WASHINGTON – Municipal market groups have launched a joint effort to come up with ways to improve continuing disclosure in hopes of staving off any efforts by regulators to try to mandate improvements through new regulation or legislation.
As a result, continuing disclosure, along with the Municipal Securities Rulemaking Board's rules for municipal advisors, markups, and best execution, as well as bank loans, will likely be key areas of focus in the coming year, muni market participants said.
The groups' continuing disclosure initiative was launched because of widespread fear among issuers, and a few other market participants, that the Securities and Exchange Commission will use the violations voluntarily reported under the Municipalities Continuing Disclosure Cooperation initiative, which has already led to SEC settlements with 58 underwriters, as evidence that its Rule 15c2-12 isn't working.
"I think it is a concern of many of [the Government Finance Officers Association's] members that the MCDC initiative will be used to generate a large number of instances of issuer violations of the continuing disclosure agreements and obligations … and that the violations will be grouped and presented to Congress and SEC commissioners as the basis for organizing some kind of one-size-fits-all regulatory scheme to impose further regulation on issuers," said Dustin McDonald, director of the GFOA's federal liaison center here.
The groups that attended what McDonald called a "sit-down on continuing disclosure" in October included, besides the GFOA, the Securities Industry and Financial Markets Association, Bond Dealers of America, the National Association of Bond Lawyers, the Investment Company Institute, the National Federation of Municipal Analysts, and the National Association of Municipal Advisors. The regulators were not at the meeting.
Jessica Kane, director of the SEC's Office of Municipal Securities, would not comment on the possibility of issuer regulation, but said she thinks the MCDC initiative has shown "a very bright light" on SEC Rule 15c2-12 concerning disclosure in the muni market.
"The MCDC initiative may provide us with valuable insight into how 15c2-12 is working and where to best channel our efforts going forward," she said in an interview.
The groups participating in the October meeting were trying to figure out how to effectively improve continuing disclosure both because they have a genuine interest in doing so and because they want to show regulators like Olsen they can work together and do not need furtherregulatory interference from the SEC, McDonald said. Those who attended the meeting kicked around a number of ideas to improve continuing disclosure, including how to package information about disclosure compliance in a way that can be easily understood by smaller, infrequent issuers or new municipal debt managers, sources said.
The groups also discussed working with the MSRB to make changes to the EMMA system, so that smaller issuers better understand how to use the site. One idea might be to create a "decision tree" to show issuers how to put information onto the site so that they can be sure they are putting data in the correct boxes.
MSRB's chair Nat Singer and executive director Lynnette Kelly, without mentioning the groups' meeting, both said that the board hopes to continue to focus during the coming year on improving EMMA to make it more useful in the market. The next step for the market groups is to split into working groups and tackle different areas they have identified for improving continuing disclosure practices, McDonald said.
SIFMA managing director and co-head of municipal securities Michael Decker said in a separate interview that a lot can be done to improve disclosure apart from regulation or legislation.
"I don't think you have to repeal the Tower Amendment to improve the disclosure regime," he said, referring to an amendment included in the Securities Exchange Act of 1934 that prevents the SEC and MSRB from requiring issuers to file documents with them before issuing bonds.MSRB cannot require filings after issuances either.
Louisiana, for example, adopted a law in 2014 requiring firms auditing state and local governments to check their compliance with continuing disclosure obligations.
Some market participants said the SEC could overhaul or update its Rule 15c2-12 to, among other things, require the disclosure of bank loans in issuers' annual financial and operating information. The commission cannot directly regulate issuers and would have to make the change through the dealer community. 15c2-12 currently states dealers cannot underwrite bonds unless the issuer has contractually agreed to disclose annual financial and operating information as well as material event notices.
Singer said it is "definitely a priority of the MSRB to have a greater focus on bank loans" in the coming year. The MSRB has been talking to the SEC about the need for more loan disclosure, he said, but the self-regulator would also like to see guidance from the commission on the line between when a loan is a loan and when it is a security as well as the point when an MA becomes a placement agent when working on bank loans for a municipal client.
Other market groups have echoed those calls for more guidance on bank loans. Olsen said OMS is aware of the requests. There "are no concrete plans" for guidance, she said, but guidance on both the classification of a loan and MAs acting as placement agents is something the office could consider next year, she said.
The MSRB and SEC's continued roll out of municipal advisor rules will also continue to be an area of focus next year, market participants said."I think we will probably be active in all phases of MSRB rulemaking both working to implement [approved MSRB] rules and working with the MSRB as they develop new rules for municipal advisors," Kane said.
The MA rules have implications that cut across both dealer and non-dealer market participants, they said.
Non-dealer municipal advisors are now at the point where they are moving past basic compliance practices, said Public Finance Management chief compliance officer Leo Karwejna. They will be expected to comply with MSRB Rule G-20 on gifts and gratuities by May 6, and have their first opportunity to take the new and required MA professional qualification exam in 2016.
The MSRB's Series 50 pilot exam will be offered from Jan. 15 to Feb. 15 and will be a test run for the MSRB's professional qualification exam expected to be finalized in June. Karwejna said he "hopes every municipal advisor who can signs up to take the pilot" and added PFM already has a "full blitz" on work needed to get its MAs past the examAny MA who takes and passes the pilot exam will not need to take the official exam. Once the official exam is completed and the testing period starts, MAs will have one year to take and pass the exam.
Ernesto Lanza, a shareholder in Greenberg Traurig's Washington office and former MSRB deputy executive director said that both the pilot and eventual official exam will be a time for MAs to "fish or cut bait" on whether they are going to continue to be in the MA business. While the tests will not result in a large number of people leaving the advisor space, he said, it will cause firms that have split dealer/MA business models to make important determinations of who falls on which side of the MA line.
The MSRB's rule that outlines the core duties of municipal advisors, Rule G-42, will also play a significant role in 2016, as it will have an implementation date in June. The SEC approved the rule on Dec. 23 despite dealer and issuer group complaints, mainly about the rule's ban on principal transactions.
"I would definitely stress that I think it is very important for the market that we do get these core municipal advisor rules in place and I would certainly like to see it done during my term as chair," he said. Singer's term will end Sept. 30.
Leslie Norwood, associate general counsel and co-head of the municipal securities division for SIFMA, said the dealer group would also like to see the MSRB's MA rules completed in 2016.
Lanza said that he wouldn't be surprised if the MSRB has to provide guidance in a question and answer format to clarify some of the provisions of G-42. A final central piece to MA regulation is the proposal to extend Rule G-37 on political contributions to non-dealer advisors, which the MSRB filed with the SEC on Dec. 16. While it is unclear how the SEC and the market will view the changes, some observers believe there could be challenges brought against the rule on constitutional grounds.
"I think G-37 may end up being a story just because there was a lawsuit against the investment advisor version of it and I think anything the MSRB does to G-37 is likely to get challenged," said Dave Sanchez, a lawyer for Sidley Austin in California and former SEC muni official.
Singer said he would not be surprised if the rule was challenged in court, but that a challenge is not a reason to avoid pursing it.
The SEC and MSRB will also be busy with dealer-specific implementations and rulemaking next year.
The MSRB and the Financial Industry Regulatory Authority are both pursuing separate markup disclosure rules for the muni and corporate bond markets. SEC commissioners have urged the self- regulators to adopt these rules, warning if they do not, the commission will act. Singer said the markup proposal is a priority for him as well as the MSRB board and, despite the variance between the current MSRB and FINRA proposals, said the two regulators plan to continue to closely collaborate as the rulemaking process continues.
Tom Dannenberg, president and chief executive officer of Hutchinson, Shockey, Erley & Co. and a member of BDA's board, said he expects the markup rules to be completed by the end of 2016 because of the focus from both the regulators and the SEC.
"The big hurdle we would like to see them overcome is to harmonize the FINRA and MSRB proposal so the burden is not as significant as it already is," Dannenberg said.
Lanza agreed that there would need to be some "convergence" of the rules before they go to the SEC for approval. He also said he expects that, after going through the required rulemaking process, the rules will ultimately look much different than they do now.
Dannenberg and other dealers will also be working to implement the already approved MSRB Rule G-18 on best execution, which has an effective date of March 21. The rule requires dealers, whether acting as agents or principals, to use "reasonable diligence" to determine the best market for a security and to then buy or sell the security in that market so the price for the customer is as favorable as possible under prevailing market conditions.
The MSRB released guidance on the rule in a frequently asked questions format on Nov. 20. But Dannenberg said that, even with the guidance, there will still be overarching problems and uncertainty about how dealers apply the rule.
"This is going to be a new undertaking for a lot of broker-dealers, especially smaller ones," he said, adding that more clarifications from regulators will be needed as questions come up. "Trading munis is often more of an art than a science and following your procedures to prove you are adhering to a best execution standard is going to be challenging."
Kelly said the MSRB is aware of the challenges for both dealers and advisors in implementing new rules in 2016.
"The effective date of a rule is obviously an important date for the market and for the regulated entities, but for regulators it really is just another step in a long process," she said. "We've got an effective date but we've got a significant amount of work to do before and after the effective date, and that includes providing very specific education materials."
