New SEC Rules Makes It Harder For Muni Bond Issuers To Hide Bad News
On Dec 2010, the Securities Exchange Commission put into effect Rule 15c2-12 which prohibits dealers from underwriting most muni bond deals unless the issuers have contractually agreed to disclose annual audited financial and operating information, as well as the occurrence of key events. The rule also makes it harder for municipal bond issuers to hide financial problems behind the “material events” defense since certain new Listed Events, would no longer be subject to a materiality determination before triggering a requirement to provide notice. Click here to see a real a portfolio of defaulted municipal bonds.
The list of material events were expanded to include IRS notices, missed payments, etc. The full list now includes: (i) principal and interest payment delinquencies; (ii) unscheduled draws on debt service reserves reflecting financial difficulties; (iii) unscheduled draws on credit enhancements reflecting financial difficulties; (iv) substitution of credit or liquidity providers or their failure to reform; (v) defeasances; (vi) rating changes; (vii) adverse tax opinions, the issuance by the Internal Revenue Service of proposed or final determinations of taxability or Notices of Proposed Issue (IRS Form 5701-TEB); (viii) tender offers; and (ix) bankruptcy, insolvency, receivership or similar event of an issuer or Obligated Person. “adverse tax opinions, the issuance by the Internal Revenue Service of proposed or final determinations of taxability, Notices of Proposed Issue (IRS Form 5701-TEB) or other material notices or determinations with respect to the tax status of the security or other material events affecting the tax status of the security”.
More details of the ruling are below:
Brokers, dealers and municipal securities dealers (“Participating Underwriters”), issuers of municipal bonds, and borrowers of municipal bond proceeds (“Obligated Persons”). Rule 15c2-12 generally requires Participating Underwriters to reasonably determine, prior to purchasing municipal bonds, that an issuer or Obligated Person is contractually obligated to provide annual reports, including financial information, and notices of the occurrence of certain events (“Listed Events”) with a nationally recognized municipal securities repository. Currently, the only nationally recognized municipal securities repository is the Electronic Municipal Market Access System, which is maintained by the Municipal Securities Rulemaking Board.
The Amendments: (i) expanded disclosure obligations under the Rule by (a) adding additional “Listed Events”, and (b) eliminating the exemption for variable rate demand obligations from continuing disclosure requirements; (ii) provided that the occurrence of certain Listed Events, including certain new Listed Events, would no longer be subject to a materiality determination before triggering a requirement to provide notice; and (iii) established a strict ten-day time frame for submitting required event notices. The SEC also provided interpretive guidance to Participating Underwriters with respect to certain of their obligations under the Rule. The Amendments became effective on December 1, 2010 and apply to municipal securities issued on or after December 1, 2010 in a principal amount equal to or greater than $1,000,000 and to any remarketing that would be considered a primary offering under the Amendments.
Expanded Disclosure Obligations
Tender Offers;
Bankruptcy, insolvency, receivership or a similar event;
Merger, Consolidation, Acquisition, and sale of all or substantially all assets; and
Appointment of a successor or additional trustee, or a change of name of a trustee.
In addition, the Amendments expanded the “adverse tax opinions or events” Listed Event to include “adverse tax opinions, the issuance by the Internal Revenue Service of proposed or final determinations of taxability, Notices of Proposed Issue (IRS Form 5701-TEB) or other material notices or determinations with respect to the tax status of the security or other material events affecting the tax status of the security”. This amendment was designed to, among other things, “focus the disclosure on information relevant to investors, whether the municipal security is taxable or tax-exempt”.
Primary Offerings of Variable Rate Demand Obligations Are Now Subject to Continuing Disclosure Requirements. The Amendments also eliminated the exemption from continuing disclosure requirements for primary offerings of variable rate demand obligations (including remarketings that are primary offerings) that occur after December 1, 2010. The Amendments included a “limited grandfather provision” for remarketings of variable rate demand securities that were outstanding in the form of demand securities on November 31, 2010 and that continuously have remained outstanding in the form of demand securities.
Elimination of Materiality Determination for Certain Events
Prior to the Amendments, the occurrence of a Listed Event only needed to be disclosed if a determination was made that the occurrence of such event was “material.” The Amendments now require that the occurrence of the following Listed Events must be disclosed without regard to whether the issuer or Obligated Person determines the event to be material: (i) principal and interest payment delinquencies; (ii) unscheduled draws on debt service reserves reflecting financial difficulties; (iii) unscheduled draws on credit enhancements reflecting financial difficulties; (iv) substitution of credit or liquidity providers or their failure to reform; (v) defeasances; (vi) rating changes; (vii) adverse tax opinions, the issuance by the Internal Revenue Service of proposed or final determinations of taxability or Notices of Proposed Issue (IRS Form 5701-TEB); (viii) tender offers; and (ix) bankruptcy, insolvency, receivership or similar event of an issuer or Obligated Person. The other Listed Events (namely: non-payment related defaults, other material events affecting the tax status of a security, modifications to rights of security holders, bond calls, release, and substitution or sale of property securing repayment of the securities and appointment of a successor or additional trustee or the change of a name of a trustee) need only be disclosed upon a determination that the occurrence of such event is material.
Event Notices Must be Filed within Ten Days of the Occurrence of the Event
Prior to the Amendments, Rule 15c2-12 only required that Listed Events be disclosed in “a timely manner”. The Amendments now require that Listed Events be disclosed “in a timely manner not in excess of ten business days after the occurrence of the event” (emphasis added).
Interpretive Guidance to Underwriters of Municipal Securities
The SEC affirmed previous guidance that, under the Rule, it is doubtful that an underwriter could form a reasonable basis for relying on the accuracy or completeness of an issuer’s or obligated person’s ongoing disclosure representations if such issuer or obligated person has, on multiple occasions during the previous five years, failed to provide on a timely basis continuing disclosure documents, event notices and failure to file notices as required in a continuing disclosure undertaking for a prior offering. Under such circumstances, it is the SEC’s view that it would be very difficult for an underwriter to make a reasonable determination that the issuer or Obligated Person would provide such information under a continuing disclosure undertaking in connection with a subsequent offering. The SEC also noted that an underwriter should affirmatively inquire as to an issuer’s or Obligated Person’s filing history and that reasonable belief should be based on the underwriter’s independent judgment, and not solely on representations or certifications of the issuer or Obligated Person.