SEC Proposes Modifications to Rule 15c2-12 to Increase Event-Driven Disclosures by Municipal Issuers

Disclosure in the municipal securities markets has been a focus of the Securities and Exchange Commission for some time, but it has recently returned to center view with the SEC’s proposals for additions to the event-driven disclosures under Rule 15c2-12. The rule change would add to the roster of events requiring current disclosure the creation of financial obligations and the occurrence of defaults and similar events in respect of such obligations.  The proposals have generated comments showing rifts and starkly competing interests between buy-side and sell-side participants in the muni market. The SEC will need to balance these competing interests as it seeks to create greater reporting transparency for municipal securities.

Background

Unlike with the corporate disclosure regime, the SEC cannot directly impose reporting obligations on municipal issuers. Instead, it mandates municipal securities disclosures through its authority to regulate broker-dealers under Section 15 of the Securities Exchange Act of 1934. The SEC leans heavily on the anti-fraud powers conferred upon it by Section 15(c)(2)(D).

In furtherance of the objectives of Section 15(c)(2)(D), the SEC requires underwriters of municipal securities to ensure that issuers commit to making certain disclosures prescribed by Rule 15c2-12. The undertaking by issuers to make these disclosures is contained in a so-called continuing disclosure agreement, or CDA. The CDA requires a range of disclosures that an issuer must make on an ongoing basis in compliance with Rule 15c2-12, including but not limited to certain annual financial and operating information and notices of certain events. See Debt Dialogue, November 2016, “Overview of the Municipal Bond Securities Law Framework and Recent SEC Enforcement Activity.”

The Proposed Rules

On March 1, the SEC issued a proposal to add to the event-driven disclosures under Rule 15c2-12. Under the proposed rule amendments, issuers would be required under the terms of their CDA to disclose:

• Incurrence of a financial obligation of the obligated person, if material, or agreement 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.
   
• 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 term “financial obligation” is defined as debt obligations, leases, guarantees, derivative instruments and monetary obligations resulting from a judicial, administrative or arbitration proceeding.

So, for example, a municipal issuer would be required to disclose on the Electronic Municipal Market Access (EMMA) system of the MSRB, within 10 days of occurrence, its entry into any material financing. Publicly traded corporate issuers — if they have a class of securities registered under the Securities Exchange Act or if they have registered securities under the Securities Act (at least within the past year) — currently have a similar obligation to report on Form 8-K within four business days.

The comment period for the proposed rules ended on May 15, with reaction to the proposal in the municipal securities community split between buy-side and sell-side participants.

The buy side was supportive of the proposed rules, even urging the SEC to further expand municipal security event-driven disclosures. The municipal securities disclosure regime, the buy-side participants observed, is considerably weaker than the disclosure requirements for corporate issuers, and the documentation for material financial transactions that corporate debt investors routinely expect and receive is generally not available on the municipal side. Moreover, the information available to holders of publicly traded municipal bonds is substantially less than the data customarily provided to other credit providers to municipal issuers. This informational asymmetry, the buy-side participants maintain, has resulted in unjust outcomes for holders of municipal securities.¹

For its part, the sell side was generally opposed to the expansion of municipal securities disclosures. The primary concern of the broker-dealer community² was the specter of increased liability for underwriters.³ Under Rule 15c2-12, underwriters are responsible for diligence in the offering documentation for the securities they bring to market, including statements of compliance of the issuer during the preceding five years with CDAs executed in respect of prior issuances of securities. This, claim these sell-side participants, places underwriters in the position of responsibility for the issuer’s violation of its reporting obligations, over which underwriters have no control or visibility. The situation, they say, has become more acute because of the SEC’s Municipalities Continuing Disclosure Cooperation Initiative. Under that program, underwriters are pushed to self-report even marginal or uncertain violations lest they be tagged with more severe penalties in SEC enforcement actions.⁴

Status

The SEC has yet to respond to the comments received on the proposed changes to Rule 15c2-12. The Commission has any number of alternatives, from taking no action on the rule change to implementing the rule as proposed to adopting the rule with various modifications.  However, as the Commission proceeds, it is clear that it will need to balance the demands of the buy side for greater transparency in the multitrillion-dollar market for municipal securities with the concerns of the underwriting community that it not be unfairly tagged with liability for the misdeeds of the municipal issuers whose securities they bring to market.

¹ See comment letter, dated May 15, 2017, Timothy Cameron, Esq., head, and Lindsey Weber Keljo, Esq., managing director and associate general counsel, Asset Management Group (AMG) of the Securities Industry and Financial Markets Association (SIFMA), a buy-side industry group. Kramer Levin Naftalis & Frankel LLP assisted the AMG in formulating its comment letter on the proposed rules. Among various other suggestions, the AMG letter advocates that municipal issuers be required to disclose and post to EMMA material contracts of the issuer, similar to the obligations of corporate issuers under the Regulation S-K disclosure regime, and certain financial information furnished to other financing sources of the municipal issuer. The letter can be found at https://www.sec.gov/comments/s7-01-17/s70117.htm.
 
² Representatives of municipal issuers who commented on the proposed rule changes generally voiced opposition as well, based upon what they perceived to be the costs and burdens of the new disclosures, as well as perceived imprecision of and uncertainty about the formulation of the proposed rule amendments. See comment letters at https://www.sec.gov/comments/s7-01-17/s70117.htm.

³ The SEC can bring proceedings against underwriters under Sections 17(a)(2) and (3) of the Securities Exchange Act for failing to form a reasonable basis through adequate diligence that the official statements for offerings that they underwrote were truthful and complete. Liability under these sections requires only a showing of negligence. The SEC can also sue underwriters under Section 32 of the Exchange Act for violations of Rule 15(c)(2), but a showing of willfulness is required. See Debt Dialogue, April 2017, “SEC Action Against Underwriter Illustrates Enforcement of Disclosure Violations in the Muni World.”

⁴ See Securities and Exchange Commission, Division of Enforcement, Municipalities Continuing Disclosure Cooperation Initiative (November 13, 2014) (“The Municipalities Continuing Disclosure Cooperation Initiative ... is intended to address potentially widespread violations of the federal securities laws by municipal issuers and underwriters of municipal securities in connection with certain representations about continuing disclosures in bond offering documents.”), available at https://www.sec.gov/divisions/enforce/municipalities-continuing-disclosure-cooperation-initiative.shtml.