Category: Security

Source: Securities and Exchange Commission

Good afternoon. Thank you to the Government Finance Officers Association (“GFOA”) for inviting me to speak with you today. In my role as the Securities and Exchange Commission’s (“Commission” or “SEC”) Director of the Office of Municipal Securities (“Office of Municipal Securities” or “OMS”), I get a front row seat to see how government finance professionals strive to advance the continued integrity of the municipal securities market. However, I also get a front row seat to some concerning behaviors that may impact the investor confidence and transparency of the municipal securities market. 

As is customary, I must remind you that this speech is provided in my official capacity as the Commission’s Director of the Office of Municipal Securities but does not necessarily reflect the views of the Commission, the Commissioners, or other members of the staff.

I. What’s in a Title?

Before I delve into disclosure practices, I would like to start by offering my views on another area of concern to which OMS is paying careful attention. It’s been fifteen years since Congress created a new class of regulated person required to register with the Commission: municipal advisors.[1] But when I speak with market participants or pick up an official statement or visit an issuer’s website, I am regularly confronted with a title that imprecisely[2] reflects the nature of the relationship between municipal entities and/or obligated persons and their advisors: financial advisor.[3]

While some of you may view using the terms “financial advisor” and “municipal advisor” to be interchangeable when discussing hiring a professional to negotiate terms of a transaction or verify pricing as just a matter of a title, Congress expressly defined those persons who engage in municipal advisory activities[4] as “municipal advisors”.[5]

I’m going to start with why I think it’s helpful to use regulatory terms. Although not required, using regulatory terms such as “municipal advisor” in solicitations and offering documents is helpful because it clearly indicates to investors that those professionals are subject to the rules and regulations designed to protect investors and municipal entities[6] and obligated persons.[7] Additionally, using defined regulatory terms in these documents may be helpful to municipal entities and obligated persons in avoiding including confusing or ambiguous statements in disclosures to investors.

Now, for the what. Let’s start with hiring professionals. Municipal entities and obligated persons often retain various professionals through a competitive request for proposal/qualification (“RFP/Q”) process. Before anyone objects, you’re correct: responses to RFP/Qs do not on their own constitute municipal advisory activity.[8] I have, however, observed instances (most notably in public-private partnerships[9] and charter schools[10]) where the work or services requested in the RFP/Qs would require the selected professional to be registered as a municipal advisor because they would be providing advice with respect to the issuance of municipal securities or the use of municipal financial products. In our review of these RFP/Qs, we have either seen municipal entities be silent on requiring that respondents to an RFP/Q be registered as a municipal advisor with the Commission and Municipal Securities Rulemaking Board (“MSRB”) or, worse, affirmatively say that registration as a municipal advisor is not a requirement.[11]

Given that unregistered entities may be engaging in what appears to be municipal advisory activity, you may want to confirm not only that any professional providing municipal advisory services to you is properly registered[12] but also that you have in your RFP/Qs for services or work constituting municipal advisory activity a requirement that respondents be registered with the Commission and the MSRB as municipal advisors in order to submit a response. At a minimum, I do not believe these RFP/Qs should be soliciting the services of a “financial advisor” or “consultant” which may create the impression that they do not need to be registered with the Commission or the MSRB. If you are seeking the services of a municipal advisor, it would be helpful to use the term municipal advisor in your RFP/Qs.

Another area where I see a concerning use of “financial advisor,” where “municipal advisor” should be used, is in your offering documents. As previously mentioned, municipal advisor is more than just a title: it is a regulatory term. Using “municipal advisor” tells investors that the firm, its associated persons, and its activities are subject to rules and regulations; that the Commission monitors municipal advisors for compliance; and takes necessary action to enforce Congress’s mandate. If you use municipal advisors in your transactions, I think it would be beneficial to use the defined term “municipal advisor” in your offering documents to accurately describe the professionals fulfilling that role. Using a term that is explicitly defined by law may also help avoid including confusing or ambiguous statements in disclosures to investors.

There are also strong benefits to being involved with or retaining persons or firms registered and regulated as municipal advisers, as it demonstrates that these persons or firms recognize that they are engaging in municipal advisory activity. Registering as a municipal advisor may also demonstrate that the advisor understands that it has certain legal obligations, including a requirement to register unless an exclusion or exemption applies. These obligations include, among other things, a requirement to disclose to clients any material conflicts of interest. If you remember nothing else from today, remember this: your municipal advisor is required to always act in your best interest.

II. Observations on Amendments to Continuing Disclosure Undertakings

Now turning to disclosure practices. When the Commission proposed amendments[13] to Rule 15c2-12 (“Rule 15c2-12” or “Rule”)[14] of the Securities Exchange Act of 1934 (“Exchange Act”) in 1994[15] prohibiting underwriters, subject to certain exemptions, from purchasing or selling municipal securities covered by the Rule in a primary offering, unless the underwriter had reasonably determined that the issuer (or obligated person) had undertaken in a written agreement or contract[16] (“continuing disclosure undertaking”) to provide specified annual information and event notices,[17] practitioners expressed concern[18] that the amendments were not sufficiently flexible to address changing conditions to financial and pertinent operating information. The Commission addressed practitioners’ concerns when it adopted the amendments.[19]

a. NABL 1 Letter

The Commission explained in the 1994 Amendments Adopting Release that Rule 15c2-12, as amended, requires that continuing disclosure undertakings specify only the general type of information to be provided[20] and that undertakings should be drafted with sufficient flexibility to accommodate for subsequent developments that may require adjustments in the financial information and operating data contractually agreed upon in the undertaking.[21] Shortly after adoption of the amendments, the National Association of Bond Lawyers (“NABL”) requested[22] staff guidance interpreting an issue that I see continues to be debated thirty-one years later: amending continuing disclosure undertakings.

Let’s take a moment and revisit the statements made by staff on amending continuing disclosure undertakings in response to the NABL 1 Letter.[23] Staff first noted that in meeting the requirement that annual financial information be specified in reasonable detail, staff anticipated that continuing disclosure undertakings would set forth a general description of the type of financial information and operating data that would be provided. Staff further observed that these descriptions would not need to state more than a general category of financial information and operating data. Moreover, staff noted that where a continuing disclosure undertaking calls for information that no longer can be generated because the operations to which it related had been materially changed or discontinued, a statement to that effect would satisfy the continuing disclosure undertaking. In such instances, staff explained that it may be good practice to provide similar operating data with respect to any substitute or replacement operation. Further, staff noted that issuers and obligated persons may provide additional information that is not required by the terms of the undertaking. Accordingly, the staff did not anticipate that it often would be necessary to amend informational undertakings.

In addition to providing guidance on the circumstances under which an undertaking could be amended, the staff also provided several examples[24] of annual financial information descriptions. For example, categories of operating data provided for a college or university facility bond offering might include, among others, information regarding attendance, applications, and tuition and room and board rates charged to students. In a water or sewer financing, categories of information provided might include, among others, customers, rates, use, capacity, and demand.

b. Current State of Continuing Disclosure Undertakings

Now I would like to take the opportunity to reflect on the current state of continuing disclosure undertakings. Since the 1994 amendments promoted flexibility in drafting continuing disclosure undertakings, staff has heard that practitioners have discovered ambiguities and inconsistencies in their continuing disclosure undertakings that have resulted in overlapping, inconsistent, and outdated information in required disclosures. Consequently, practitioners continue to struggle with questions about amending continuing disclosure undertakings and have asked the staff for guidance on this issue.

To start, I want to remind practitioners that Rule 15c2-12, as amended, offers flexibility in the content and scope of disclosed financial information.[25] The Rule specifies only general types of information relating to the financial information and operating data to accommodate for any subsequent developments that would require adjustments to the data.[26] Further, adhering to your continuing disclosure undertakings does not preclude you from providing additional information, particularly where disclosure may be necessary to avoid liability under the antifraud provisions.[27]

The staff recognizes that, despite the staff interpretive guidance in the NABL 1 Letter, which elaborated on statements in the 1994 Amendments Adopting Release, some obligated persons have continued to provide specific and relatively unflexible descriptions of annual financial information or operating data in the continuing disclosure undertakings by, for instance, pointing to specific tables of information in an official statement because they believe it makes it easier for issuers and dissemination agents to comply with the undertaking. Although Rule 15c2-12 does not prohibit such specificity or incorporation by reference,[28] I believe that where obligated persons choose to include references to specific tables or similar specificity, they might consider including language allowing for flexibility, such as describing tables “of the type” or tables “of the kind” provided in the official statement.

The inclusion in continuing disclosure undertakings of clear descriptions of the disclosures to be made by municipal issuers and obligated persons promotes a more transparent and efficient market. However, drafters of continuing disclosure undertakings may want to be mindful when specifying the particular types of information that will be provided for many years into the future, as continuing disclosure undertakings are contractual obligations that cannot be amended based on a unilateral decision by an issuer or any other party. With very limited exceptions, issuers and obligated persons may not later decide unilaterally what types of information an investor would consider necessary or meaningful, especially where such information has previously been agreed upon.[29]

Continuing disclosure undertakings would be meaningless if issuers and obligated persons could unilaterally determine that certain types of information were no longer necessary or meaningful to investors.[30] Despite previous requests from the market for guidance on amending continuing disclosure agreements, I remind you that those agreements are contracts governed by state law[31] from which the Commission does not have the authority to provide exemptions. Failure to comply with continuing disclosure undertakings would be breaches of contract enforceable by private parties.[32] This is why staff statements have focused on using language in continuing disclosure agreements that allow for changing conditions.

III. The Importance of Voluntary Disclosure in the Municipal Securities Market

Sound, timely, and accurate disclosures of the financial condition and operating status of issuers and obligated persons promotes the continued integrity of the municipal securities market.[33] As we all know, Rule 15c2-12 requires that continuing disclosure undertakings set forth certain enumerated requirements. Rule 15c2-12 does not generally impose an obligation to provide ongoing information beyond the contractual continuing disclosure obligations. I am of the view, however, that voluntary disclosures[34] — providing information beyond contractual continuing disclosure obligations — by issuers and obligated persons can provide market participants with updated financial and other disclosures regarding the effects of evolving economic conditions.[35]

a. Improving Transparency and Market Efficiencies

Issuer organizations and other market participants have noted that providing voluntary interim disclosure can serve the interests of municipal issuers and have developed voluntary disclosure best practices designed to improve the quality and quantity of voluntary disclosure in the secondary market.[36] GFOA issued a Best Practices on Voluntary Disclosure in 2021.[37]

I am of the view that if issuers and obligated persons provide voluntary disclosures of their financial condition and operating status on a more frequent basis, the additional information could potentially reduce information asymmetries and help investors and other market participants identify early warning signs of an issuer’s or obligated person’s deteriorating financial condition sooner (such as budget deficits and imbalances, high unfunded pensions liability, and decreases in property value), which could lead to increased market efficiencies.

Some examples of helpful voluntary disclosures that municipal issuers and obligated persons could consider disseminating are[38]

• More Timely Financial Information. Municipal issuers routinely prepare periodic reports containing financial information and/or operating data, such as investment positions, interim financial information, or capital improvement plans, for various non-disclosure purposes,[39] which are generally produced in accordance with governance documents, best practices, and generally accepted guidelines. Municipal issuers could consider submitting such reports via the repository designated by the Commission (currently the MSRB’s Electronic Municipal Market Access (“EMMA”) system) and/or through their own designated website.
• Reports Prepared for Other Governmental Purposes. Municipal issuers and obligated persons may have prepared reports addressing relevant climate, cybersecurity, litigation, or other risks for other purposes.
• Reports and Information Shared with Third Parties. Reports prepared to be shared with rating agencies, bank loan providers or other market participants may also include information material to investors.[40]
• Information Regarding Availability of Federal, State and Local Aid. If it materially affects, or is reasonably likely to materially affect, your ability to repay debt service, you could make available a description of available aid that you have sought or are planning on seeking and any other material terms of the aid to investors.
• Information Regarding Non-Routine Events that May Impact an Issuer’s Ability to Repay Securities. For instance, a large business relocating to your jurisdiction may have a positive impact, while a natural disaster may have a negative impact. Sharing information with the market on any non-routine events that may impact your ability to repay debt service could be helpful.

In my view, making any voluntary disclosures available in the place or places where they regularly make information available to investors, such as on the EMMA system and/or on their own websites, would be helpful to both issuers and investors.

b. Observations on Liability

I sometimes hear from issuers that they would disclose more information to the market, but that their counsel advises them, as a matter of course, not to provide any information that is not required. I recognize that the issue of liability is often raised in connection with voluntary disclosures.

I believe that accompanying voluntary disclosures that contain projections or forward-looking statements with meaningful cautionary language — including, for example, (1) a description of relevant facts or assumptions affecting the reasonableness of reliance on and the materiality of the information provided, (2) a description of how certain important information may be incomplete or unknown, and (3) the process or methodology (audited versus unaudited) used by the municipal issuer or obligated person to produce the information — could not only improve the quality of the disclosure but also help mitigate associated legal risks.

As I observe the municipal securities market and consider appropriate paths to address behaviors that impact investor confidence and transparency, I believe that it would be beneficial for municipal issuers to disclose, to exercise reasonable care, and to follow best practices in the creation and release of any voluntary disclosure.

It’s always a pleasure to speak with members of the GFOA. Thank you again for the invitation to discuss these important issues with you today.

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