” selective disclosure, and to determine that their most efficient options are to err on the side of not entertaining calls or meetings involving individual analysts or investor groups or to post all nonpublic communications (presumably including transcripts of oral discussions) on EMMA.  Although some issuers have adopted model standards to address these concerns; for some issuers, especially smaller issuers that are not in the market regularly, a policy of publicly posting everything that is said may well have a chilling effect on routine conversations between issuer representatives and investors.  There also may be routine and follow-up conversations between issuer representatives and investor representatives that focus on details and monitoring of generally known items that an issuer may reasonably deem not to be material, and there is no reason to discourage such interactions.

It is to be hoped that the municipal market will continue to operate in a manner that acknowledges investor protection and market integrity and that continues to disclose material information to all without an overreaction that shuts down individualized discussions.

By CHARLES E. CAREY

On March 15, 2017, the Securities and Exchange Commission (“Commission” or “SEC”) published in the Federal Register for comment proposed amendments to Rule 15c2-12 (the “Rule”) under the Securities Exchange Act of 1934 (“Exchange Act”) that would amend the list of event notices required under the Rule in a manner that, if such amendments are finalized in their proposed form, would likely require issuers of, or “obligated persons” on, publicly offered municipal bonds to provide detailed ongoing disclosure of any new debt, derivatives and other “financial obligations.”

The Rule requires that a broker, dealer, or municipal securities dealer (collectively, “dealers”) acting as an underwriter in a primary offering of municipal securities reasonably determine that an issuer or an obligated person has undertaken, in a written agreement or contract for the benefit of holders of the municipal securities, to provide to the Municipal Securities Rulemaking Board (“MSRB”) through the MSRB’s Electronic Municipal Market Access (“EMMA”) system, prompt notice of specified events. The proposed amendments would amend the list of such event notices to include;

  • (i) incurrence of a financial obligation of the obligated person, if material, or agreement [by the obligated person] to covenants, events of default, remedies, priority rights, or other similar terms of a financial obligation of the obligated person, any of which affect security holders, if material; and
  • (ii) default, event of acceleration, termination event, modification of terms, or other similar events under the terms of a financial obligation of the obligated person, any of which reflect financial difficulties.

The proposed amendment provides a broad definition of “financial obligation” which includes: a (i) debt obligation, (ii) lease, (iii) guarantee, (iv) derivative instrument, or (v) monetary obligation resulting from a judicial, administrative, or arbitration proceeding. The “financial obligation” definition excludes traditional municipal bonds which are already covered by the Rule.

In the release accompanying the proposed amendments, the SEC noted that if new financial obligations or new material covenants, events of default or remedies impacted an issuer’s or obligated person’s liquidity and creditworthiness, the credit quality of the issuer’s or obligated person’s outstanding debt could be adversely affected which could impact an investor’s investment decision or other market participant’s credit analysis. Such changes to credit quality could also affect the price of the issuer’s or obligated person’s existing bonds.  Items the SEC referenced as potentially material include debt service coverage ratios, rate covenants, additional bond tests, contingent liabilities, events of default, remedies and priority payment provisions (including structural priority such as balloon payments, for example).

The Commission’s accompanying release stated that the event notice of incurrence of a material financial obligation generally should include a description of the material terms of the financial obligation. According to the release, examples of such material terms include the date of incurrence, principal amount, maturity and amortization, and interest rate, if fixed, or method of computation, if variable (and any default rates); the release states that disclosure of other terms may be appropriate as well, depending on the circumstances.

Unless the proposed amendments are pared back following the comment period, they are likely to result in the required disclosure by issuers or obligated persons of municipal bonds subject to the Rule of virtually all new loan agreements with banks or other private lenders, privately placed municipal bond indentures or loan agreements, swap agreements, real estate leases, and material judgments or arbitration rulings, as issuers and obligated persons are unlikely to shoulder the administrative burden and legal risk associated with determinations of which obligations, and which terms of such obligations, are “material” and which are, and will remain in hindsight, clearly immaterial.  Similarly, for expense and risk reasons, it is more likely that full legal documents will be disclosed versus substantially redacted or summarized versions.

The proposed amendments do not appear to require disclosure of the termination or satisfaction of financial obligations previously disclosed on EMMA as material events; accordingly they may result in the accumulation over time on EMMA of a variety of lengthy loan agreements, indentures, swap agreements and the like with no clear way for bondholders or brokers accessing EMMA to determine whether the relevant obligations and the related agreements continue in effect. Such overdisclosure may limit the pool of investors with respect to the obligations of the issuer or obligated person, in that brokers responsible under MSRB Rule G-47 for conveying to customers all material information about the security accessible on EMMA may opt not to do so for securities with EMMA postings that include unwieldy amounts of raw legal documents.

Issuers and obligated persons may also deem the requirement to publicly disclose otherwise private transactions adverse to their business interests. Currently, for example, an issuer or obligated person may negotiate different covenants and different covenant levels with different private lenders, without each lender necessarily having access to the covenants of the other lenders.  If the amendments require the issuer or obligated person to disclose on EMMA the coverage, days cash on hand, interest rates and other material terms of its private loan arrangements, the result over time may be for each new lender to require, in effect, most favored nation status with covenants and other terms at least as tough as the toughest terms previously agreed to by the applicable issuer or obligated group.  Reasonable minds may disagree on whether that should “come with the territory” when an issuer chooses to access the public municipal market, but to date such public disclosure of the details of private transactions has not been required.

The second new event notice, for the occurrence of a default, event of acceleration, termination event, modification of terms, or other similar events under the terms of a financial obligation of the issuer or obligated person, presents a different judgment call for issuers and obligated persons, as such disclosure is only required if the event “reflects financial difficulties.” Some of the examples cited in the release for subsequent events include monetary or covenant defaults that might result in acceleration of the debt, swap events, such as rating downgrades, which might require the posting of collateral or the payment of a termination payment and changes to the contract rights of the counterparties to financial obligations. Again, it is unlikely that entities subject to such requirements would expend much legal capital on parsing through whether a swap termination event, or even an amendment of loan documents, “reflects financial difficulties”, and the tendency is likely to be towards overdisclosure.

There are additional ambiguities in the proposed amendments. According to the accompanying release, the amendments will only be applicable to continuing disclosure agreements executed after the amendments are finalized, but it is unclear, for example, whether an issuer or obligated person that executes a continuing disclosure agreement governed by the amended Rule will be required to disclose all previously incurred material “financial obligations”, or whether only “financial obligations” incurred following the execution of such an agreement will be subject to such disclosure.  The accompanying release does indicate that the required notice of default, event of acceleration, termination event, modification of terms, or other similar events under the terms of a financial obligation which reflect financial difficulties would apply with respect to financial obligations previously incurred.

Unlike many of the existing events for which event notices are currently required under the Rule, which occur rarely, incurrence of financial obligations occurs regularly for many issuers and obligated persons. Accordingly, these amendments arguably would constitute the broadest expansion to date of the Rule’s continuing disclosure requirements. They are sure to generate many comments from affected parties before they are finalized.

By JOHN REGIER and BRETON LEONE-QUICK

Last week, the National Association of Bond Lawyers held its 13th Annual Tax and Securities Law Institute.  Some of the panels included current and former employees of the SEC who spoke on several of the more notable recent developments with respect to enforcement actions in the Municipal Securities space:

1)  The SEC is policing negligence.  Peter Chan, a former staff member of the SEC’s Enforcement Division, acknowledged that suspicion of recklessness is no longer seen by the Staff as a prerequisite for opening an SEC investigation of an issuer – negligence is sufficient.  He noted how “people walking in a fog can cause as much harm as people conspiring to do wrong.” Chan also cited SEC Chairman White’s “broken windows” strategy in support of this practice, and said that the MCDC Initiative is a prime example. However, Chan also acknowledged that the SEC is not likely to bring a case if an issuer has followed sound disclosure policies and procedures and engaged in thoughtful deliberations, even if the SEC questions the accuracy of statements made in the Official Statement.

2)  Exploration of Allen Park and control person liability.  During one of the panels, Mark Zehner, Deputy Chief of the Enforcement Division’s Municipal Securities and Public Pension Division Unit, spoke at some length about the Allen Park, Michigan case in which the SEC, for the first time, charged a municipal official (the mayor of the city) as a “controlling person” under Section 20(a) of the Exchange Act.  Mr. Zehner noted that the SEC has a lot of experience with control person liability, and has brought more than one thousand such cases in the private sector. From his presentation, it appeared as if one of the reasons why the SEC chose to assert a Section 20(a) claim in the Allen Park case was the somewhat more flexible standard for proving control person liability that exists in the Sixth Circuit.  Mr. Zehner noted that the SEC has a lot of ways to hold someone liable (e.g., aiding and abetting) without having to resort to Section 20(a) liability and that there is a good faith exception to control person liability written right into the statute. Reading between the lines, it appears as if the SEC believed they had proof that Allen Park’s mayor was complicit in the alleged fraud and they had an opportunity to use control person liability in a way that would make headlines and create a deterrent for other municipal officials around the country.

3)  Update on the MCDC initiative.  LeeAnn Gaunt, Chief of the Enforcement Division’s Municipal Securities and Public Pensions Unit, spoke at some length about the MCDC Initiative. She did not disclose the number of reports the SEC received, but from her comments it appears as if the SEC received a substantial number of them.  She explained that the Staff is dealing with the broker-dealer submissions first, but are cross-checking to see if issuers reported the same transactions. Settlement orders will be released in batches so as not to stigmatize individual broker-dealers. The orders will identify two or three types of material failures but will not identify issuers or transactions. The broker-dealers will be given two weeks to sign the papers and return them. Ms. Gaunt did not commit to a timetable as to when this would occur, but implied that there would likely be several waves of orders during this calendar year. Every party that self-reported will receive a response from the SEC at some point. Issuers who were reported by broker-dealers but did not self-report will not necessarily hear from the SEC.

By Len Weiser-Varon

The U.S. Securities and Exchange Commission recently settled the first securities fraud charges brought against a municipal official alleging “control person” status under the federal securities laws.  The SEC’s settlement with the former mayor of the city of Allen Park, Michigan bars him from participating in future securities offerings and imposes a $10,000 penalty. A city administrator also was charged and barred from participation in future securities offerings

The SEC’s enforcement actions, brought against the city and the two city officials, alleged that the offering documents for a “double-barreled” general obligation bond issue contained false and misleading statements.  In particular, the SEC alleged that the offering documents failed to disclose adverse developments relating to a proposed public-private transaction for a film studio project to be located on land purchased with the bond proceeds; the project was not consummated, leading to financial difficulties that caused the state of Michigan to appoint an emergency manager for the city.  The bonds issued for the project were rated A by S&P and subsequently downgraded to BB+, and recent audited financial statements for the city have carried a going concern qualification.

The enforcement action against the city was brought under  Section 17(a)(2) of the Securities Act of 1933, which permits administrative action by the SEC for negligent conduct, and under SEC Rule 10b-5, which permits administrative action by the SEC as well as a private right of action by affected investors, but requires proof of “scienter”, or an intent to deceive (which has been interpreted to include highly unreasonable conduct or recklessness.)

More notably, the SEC charged the mayor as a “control person” under Section 20(a) of the Securities Exchange Act, under which any person who directly or indirectly “controls” another person found liable for a violation of the Securities Exchange Act or any regulation thereunder is jointly and severally liable, to the same extent as the controlled person, to any person to whom the controlled person is liable.  Liability as a “control person” can be avoided if the “control person” establishes that he or she acted in good faith and did not directly or indirectly induce the act or acts constituting the violation.

Liability under Section 20(a) generally requires two elements: a primary violation of the federal securities laws by the “controlled person”, and proof that the person charged with the Section 20(a) “controlled” the primary violator.  It is unclear whether there are any circumstances under which a municipal official sitting on a multi-person board or council could be held to “control” an issuer, or issuer personnel, found to be a primary violator responsible for fraudulent statements in an offering document for municipal securities.  But in the Allen Park enforcement action the SEC appears to have alleged that the mayor controlled the city, the alleged primary violator.

If a primary violation and “control” of the person or entity that made the misleading statement is established, the burden shifts to the “control person” to establish good faith, which, unsurprisingly, means the absence of bad faith, which is akin to the absence of scienter.  In theory, even if an accused official does not establish good faith, he or she can avoid liability upon proof that he or she did not “induce” the primary violation.  The courts have not conclusively adjudicated whether to “induce” requires active encouragement, or whether in some circumstances the failure to exercise efforts to prevent a violation can be deemed to induce the violation.

The Allen Park enforcement action was settled by the issuer and the officials without admitting or denying liability, and sets no precedent on what type of conduct by an issuer official constitutes “control” over a primary violator of the securities laws or induces the violation.  But it suggests that in the aftermath of U.S. Supreme Court decisions that have eliminated aiding and abetting liability in private actions under Section 10(b) of the Securities Exchange Act and narrowed the circle of potential primary violators that the SEC can allege “make”, within the meaning of Section 10(b), a fraudulent statement in a securities offering document, the SEC intends, when feasible, to use a “control person” theory to go after actors it deems culpable for securities fraud in municipal offerings but cannot reach as primary violators.

Initial reaction to the SEC’s introduction of “control person” charges to municipal securities enforcement actions has included concern that public officials involved with municipal entities that issue bonds or other securities may now face charges and potential vicarious liability for disclosure malfeasance by other issuer officers or employees.  However, the SEC will face an uphill battle proving allegations of “control”, bad faith and “inducement” of a primary violation by an issuer board member or official who may have approved the distribution of an official statement but was not actively involved in its preparation, did not sign the official statement, and did not urge another official to exclude or include particular disclosure. The extent to which the SEC will include “control person” charges in future enforcement actions alleging primary securities law violations by an issuer or another issuer official remains to be seen, but such charges are most likely to be brought where there is evidence of active complicity in deceptive disclosure.

 

 

The post on our securities litigation and compliance blog titled “SEC Steps Up Scrutiny of Municipal Bonds: Recently Filed Enforcement Actions”  surveys recent SEC enforcement actions against municipal bond issuers.  As discussed in the post, the SEC’s charges in these actions include charges based on issuer negligence (versus the “scienter” standard of knowingly or recklessly misleading disclosure applicable to private securities law claims against municipal bond issuers), and also notes the SEC’s position that an officer’s state of knowledge can be imputed to a municipal bond issuer for purposes of establishing the issuer’s “scienter” in a securities fraud action.

 

As indicated in the adjacent blog posts, the SEC is increasing its enforcement presence in the municipal bond market, including enforcement and self-reporting initiatives relating to disclosures about an issuer’s historic compliance with Rule 15c2-12 continuing disclosure agreement obligations.  Mintz Levin is hosting a webinar to review these developments and the conundrums the self-reporting initiative may cause for issuers and underwriters.   Registration for the free webinar is available through the link below.

 

A New Era of SEC Muni Enforcement

Tuesday, April 29

1:00 pm ET

 

Over the last few years, the SEC has put its spotlight on the municipal market, increasing its scrutiny of issuers and underwriters alike. This new and aggressive approach has broken unspoken barriers that long defined the SEC’s long-standing policy of minimal regulation and intervention in the municipal market. Most notably, the SEC has increased its enforcement actions and imposed steep sanctions against individuals, issuers, and underwriters.

Join us for a review of the SEC’s recent enforcement actions and a discussion of its priorities and initiatives for 2014, including the new Municipalities Continuing Disclosure Cooperation (MCDC) Initiative.

Register Here: http://w.on24.com/r.htm?e=777668&s=1&k=70279BACFC42C416B572DBE16785E538&partnerref=pfblog

 

 

For an analysis of the SEC Enforcement Staff’s recent announcement that it is one year into a general sweep of financially distressed municipal bond issuers and that it has commenced formal investigations against some of these issuers, please view the post on our securities litigation and compliance blog titled, “SEC Enforcement Staff’s Investigations of Financially Stressed Municipal Issuers.”

That blog post examines several legal issues arising out of this sweep and the resulting investigations, including how this announcement by the Staff could be intended to put further pressure on municipal issuers and underwriters to self-report inaccurate disclosures, how investors may be swept up into these investigations, and the potential collateral legal issues that can arise if the SEC brings more actions in this area.

By LEN WEISER-VARON

MSRB Rule G-17 has been interpreted by the MSRB as requiring a broker or dealer (“broker”) to  disclose to its customer, at or prior to the time of trade of a municipal security, all material information about the transaction known by the broker, as well as material information about the security that is reasonably accessible to the market.  On February 11, 2013, the MSRB issued a notice of its proposal to consolidate some, but not all, of its multiple interpretive notices relating to the Rule G-17 “time of trade disclosure obligation” in a new Rule G-47. http://msrb.org/Rules-and-Interpretations/Regulatory-Notices/2013/2013-04.aspx

The proposed rule is not intended to alter the substance of a broker’s time of trade disclosure obligation, merely to make it easier to locate that substance in rule form rather than by reviewing a collection of G-17 interpretive notices previously issued by the MSRB, some of which deal with unrelated topics, as G-17 is a fair dealing rule of wide scope.  Facilitating the finding and reviewing of applicable legal requirements is a sensible goal, and it seems unlikely that there will be significant opposition to MSRB’s objective in proposing the “new” rule.

As is generally the case with any attempt to consolidate or summarize, comments on the proposed rule, which are due by March 12, 2013, are likely to focus on what is left out of the rule and on requests for clarification of items that have been unclear under the G-17 interpretations and remain unclear under the proposed rule.

A few preliminary observations on potential improvements to the proposed rule:

  • The Rule G-47 disclosure obligation would apply to purchases and sales between a broker and its customer, whether unsolicited or recommended, and whether in a primary offering or secondary market transaction.  However, prior interpretations deem the time of trade disclosure obligation automatically satisfied if the customer is a “sophisticated municipal market professional” or “SMMP”.  This important exception deserves to be called up from the minor leagues of interpretation to the major leagues of the new rule.
  • Rule G-47 provides a non-exhaustive list of potentially material information that must be disclosed by a broker at or prior to sale or purchase, but, beyond noting that such information may be provided “orally or in writing”, appears deliberately vague about permissible mechanisms for delivering material information.  Rule G-47 indicates that the public availability of material information through EMMA or other established industry sources does not relieve brokers of their obligation to make the required time of trade disclosures to a customer, and that a broker may not satisfy its disclosure obligation by directing a customer to an established industry source.  Though unstated in the proposed rule, presumably a broker can satisfy its obligation to disclose material features of the security by providing a copy of the official statement for the security, which is the primary source of such information, versus by attempting to synthesize, reword or isolate “material” information from immaterial information.  In circumstances where an official statement would include all available material information (which may be the case if there has been no material change to the basic features of the security or credit profile since the date of the official statement), it is unclear whether the Rule is intended to spare the customer the trouble of going to EMMA to review such material disclosure by forcing a broker to provide such disclosure directly to the customer, or whether the Rule’s wording is merely intended to differentiate a generalized statement by the broker that “you can find all material information on EMMA” from a broker-provided link or links to specific EMMA disclosure for the applicable security that the broker has determined contains all required material information.  The MSRB might consider clarifying in the rule whether the provision that “a broker may not satisfy its disclosure obligation by directing a customer to an established industry source” is intended to require the broker to determine whether an established industry source such as EMMA in fact contains all material information at the time of trade (and, if not, to require the broker to supplement EMMA by providing missing material information available from other public sources), or whether it is a complete ban on use of any time of trade disclosure mechanism that does not create a record of whether the customer actually accessed the publicly available information to which the customer was referred by the broker.
  • Proposed Rule G-47 lists 15 specific items that may be material in certain scenarios for purposes of the time of trade disclosure obligation.  This non-exhaustive list focuses primarily on technical features of the security, with the only listed “material” item relating to the underlying credit being item c, “[t]he credit rating or lack thereof, credit rating changes, credit risk of the municipal security, and any underlying credit rating or lack thereof.”  Although the specified items are consolidated from prior notices intended to emphasize the MSRB’s view that such items are or may be material, and are not intended to constitute a compendium of the most frequently material items, when assembled as a list in the proposed rule they highlight the incompleteness of the list.  It seems odd, for example, to list “the investment of bond proceeds” as a potentially material item, while omitting, for example, items such as whether the security is a general obligation, revenue or conduit bond, whether the interest is an AMT preference item and whether a conduit bond is secured by a mortgage and/or gross receipts lien.  The MSRB will need to consider whether half a list is better than none.

By CHARLES E. CAREY

Since August 2, 2012, investment banking firms retained to act as underwriters on municipal finance transactions have been required to provide written disclosure to issuers concerning the relationship between issuers and underwriters, possible conflicts of interest and certain other matters under Municipal Securities Rulemaking Board (MSRB) Rule G-17 (Rule G-17) and MSRB Notice 2012-25 (the “Interpretive Notice“).  .  The Securities Industry and Financial Markets Association (SIFMA) has provided a model for such disclosure letters (the “SIFMA Model“).

The following are some thoughts on the form of the SIFMA Model and on sample disclosure letters received to date by certain issuers represented by this firm:

  • The sections of the disclosure letters concerning the underwriters’ role and underwriters’ compensation will likely quickly become boilerplate using the SIFMA Model language, which closely parallels the Interpretive Notice.  Many underwriters have been including a section in their form bond purchase agreements to address the role of the underwriters in light of Rule G-17.
  • The section of the disclosure letters concerning “additional conflicts disclosures” is more problematic.  While the Interpretive Notice and the SIFMA Model appear to contemplate that underwriters either state that they have not identified “any additional potential or actual material conflicts that require disclosure” or provide a listing on the particular conflicts, most underwriters appear to be taking the approach of listing the various products and services they provide which may give rise to conflicts without actually identifying any conflicts.  This approach of not specifying any particular conflict beyond those inherent in the services provided raises issues, discussed in the next paragraph, regarding the issuer acknowledgment of the disclosure. 
  • The SIFMA Model contains the following paragraph: “It is our understanding that you have the authority to bind the Issuer by contract with us, and that you are not a party to any conflict of interest relating to the subject transaction. If our understanding is incorrect, please notify the undersigned immediately.”  This language varies from the Interpretive Notice and from comment 4 to the SIFMA Model itself, which reads: “All of the disclosures must be made in writing to an official of the Issuer that the underwriter reasonably believes has the authority to bind the Issuer by contract with the underwriter and that, to the knowledge of the underwriter, is not a party to a disclosed conflict.”  Asking the recipient of a disclosure letter to acknowledge s/he has authority to bind the issuer is not required by the Interpretive Notice but may not be an unreasonable request.  The second part concerning conflicts is more troublesome given that, as noted above, the pattern in disclosure letters appears to be that underwriters are not disclosing any specific conflicts.  The SIFMA Model language, by asking the recipient to acknowledge s/he is not party to any conflict relating to the transaction, arguably shifts to the issuer the burden of making the determination that no conflict exists.  
  • Because of these wording concerns, we are seeing some issuers take the approach of acknowledging receipt of the disclosure letter while specifically stating that the acknowledgement is only as to receipt and not an acceptance, confirmation or consent to the contents of such letters.

At this point, it seems unlikely that individual underwriters will deviate very far from the SIFMA Model letter.  It is likely that SIFMA will review the form and comments received from issuers and underwriters and may incorporate changes to address any concerns raised by issuers as to the language regarding conflicts or otherwise.

BY CHARLES CAREY

On March 19, the SEC’s Office of Investor Education and Advocacy issued an Investor Bulletin http://www.sec.gov/investor/alerts/municipalbonds.htm to help educate individual investors about municipal bonds.

While the Investor Bulletin is fairly basic and addressed primarily to investors generally, the list of some of the risks of investing in municipal bonds included in the Bulletin may be helpful to issuers and underwriters when preparing or reviewing disclosure documents.  The risks highlighted in the Bulletin (and a few additional thoughts) are outlined below:

Call risk. Call risk refers to the potential for an issuer to repay a bond before its maturity date.  (It should be noted that in addition to the “call” provisions which might apply to the obligations being offered for certain types of obligations, investors may also be interested in information as to past call practices of the issuer.)

Credit risk. This is the risk that the bond issuer may experience financial problems that make it difficult or impossible to pay interest and principal in full.  (Credit ratings are of course available for many bonds, and used by many individuals as a proxy for their own credit analysis; however, in light of the recent problems with “rated” mortgage-backed and asset-backed obligations, an increasing number of investors are attempting to look through the credit ratings and make their own determination of credit risk.)

Interest rate risk. A bond’s market price will move up as interest rates move down and it will decline as interest rates rise, so that the market value of the bond may be more or less than its par value. U.S. interest rates have been low for some time. If they move higher, investors who hold a low fixed-rate municipal bond and try to sell it before it matures could lose money because of the lower market value of the bond.

Inflation risk. Inflation is a general upward movement in prices. Inflation reduces purchasing power, which is a risk for investors receiving a fixed rate of interest. It also can lead to higher interest rates and, in turn, lower market value for existing bonds.

Liquidity risk. This refers to the risk that investors won’t find an active market for the municipal bond, potentially preventing them from buying or selling when they want and obtaining a predicable price for the bond. Many investors buy municipal bonds to hold them rather than to trade them, so the market for a particular bond may not be especially liquid and quoted prices for the same bond may differ.

Change in tax law risk. While not included in the Bulletin’s list of risks, discussions in Washington as to the possible repeal or limitation of the exclusion of interest on municipal obligations are raising concerns in the municipal markets.  Changes in the tax treatment of municipal obligation will have an immediate effect on market values of affected obligations.

The Investor Bulletin is clearly intended as fundamental guidance to investors. The list of risks included in the Investor Bulletin is by no means comprehensive and not necessarily a list of risks that should be disclosed in offering documents. However, the list does highlight factors the SEC believes are important to investors and similar disclosures have become fairly routine in corporate and mutual fund risk disclosure sections.