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.

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.