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A Watched Pot Never Boils: the Need for SEC Supervision of Fixed Income Liquidity, Market Structure, and Pension Accounting

Commissioner Daniel M. Gallagher

New York, NY

March 10, 2015

Thank you, Susan [Axelrod], for that kind introduction.  Today’s conference could not be timelier.  As many of you know, I have spoken repeatedly about the significant risks that have been brewing in the fixed income markets.[1]

I am pleased to report that the public debate, and the Commission focus, on the topic of fixed income reforms has dramatically increased since I first started talking about these issues in 2012.[2]

At the Commission level, there has been a lot of discussion about issues such as enhanced pre and post trade disclosures and transparency,[3] and market structure issues relating to increased liquidity and the facilitation of electronic trading.[4]

The SEC has plenary authority over the corporate fixed income markets, and important, though limited, authority over the muni markets.  If the Commission does not take the lead in seeking reforms in these markets, they will continue to operate as they have for decades, and despite the historical vibrancy of the markets, that is not necessarily a good thing.

*  *  *

As we consider fixed income market reforms, it is important to reflect on the importance of these markets to our economy.

Debt financing is crucial to the U.S. capital markets.  The numbers speak for themselves.  Municipal bonds, of which there are approximately $3.7 trillion in principal amount outstanding,[5] allow state and local governments to finance their infrastructure projects and to provide for cash flow and other governmental needs.  They also constitute a large percentage of retail investors’ retirement assets.  Meanwhile, the corporate bond market enables companies to operate and grow their business through capital investments.  There is over $11 trillion outstanding in the corporate debt market.[6]  The value of U.S. corporate bond issuances in 2014 reached a record of more than $1.4 trillion.[7]  The average daily trading volume for fixed income securities of all kinds in February 2015 was 818 billion.[8]

The search for yield arising from over six years of near-zero interest rates is driving investors to the debt markets.[9]  Yet, as I have pointed out several times before, despite record issuances of corporate bonds, dealer inventory and liquidity in the secondary markets has dramatically decreased.  Even the Chair of the Financial Stability Board – the “shadow parent of the FSOC” — Mark Carney has acknowledged that new prudential regulations have caused dealer inventories to drop.[10]  By my calculation, inventories are down over 75% since the pre-crisis period.[11]  Chair Carney has noted that the “time to liquidate a given position is now seven times as long as in 2008, reflecting much smaller trade sizes in fixed income markets.”[12]

With a record notional amount of outstanding corporate debt and dealers unable to commit capital and hold significant inventories, there is a real liquidity crisis brewing.  The significant risk is that when the Fed starts to hike interest rates, which some tea leaves tell us could happen as early as this June[13] — investors may rush to exit their positions in high yielding and less liquid debt and may have severe difficulty in doing so.

Interestingly, while the biggest banks have cut back on their positions in more risky debt, insurance companies and mutual funds have increased their positions in those assets.[14]  These firms have boosted their holdings of corporate and foreign bonds to $5.1 trillion, a 65% increase since the end of 2008.[15]  This has offset the $800 billion decline in holdings at banks and securities firms in the same period.[16]  Rather than banks holding the inventory, there are now “ballooning bond funds that own more and more risky debt,” and it is unclear how institutional asset managers and their clients will react when interest rates rise.[17]

Although the SEC may not have a silver bullet to address these issues, there are some discrete steps the agency can take to address the liquidity risks that plague the debt markets.  For example, the Commission should be looking at all options for facilitating electronic and on-exchange transactions of these products.

Last fall, I called on the Commission to engage market participants and other interested parties to develop creative solutions to increase liquidity in the secondary fixed income markets.[18]  I am very pleased to report that a number of firms have been meeting with the SEC staff and among themselves to discuss ways to facilitate electronic trading.[19]

The Commission also must commit the necessary resources to determine how to incentivize standardized primary offerings to further facilitate secondary liquidity.  Today, most corporate bonds are highly differential and bespoke.  Electronic and on-exchange transactions could be facilitated through products that are substantially standardized.  However, we should not wait until standardization of issuances occurs to begin the migration to electronic platforms.  Today, options exchanges handle massive volumes of trading in thousands of unique options.  Electronic and exchange trading can be done and should be considered in parts of the fixed income markets also.  Indeed, in the early part of the twentieth century, there was an active market in corporate and municipal bonds on the New York Stock Exchange.  Obviously, technology has improved at least somewhat since then — if you don’t believe me, you can go read Flash Boys!

We all need to recognize that the status quo is not sufficient.  I fear that if more progress is not made, Congress could respond in a draconian way, for example by mandating that all corporate bond transactions be executed on exchange platforms.  This is exactly what happened in another over-the-counter market, the swaps markets, in the Rube Goldberg machine known as Title VII of Dodd-Frank.[20]  I cannot say it loudly enough — the industry must get together and create private market solutions, solutions that actually work and are efficient, before the government imposes its worldview.

While this potential liquidity crisis is a serious risk that warrants serious attention, there is a more discrete and addressable issue in the fixed income markets, an issue that disproportionately impacts retail investors.  That issue is the lack of transparency.  Retail participation in the municipal and corporate bond market is very high:  over 70% in the municipal markets and 40% in the corporate markets.[21]  And yet, these markets are incredibly opaque to retail investors.

One of my gravest concerns with respect to munis is that retail investors do not understand exactly what they pay in bond transactions.  Municipal bond dealers execute virtually all transactions in a principal capacity, with a portion of these principal trades effected on a “riskless principal” basis.[22]  In a “riskless principal” transaction, a dealer who has received a customer order immediately executes an identical order in the marketplace, while taking on the role of principal, in order to fill the customer order.[23]  By doing so, the dealer takes on very little risk that the market will move against it.

The dealers typically charge their customer a markup to execute their order.  But a dealer acting as a principal is not required to disclose its markup on a confirmation, even for a riskless principal transaction.[24]  Given that “riskless principal” is basically just a fancy name for “agency,” there is no real reason to perpetuate this dichotomy.  Disclosure of the markup or markdown in riskless principal transactions would enable customers to assess the fairness of the execution prices.[25]

I am pleased that FINRA and the MSRB are actively engaging this issue.  I applaud Rick Ketchum and Lynnette Kelly for their leadership on those initiatives.  Late last year, both SROs issued proposals that would require dealers in retail-sized fixed income transactions to disclose on trade confirmations the price of the dealer’s same-day principal trades in the same security, as well as the difference between this reference price and the customer's price.[26]  As expected, these proposals generated a hearty response from the industry!  And separately, the SEC recently approved the MSRB’s best execution rule and I understand that the MSRB and FINRA are working together to provide further guidance.[27]  These are positive steps in bringing transparency to a market whose depiction in another older Michael Lewis book, Liar’s Poker, remains accurate to this day.

*  *  *

In addition to bringing much-needed transparency, there have been growing calls for changes to the bond disclosure regime, particularly in the muni space.  The SEC’s authority in this area is of course limited; the Tower Amendment famously restricts the Commission’s ability to require presale filings of documents with the SEC, and there is no statutory grant of authority to otherwise regulate directly the form and content of disclosures by muni issuers.  And so the SEC’s regulatory regime is cobbled together from other sources of authority — in particular, generalized antifraud authority over municipal issuers and their principals, and more comprehensive authority over intermediaries, including Rule 15c2-12.

The SEC recently has been making better use of this existing authority to improve municipal disclosure practices.  For example, the SEC through the Municipalities Continuing Disclosure Cooperation Initiative, or MCDC, has been testing compliance with Rule 15c2-12, and holding muni issuers accountable for representations in offering documents, and for compliance with their continuing disclosure obligations.[28]  I will note that there has been a 40% increase in the financial and operating documents filed on EMMA between June 2013 and 2014, perhaps due to our MCDC program.[29]

The SEC’s Municipal Securities and Public Pension Unit, led by the very able LeeAnn Gaunt, is, in addition to administering the MCDC, actively pursuing muni issuers and related individuals who commit fraud.  For example, in June of last year, the SEC secured an emergency order to stop a bond offering by the City of Harvey, Illinois, based on evidence that the proceeds of the bond issuance were to be fraudulently diverted with some of those sums directed to pay the city’s comptroller and muni bond adviser, Joseph Letke.  In December, the City agreed to a settlement enjoining it from violating the antifraud provisions of the federal securities laws, and also to an undertaking to stay out of the muni markets for as many as three years.  The SEC also obtained a default antifraud judgment against Letke, along with a bar against participating in future municipal securities offerings as an adviser.  This case was an outstanding use of agency resources, and I fully support prohibiting municipalities that cannot or will not comply with the law from accessing the securities markets, as well as pursuing the culpable officials who perpetrate the fraud.

The SEC is also bringing cases against state and local entities — San Diego, New Jersey, Illinois, and most recently Kansas — for making misleading disclosures about the funding of their pension plans.  The failure by municipal issuers to provide adequate disclosures of underfunded pension plans is an unpardonable sin.  Politically-powerful state workers’ unions, and state constitutional protections for benefits, make the reduction of these liabilities extremely difficult.  The failure to set aside adequate funds to cover these liabilities creates a material risk that future payments to bondholders would need to be sacrificed.  This risk is not merely theoretical; we have seen it play out already in Detroit’s bankruptcy.[30]  Pension liabilities are a true systemic risk, but don’t hold your breath waiting for FSOC to address it.  They are probably too busy with Stage 3 assessments of lemonade stands anyway![31]

This leads me to another topic that deeply concerns me:  accounting for municipal pension and other post-employment benefit, or OPEB, liabilities.  Little did I know when I started this job, as a broker-dealer lawyer, that I’d be taking an interest in anything accounting-related, much less pension and OPEB accounting.  And yet, here we are.  As I noted in a speech last year, municipalities have taken advantage of heretofore lax governmental accounting standards to hide the yawning chasm in their balance sheets.  Those standards permitted municipalities to discount their pension liability using a projected rate of return on assets, which is contrary to economic fundamentals.  Rather, the discount rate should reflect the risk of repayment.[32]  If one used a proper discount rate, along with some other more-realistic valuation premises, we would have seen as of 2012 approximately $4 trillion of unfunded pension liabilities, instead of the more commonly-cited $1 trillion.[33]

New GASB standards for accounting for pension liabilities are a step in the right direction.  Rather than discounting all pension liabilities using an unrealistic rate of return on assets, municipalities are permitted to use that rate only for “funded” liabilities — liabilities covered by existing and expected future assets.  Unfunded liabilities must be valued using the high-yield, tax-exempt 20-year general obligation bond rate of the governmental sponsor.

Implementation of these standards is currently underway, and already it has been bringing some much-needed transparency.  For example, New Jersey’s two largest pension funds — retired state employees and teachers — saw their funded ratios drop from approximately 50% to approximately 25%.[34]  Overall, under the new rules, New Jersey’s unfunded pension liabilities are tripling from $37 billion to $83 billion.[35]  It will be very interesting to continue to watch these newly-calculated results roll in.

That said, the new GASB standards are still only a portion of the answer.  By permitting partial use of the rate of return on assets for funded liabilities, the new GASB standards allow for some political gamesmanship, such as legislation asserting that lawmakers in the future will make back-loaded catch-up contributions to fully fund the liability.  The new approach may also increase the volatility of the liability.  The strong market returns of the past couple of years, juiced by the Fed’s monetary policy of course, have increased retirement fund asset valuations, thereby increasing the portion of the liabilities that can be discounted at the higher rate of return on assets — a figure which itself may be inflated by the bull market.[36]  Unfortunately, I worry that, if we slip into a bear market, asset valuations will decrease and more of the liability may have to be discounted at the lower, unfunded rate.  Falling assets and rising liabilities could cause funded ratios to drop dramatically.[37]

To be clear, GASB standards can result in better disclosure of pension liabilities, but it takes political leadership at the state and local government level to allocate resources to fully fund the plans.[38]  Here is where the GASB standards might be able to help again.  The new GASB standards eliminated disclosure of the ARC, or Annual Required Contribution, which previously was an easy point of reference to help investors and voters compare the contribution that would be required to steadily chip away at these accumulated liabilities with that which was actually appropriated.  Bringing back the ARC can help hold accountable governments whose contributions are insufficient to make good on their pension promises.  Those decisions are truly hard — they require cutting employee benefits, or making budgetary trade-offs, and yet they have to be made.  Muni bond investors, in turn, need to know if these hard decisions are being shirked, because they are in direct competition with these pension funds when it comes time for repayment.[39]

While I have spoken a lot about GASB’s pension standard, I should note that the GASB also has an ongoing project to update its standard for OPEB liabilities, to require better measurement of the liability and recognition of the net liability on the face of the financial statement.  This project is already proving controversial, with some protesting that municipalities can cease providing or cut OPEB benefits at any time, and therefore do not need to recognize a liability other than the current year’s funding requirement.[40]  I will believe that when I see it.  Thus, it will be much more meaningful for investors to see the full liability presented on the balance sheet, and let municipalities provide disclosure about the possibility that such liability could be reduced or eliminated.  I hope the GASB moves forward expeditiously with its OPEB project.[41]

Keep in mind that all the good work that GASB is doing in this area means nothing if jurisdictions do not follow GASB standards.  According to the most recent information I could locate, just over two-thirds of the 30,000 or so largest state and local municipal issuers use GASB standards.[42]  Data were not available for the extent to which an additional 20,000 smaller municipal issuers use GASB standards, but I would hazard a guess that their rate of compliance with GASB is lower than the larger issuers.[43]

We need a legislative fix to mandate the use of GASB standards for municipal issuers — whether it is a grant of authority to the Commission to recognize GASB standards as they do the FASB’s, or as a condition placed on the bonds’ exempt status.[44]  This should help drive better transparency for investors in the muni market.

I have spoken time and again about the Commission’s need to pursue a rational agenda given the myriad shiny objects, the politically motivated initiatives such as Conflict Minerals, that seek our attention ahead of our core blocking and tackling duties.[45]  It is critical that we make progress on fixed income market reforms as soon as possible.[46]

As my friend and colleague Commissioner Piwowar aptly stated in a recent speech, the SEC’s stove does indeed seem to have 50 front burners.[47]  This is at least an improvement from the SEC’s old model, where all the important pots were boiling over on the backburner, while we carefully tended to irrelevant Dodd-Frank saucepans.  The fixed income market pot is at a steady simmer — and at last we have a chance to intervene in an issue before another mess occurs.  I am optimistic that we can move in the right direction to address all the issues I’ve discussed today, but there’s a lot to do and a long way to go.

Thank you for your time today, and I hope you enjoy the rest of the conference.

[1] See e.g., Commissioner Daniel M. Gallagher, Speech, “Remarks Regarding the Fixed Income Markets at the Conference on Financial Markets Quality” (Sept. 19, 2012), available at; Commissioner Daniel M. Gallagher, Speech, “Remarks at Municipal Securities Rulemaking Board’s 1st Annual Municipal Securities Regulator Summit” (May 29, 2014) (“MSRB Speech”), available at; Commissioner Daniel M. Gallagher, Speech, “Remarks to the Georgetown University Center for Financial Markets and Policy Conference on Financial Markets Quality” (Sept. 16, 2014), available at

[2] See e.g., Commissioner Louis A. Aguilar, Speech, “Advocating for Investors Saving for Retirement” (Feb. 5, 2015), available at; Speech Commissioner Kara M. Stein, Speech, “Keynote Address at Columbia Law School Conference on Current Issues in Securities Regulation: The ‘Hot’ Topics” (Nov. 21, 2014), available at; Commissioner Michael S. Piwowar, Speech, “Remarks at the 2014 Municipal Finance Conference presented by The Bond Buyer and Brandeis International Business School” (Aug. 1, 2014), available at; Chair Mary Jo White, Speech, “Intermediation in the Modern Securities Markets: Putting Technology and Competition to Work for Investors” (June 20, 2014), available at

[3] See Commissioner Louis A. Aguilar, Speech, “Advocating for Investors Saving for Retirement”(Feb. 5, 2015), available at; Commissioner Kara M. Stein, Speech, “Keynote Address at Columbia Law School Conference on Current Issues in Securities Regulation: The ‘Hot’ Topics” (Nov. 21, 2014), available at; Commissioner Michael S. Piwowar, Speech “Remarks at the 2014 Municipal Finance Conference presented by The Bond Buyer and Brandeis International Business School” (Aug. 1, 2014), available at

[4] See Chair Mary Jo White, Speech, “Intermediation in the Modern Securities Markets: Putting Technology and Competition to Work for Investors” (June 20, 2014), available at; Commissioner Daniel M. Gallagher, “Remarks to the Georgetown University Center for Financial Markets and Policy Conference on Financial Markets Quality” (Sept. 16, 2014), available at

[5] See Federal Reserve Board, “Flow of Funds Accounts of the U.S.” at Table L.211 Third Quarter 2014 (providing market capitalization numbers for municipal securities) (“Fed Flow of Funds”), available at

[6] See Fed Flow of Funds at Table L.212 Third Quarter 2014, “Corporate and Foreign Bonds” (providing outstanding notional values of corporate debt and holdings of foreign issues by U.S. residents).

[7] See SIFMA, “U.S. Corporate Bond Issuance;” available at

[8] See SIFMA “US Bond Market Trading Volume Data” (note the total volume includes municipal securities, Treasury securities, Agency MBS, non-Agency MBS, ABS, corporate debt, Federal Agency securities), available at

[9] And as Chair of the Board of Governors of the Federal Reserve recently testified, the Fed continues to believe that the conditions of today’s economy “warrant keeping federal funds rate below levels the Committee views as normal in the longer run.” See Semiannual Monetary Policy Report to the Congress Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, Washington, D.C. (Feb. 24, 2015), available at;see also, Monetary Policy Report dated February 24, 2015, available at

[10] See Izabella Kaminksa, “The liquidity monster that awaits,” Financial Times (November 21, 2014) citing Mark Carney,  Governor of the Bank of England and Chair of the Financial Stability Board, Speech, “The Future of Financial Reform” (Nov. 17, 2014) (Carney notes that the new prudential regulations have “reduced incentives for banks to warehouse risk positions.”) (“Carney Speech – the Future of Financial Reform”), available at

[11] See MarketAxess “Primary Dealer Corporate Bond Inventory” available at

[12] See Carney Speech – the Future of Financial Reform at 10.

[13] See Dave Michaels, “Corporate Bond Market Poses Systemic Risk, SEC’s Gallagher Says,” Bloomberg Business (Mar. 2, 2015), available at

[14] See Lisa Abramowicz, “Major Firms Are Saying the Stage is Set for Another Crisis in the Bond Market,” Bloomberg Business (Feb. 26, 2015), available at

[15] Id.

[16] Id.

[17] Id.

[18] See Commissioner Daniel M. Gallagher, Speech, “Remarks to the Georgetown University Center for Financial Markets and Policy Conference on Financial Markets Quality” (Sept. 16, 2014), available at

[19] See Nabila Ahmed, Matthew Leising and Dave Michaels, “Bond Conundrum Leads Fund Managers to Plot Fixes: Credit Markets,” Bloomberg Business (Feb. 25, 2015), available at

[20] Commissioner Daniel M. Gallagher, “Remarks to the Georgetown University Center for Financial Markets and Policy Conference on Financial Markets Quality” (Sept. 16, 2014), available at

[21] See Fed Flow of Funds.

[22] See U.S. Securities and Exchange Commission, Report on the Municipal Securities Market (2012), (“2012 Muni Report”), available at

[23] For example, a dealer may receive a “buy” order, from a customer, go into the market and buy the security for the dealer’s own account, and then immediately turn around and sell that security to the customer, thereby acting as principal rather than purchasing the security in the market on the customer’s behalf as an agent.  See MSRB Speech.

[24] 2012 Muni Report at 132.

[25] See also Commissioner Michael S. Piwowar, Speech, Advancing and Defending the SEC’s Core Mission (Jan. 27, 2014), available at (noting that “while commissions on agency transactions must be disclosed, the same is not true for markups and markdowns on riskless principal transactions, even though the trades are economically equivalent,” and characterizing that as “low-hanging fruit” that could be picked to enhance the fixed-income markets).

[26] See e.g., MSRB Regulatory Notice 2014-20, “Request for Comment on Draft Rule Amendments to Require Dealers to Provide Pricing Reference Information on Retail Customer Confirmations;” available at

[27] See MSRB Regulatory Notice 2014-22, “SEC Approves MSRB Rule G-18 on Best Execution of Transactions in Municipal Securities and Related Amendments to Exempt Transactions with Sophisticated Municipal Market Professionals” (Dec. 8, 2014), available at

[28] I know that not all in the market have embraced this action — the look-back period can be burdensome on issuers, and intermediaries have felt pinched.  Indeed, I have decried the SEC’s pursuit of intermediaries in other areas where it seems to be taking the easy way out, rather than pursuing the principal.  Of course, in this area, the SEC cannot pursue the principal directly, except through the limited use of antifraud authority as indicated, and so can only pursue the intermediary.  I very much dislike indirect regulation of this nature, and that is part of the reason I support looking at reforms to the Commission’s authority in this area.

[29] See Lynnette Kelly, Speech, “Remarks of Lynnette Kelly, Executive Director at the Bond Buyer National Municipal Bond Summit” (Mar. 2, 2015), available at

[30] See MSRB Speech.

[31] I’ll spare you the suspense.  Lemonade stands will be designated as systemically important.  Expert forecasts of global warming’s effects on summer temperatures create a risk that the sudden withdrawal of sweet, tangy liquid relief from the U.S. financial system could cause a sudden collapse.  If you doubt me, this is at least as plausible as FSOC’s designation of insurance companies.

[32] See MSRB Speech.  If pension obligations are equivalent in seniority to general obligation debt, then the municipality’s GO bond yield would be the proper discount rate.  But if pension obligations are to be considered inviolate, then the Treasury zero–coupon yield curve — a nearly risk-free rate — should be used instead.

[33] See MSRB Speech (noting that the difference is primarily attributable to the use of an economically-inappropriate discount rate, but that assumptions about future asset growth have also been unrealistically rosy).  Other assumptions, such as retiree longevity, may also be flawed.  See Knowledge@Wharton, Underfunded Pensions: Tackling an ‘Invisible’ Crisis (Jan. 26, 2015) (discussing a conference at which Stanford Professor Joshua Rauh presented, noting that “However, between 2009 and 2013, the stock market rebounded. ‘You might have thought that in a period when the [S&P 500] rose by 75%, that would have eroded much of the unfunded liabilities,’ Rauh said. But his research showed that, measured by GASB standards, four out of 10 major cities (New York, Chicago, Jacksonville, Florida, and Philadelphia) have actually seen a rise in their unfunded liabilities recently.  The other six saw only modest improvements; their unfunded liabilities fell by an average of 16%.  Rauh noted that liabilities have continued to grow, or shrunk only marginally, in part, because actuarial assumptions have proven to be too optimistic about such factors as employee longevity and about how many workers were going to take advantage of early retirement programs.”).

[34] See Hilary Russ, New public pension accounting rules raise red flags–Fitch, Reuters (Feb. 13, 2015) (citing specific drops of 49.1% to 27.9%, and from 51.5% to 28.5%, respectively).

[35] See Elizabeth MacDonald, Chris Christie’s Biggest Problem, Fox Business (Feb. 25, 2015), at (noting that the state also faces $53 billion in unfunded health care liabilities).

[36] See Meaghan Kilroy, Fitch: GASB 67 a mixed bag for public pension funds, Pensions & Investments (Feb. 13, 2015) (quoting Fitch report as stating: “In an accident of timing, the transition to GASB 67 is taking place at a very favorable moment in the economic cycle for reporting asset valuations.  In most cases, the market value of assets reported by systems under GASB 67 is much higher than the smoothed asset value reporting previously.”).  For example, Fitch cites the Oklahoma Public Employees Retirement System as improving from a funded ratio of 88.6% to 97.9% under new standards.  Id.

[37] Specifically, given the discussion in the first half of this speech, I’m concerned that asset values in the fixed-income portion of a portfolio could decrease quite rapidly if there are disruptions in the bond market caused by rising interest rates.  Moreover, retirement plans tend to have asset allocations set by the plan’s board or investment committee.  If bond valuations gap down, these funds may look to sell equities and buy bonds in an attempt to rebalance the portfolio.  Whether this could mitigate a bond market crisis, or just result in even more significant losses for retirement plan assets, is unknown.  I am similarly worried that a rise in interest rates could cause a decline in the equities markets, as occurred in 2013 when the announcement of contemplated withdrawal of the Federal Reserve’s accommodative monetary policies caused a market drop (the so-called “taper tantrum”).  There is continued evidence that the market valuations are pegged on the continuance of the Fed’s ZIRP rather than economic fundamentals.  See, e.g., Evelyn Chang, US stocks fall sharply on fears of pending rate hikes; Dow below 18k, CNBC (Mar. 6, 2015), at (quoting an analyst that “good news is bad news again”).  Given this topsy-turvey world, I would hope that municipalities with plans whose funded ratios are improving are nonetheless taking advantage of this period of relatively good economic news to make significant process towards a 100% funded ratio.

[38] Compare Editorial, Illinois’s New Math; Rauner puts pension reform at center of his first budget, WSJ (Feb. 18, 2015), available at, with Heather Haddon & Josh Dawsey, Court Rejects Christie Pension Funding Cuts; Judge’s decision adds uncertainty to state budget negotiations, WSJ (Feb. 24, 2015), available at

[39] To ensure that investors receive adequate disclosures, I continue to believe that issuers should be making supplemental disclosures to close the gap.  Specifically, in my MSRB speech last May, I called for issuers to make supplemental disclosures of the amount of their liability valued at a risk-free rate, and of the baseline plan contribution actuarially-required to fully fund the liability.  See MSRB Speech.  I similarly continue to support Lynn Turner’s suggestion that plans should make specific disclosures, similar to “going concern” disclosures, when legislatures’ underfunding threatens those plans’ solvency.  See id.  Disclosure of these metrics would be a powerful defense, in my view, to allegations of deficient disclosures regarding muni pension liability.

[40] See GASB, Other Postemployment Benefits (OPEB), at  See also, e.g., Mark Peters, Illinois Supreme Court Rules Against Cuts in Retiree Health Benefits; Ruling Casts Doubts on Overhaul to Public Employee Pensions Passed Last Year, WSJ (July 3, 2014), available at

[41] Of course, much of that project is intended to align accounting for OPEB with the new pension standards.  To the extent that the final OPEB standards could avoid the two areas discussed herein where the new pension standards could be improved (use of blended rates and elimination of the ARC), that would obviously be preferable.

[42] See GASB, Research Brief:  State and Local Government Use of Generally Accepted Accounting Principles for General Purpose External Financial Reporting (Mar. 2008) (surveying 31,221 of the largest state and local governments, resulting in an estimated range of 67.3 to 71.5 percent).  However, this is a somewhat rough estimate; there are a lot of uncertainties.

[43] See id. (noting that there are 50,500 governments with outstanding municipal debt, 19,329 of which are smaller and were not surveyed).  It is plausible that more of these smaller municipal issuers would tend to use a cash basis or other basis of accounting rather than GASB’s full accrual basis.

[44] Granting authority to the SEC to designate the GASB’s standards as “generally accepted” was a solution suggested in the 2012 Muni Report.  See 2012 Muni Report at 136-37.  This could either be a stand-alone mandate, or as part of a broader grant of authority for the SEC to establish the form and content of municipal disclosures, including the financial statements set forth therein.  Cf. Securities Act § 19.  Alternatively, a simple legislative mandate to use GASB standards as a condition of maintaining the Securities Act exemption would also work, although the mandate would need to be nuanced, as there are some circumstances in which the use of other standards could be appropriate.  For example, it may be appropriate for a conduit bond obligor that is an operating company, as opposed to a government or pension plan, to report using U.S. GAAP as established by the FASB.  (Of course, it is far from clear that conduit bond obligors should be exempt issuers.  See 2012 Muni Report at 135-36 (seeking elimination of exemptions for conduit bond obligors who are not themselves municipal entities, given disproportionately high default rate of conduit bonds).

[45] See e.g., Commissioner Daniel M. Gallagher, Speech, “SEC Priorities in Perspective” (Sept. 24, 2012), available at; Commissioner Daniel M. Gallagher, Speech, “The Importance of the SEC’s Rulemaking Agenda — You Are What You Prioritize,” (Oct. 24, 2014), available at

[46] The time for reform is ripe.  In its 2012 Muni Report, the Commission advanced a package of potential legislative forms, regulatory fixes, and market initiatives that would improve municipal disclosures without the need for a full repeal of the Tower Amendment.  2012 Muni Report at 133–42.  More recently, the MSRB took the unusual step of submitting a comment letter on a routine Paperwork Reduction Act renewal of Rule 15c2–12 seeking substantive changes to that rule.  See Letter from Kym Arnone, Chair, MSRB to Pamela Dyson, CIO, SEC, Request for Comment on Collection of Information Provided for in Rule 15c2-12 under the Securities Exchange Act of 1934 (Jan. 20, 2015).  And my friend and colleague Commission Aguilar has issued a loud call for comprehensive muni market reform, including even a repeal of Tower.  See Commissioner Luis A. Aguilar, Speech, “Advocating for Investors Saving for Retirement” (Feb. 5, 2015), available at; Commissioner Luis A. Aguilar, Public Statement, “Statement on Making the Municipal Securities Market More Transparent, Liquid, and Fair” (Feb. 13, 2015), available at  I am somewhat skeptical regarding a full repeal of Tower — for one, I’m not sure how the Division of Corporation Finance would cope with full review authority over municipal issuers when they outnumber corporate issuers roughly 4-to-1 — but I fully support his suggestion that we pick this issue back up, and try to accomplish key changes in this area with all due speed.  To that end, I agree that looking to the Commission-endorsed 2012 Muni Report as a starting point could be a productive way forward.

[47] See Commissioner Michael S. Piwowar, Speech, “Remarks at the ‘SEC Speaks’ Conference 2015:  A Fair, Orderly, and Efficient SEC” (Feb. 20, 2015), available at

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Modified: March 10, 2015