The U.S. Securities and Exchange Commission said on Tuesday it wants to extend its regulatory reach into the $3.7 trillion municipal bond market, where states and cities that sell debt have largely escaped the kind of scrutiny faced by participants in other capital markets.
The SEC released a report that was two years in the making which focuses on improving issuer disclosures and on increasing investor protection.
But the SEC's proposed enhanced oversight of the market, which would involve enforcement of standards for financial statements and requirements for ongoing disclosure, may rile some issuers accustomed to less-stringent procedures.
The SEC enforces rules for the market that are written by a self-regulatory organization made up of banks, issuers and advisers called the Municipal Securities Rulemaking Board.
Various laws have limited the SEC's ability to oversee states and local issuers, leading to a hodgepodge of accounting techniques and financial disclosures available to investors weighing whether to purchase their debt.
The financial struggles of states and cities as a result of the weak economy over the last several years have created a desire for better disclosure and record-keeping.
Several high-profile municipal defaults and bankruptcy filings, including Jefferson County, Alabama, and several cities in California, along with growing public pension burdens have left investors and political leaders eager for more information. So, too, have concerns that institutional investors have an unfair advantage over individual buyers.
"We heard the concerns voiced by many ... that investors in the municipal securities market don't have all the protections and access to information that they need," said SEC Commissioner Elisse Walter in a conference call with reporters.
These concerns have been raised by issuers as well. In Alabama's Jefferson County, whose $4.23 billion bankruptcy in November involved credit swaps and other financial derivatives, government officials said greater disclosure might have prevented America's biggest-ever municipal bankruptcy.
"Good for them," County Commissioner Jimmie Stephens said on Tuesday in Birmingham. "If we had those regulations in place, before all the swap agreements, I wonder if we would be here."
However, Frank Hoadley, Wisconsin's capital finance director, said the SEC appears to be asking for "everything including the kitchen sink."
He said some of the SEC's recommendations would involve revisiting 1975's Tower Amendment, which limited the SEC's and the MSRB's authority to require muni issuer reporting related to their bond sales.
The Securities Industry and Financial Markets Association welcomed relief for its broker-dealer members from current disclosure requirements.
"SIFMA and its members have been frustrated that many aspects of the current disclosure regime are affected indirectly through the broker-dealer community," said Leslie Norwood, SIFMA's co-head of municipal securities. "We do have concerns about any changes that might cause significant additional burdens to the issuer community."
Investors, however, may find the SEC's proposals beneficial.
"They're recommending some pretty strong improved disclosure practices that investors are likely to welcome," said Richard Ciccarone, a managing director at McDonnell Investment Management in Oak Brook, Illinois.
HEADACHES FOR ISSUERS
Regulators are worried that lack of disclosure is masking fraud or other problems. Two years ago, the SEC rapped the state of New Jersey for not fully disclosing the financial troubles of its public pension system.
Even as the regulatory whip cracks more frequently in the muni market, issuers and underwriters often file disclosures such as annual financial statements late or not at all.
Last August, the MSRB said it received 3,550 notices over the course of two years that cities, states and local authorities would be late filing annual financial information, at an average rate of 148 notices per month.
Tom Dresslar, a spokesman for California Treasurer Bill Lockyer, said a preliminary review of the SEC's report shows it is not seeking a one-size-fits-all approach for issuers, and the calls are for incremental additions to federal regulation.
But Ben Watkins, head of Florida's Division of Bond Finance, said compliance is going to be complicated for smaller issuers.
"It sounds compelling but would prove burdensome to small issuers," he said. "I am a very different issuer from the City of Hialeah. We have the resources and we can comply. Smaller issuers might find compliance problematical."
PRICE DISCOVERY, TRANSPARENCY ADDRESSED
Walter told reporters that another goal of the report is to address price discovery and price transparency in the market.
The muni market is largely illiquid, and most bonds do not trade on a daily basis, meaning the pricing of these bonds is largely determined by the banks and brokerages.
The question has come up in the wake of manipulation by a number of banks of the LIBOR rate, which is marginally used in the muni market.
On Tuesday, MSRB Chairman Alan Polsky said that the board "appreciates the work of the SEC," but that the board still must review the recommendations.
The MSRB is reviewing how several market indexes are prepared, including those published by Municipal Market Data, a Thomson Reuters company. The MMD benchmarks are used to set rates for states, cities and other issuers that sell muni debt.
Thomson Reuters has been holding discussions with the SEC and MSRB in the course of their reviews of the muni market.
James Smith, CEO of Thomson Reuters Corp , said Tuesday on a conference call following the release of the company's earnings that "we get lots of questions just across the board on these issues and we are always very forthcoming and cooperative with all regulatory agencies on all the matters that they are investigating. But at this point we do not believe we have any exposure at this point at all."
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