Speech by SEC Commissioner:
Remarks before the 43rd Annual Securities Regulation Seminar
Commissioner Elisse B. Walter
U.S. Securities and Exchange Commission
Los Angeles, California
October 29, 2010
Thank you very much, John, for that kind introduction. I am delighted to be speaking to you at the Securities Regulation Seminar, and I thank the Los Angeles County Bar Association for hosting such a helpful and informative program every year. Today’s agenda is particularly interesting, with a focus on the important influence that the Dodd-Frank Wall Street Reform and Consumer Protection Act (“the Act” or “Dodd-Frank”) is having and will have on securities regulation in the weeks, months, years and decades to come.
Before I begin my remarks, though, please let me remind you again that they represent my own views, and not necessarily those of the Commission, my fellow Commissioners, or members of the staff.1
As we have already been discussing during this morning’s panels, in July of this year, the Act, arguably the most sweeping legislative reform of financial services regulation in decades, became the law of the land. Each of the areas the legislation reaches is important and more than a few impact securities regulation directly.
This morning, we have gone into some depth discussing several aspects of the legislation and more will be discussed this afternoon. So I’d like to mention just a few areas briefly and then focus on municipal securities regulation and particularly questions concerning current and potential regulation at the federal level. I believe much remains to be done in this area, even though it is touched — although lightly — by Dodd-Frank.
It’s hard to know what to highlight first about the Dodd-Frank reform initiatives affecting the Commission. The numbers provide only an illustration of the pervasive manner in which the Act is affecting the lives of those of us at the SEC: more than 100 rulemakings, more than 20 studies, and 5 new offices. Also, the full impact of the legislation will only be fully appreciated as the Commission and other agencies implement this broad range of initiatives.
One aspect of Dodd-Frank — not emphasized in today’s program — where the implementation stage will be particularly important is OTC derivatives. Title VII of the Act provides a comprehensive framework for the regulation of this market, and we are currently working with other regulators, especially the CFTC, to craft thoughtful rules relating to the trading, clearing, and reporting of OTC derivatives, among other things.
Another critical area is clearance and settlement under Title VIII. We are working with the CFTC and the Federal Reserve Board to develop a new framework to supervise systemically important financial market utilities, including clearing agencies registered with the SEC.
Title IV of the Act addresses private fund advisers, and we are preparing to propose rules regarding registration and reporting in this area. We are also working with the CFTC and other domestic and foreign regulators regarding the reporting of systemic risk information.
Title IX contains provisions that address a number of different topics — grouped generally as investor protection and improvements to securities regulation. These include reforms regarding credit rating agencies that we are implementing by, for example, undertaking rulemakings regarding internal controls and procedures, conflicts of interest, credit rating methodologies, rating methodology symbology, disclosures accompanying asset-backed securities, and removal of credit rating references in our rules.
Title IX also addresses municipal securities, an area on which I have focused both in the last few months and when I was the Deputy Director of Corp Fin two and one half decades ago. The municipal securities market is large and highly diverse, with holdings dominated by retail investors, who hold municipal securities both directly and through mutual funds. It is also a market that is critically important to our economy and national infrastructure — both for investors and also for all of us as U.S. residents, given its integral role in financing state and local environmental, educational, transportation, and health care facilities across the nation. Yet, to date, despite the size and significance of this market, it generally has been thinly regulated.
There have been some efforts at reform, however, and Congress did address municipal securities in a few important ways in Dodd-Frank. I will highlight for you a few of these changes, but you should know from the outset that I believe these efforts should only be the first step, and that much more needs to be done in this area.
Municipal Advisor Registration (Section 975)
First, the Act creates a new registration regime for municipal advisors, which are persons that advise or solicit municipal issuers and other players. Subject to certain exemptions, the definition of municipal advisor includes financial advisors, guaranteed investment contract brokers, third-party marketers, placement agents, solicitors, finders, and certain swap advisors that provide municipal advisory services. Municipal advisors are now subject to registration with the Commission and to the resulting obligations imposed by Municipal Securities Rulemaking Board (the “MSRB”) rulemaking — and, significantly, to a fiduciary duty to municipal entities they advise. Through this new regime, interestingly, the Act expands the MSRB’s umbrella to include protection of issuers of municipal securities, as well as protection of investors.
We have already begun to implement these reforms. On September 2 — in what was the first regulation adopted by the SEC to implement the requirements of Dodd-Frank — the Commission announced the adoption of a temporary rule requiring municipal advisors to register with us by October 1.2 Municipal advisors have been able to access and complete the new registration form (Form MA-T) on the SEC’s website, and as of Monday, 729 municipal advisors had registered with the Commission.
Although it was necessary for the Commission to put a temporary system in place very quickly, prior to the expiration of the temporary rule on December 31, 2011, it will endeavor to propose, seek public comment, and adopt a final permanent registration program. This program will include detailed requirements for the registration of municipal advisors.
MSRB Board Composition (Section 975)
A second key development in this area under the Act is that a majority of the MSRB Board must be public. In other words, the number of public representatives on the MSRB Board must at all times exceed the number of broker-dealer, bank, and advisor representatives. The phrase “independent of any municipal securities broker, municipal securities dealer, or municipal advisor” means that the individual has “no material business relationship” with any of these persons. The phrase “no material business relationship,” in turn, means that the individual has not been associated with any of these persons for at least two years, and that the individual does not have a relationship with any such person that reasonably could affect his or her independent judgment or decision making.3
The new MSRB Board structure took effect October 1 — and the newly-constituted Board met for the first time last week. I was privileged to spend some time with them during that meeting, and I am pleased to report that they are approaching their responsibilities thoughtfully and vigorously. I am looking forward to their efforts to continue rulemaking and oversight in the public interest.
Independent Funding for GASB (Section 978)
The Governmental Accounting Standards Board (“GASB”), a not-for-profit organization that operates under the oversight of the Financial Accounting Foundation, has been funded only by voluntary payments and contributions from states and local governments and the municipal bond community, as well as sales of its own publications. Last fall, in a speech about municipal securities, I took the position that Congress should instead provide for an independent and more reliable funding mechanism for GASB as well as Commission oversight — an approach analogous to the one in place for the Financial Accounting Standards Board.4
I was thus very pleased to see in Dodd-Frank a provision granting the Commission authority to require a national securities association — in other words, the Financial Industry Regulatory Authority — to establish a reasonable annual accounting support fee to fund GASB’s annual budget and to establish rules and procedures for the equitable allocation, assessment, and collection of the accounting support fee. Although the Act ultimately did not provide for Commission oversight of GASB, the first step of independent funding is crucial. It should help to ensure GASB’s independence as a standard setter that is able to develop high-quality governmental accounting standards without undue pressure.
The Act also requires the Government Accountability Office (“GAO”) to conduct a study regarding GASB, pursuant to Section 978, which is due to Congress by January. Commission staff is consulting with the GAO on this and other studies required by the Act.
New Office of Municipal Securities
Another relevant provision of the Act obligates the SEC to establish an Office of Municipal Securities, whose director reports directly to the Chairman. The new office will administer the rules pertaining to broker-dealers, advisors, investors, and issuers of municipal securities and coordinate with the MSRB on rulemaking and enforcement actions. We anticipate creating this office imminently and transferring over existing staff who perform these duties — and, the search for a new director is in full swing. I believe that the office will be in an excellent position to harness staff and resources from across the Commission who are involved in the municipal securities market from a variety of vantage points.
I am delighted with the establishment of this new office — it resonates with my belief in the critical importance of the municipal securities market.
Field Hearings and Potential Areas for Future Legislative Action
Notwithstanding this and other positive developments that I just described, in my view, Dodd-Frank simply scratched the surface with respect to the muni market — not going nearly far enough in protecting investors in municipal securities.
Because Chairman Schapiro shares my interest in strengthening investor protections in this area, this past spring she asked me to lead a series of field hearings across the country to elicit the analyses and opinions of a broad array of municipal market participants.5 A month ago, we launched the series of hearings with an inaugural hearing in San Francisco — and over the course of the next several months, the Commission anticipates holding additional field hearings in Washington DC, Chicago, Tallahassee, Austin, and Birmingham.
At the conclusion of all of the hearings, the Commission staff will prepare a report concerning what we have learned, including their recommendations for further action that could be pursued, which may include legislation, rulemaking, and changes in industry practice. I view these field hearings as an opportunity — for both the Commission and myself — to take a fresh look at the way the municipal securities market works and to effect real regulatory change. Although I have thought about these issues for a long time, and have publicly expressed my views about the need for legislative and regulatory changes, I am committed to listening and learning during the field hearings, to deepening and broadening my knowledge base, and to reexamining and (perhaps) changing my opinions as a result. Similarly, I believe that if the staff wrote its report today, that report would look very different than the report it will ultimately write at the end of our series of field hearings.
As I mentioned, I believe that Dodd-Frank merely scratched the surface with respect to municipal securities. I’d like to highlight for you a few additional legislative changes that I have been vocal about in the past — and that we will be exploring in our field hearings.
One legislative change that I have argued for in the past — and which the Commission has advocated — is a requirement that non-governmental conduit borrowers be subject to mandated registration and disclosure as would be the case if they issued their securities directly without using municipal issuers as conduits.6
Conduit bonds are frequently issued by municipalities on behalf of third parties. They are referred to as “conduits” because the municipality acts as a “conduit” through which the third party receives money from investors. The investors lend money to the municipal entity, which then lends the money to a third party and the third party then repays the debt. The credit of the third party backs the conduit bond, and the debt, while technically issued by the municipal entity, is non-recourse to such municipal entity. As a result, investors must look to payments from the third party, whether the hospital, college, or private company, for repayment of the bonds. Municipalities typically issue conduit bonds to finance the construction, purchase, or lease of dormitories, hospitals, private colleges, or manufacturing and other types of facilities to be constructed and operated by the third party. Using a municipal entity as the financing vehicle to obtain monies from the public, allows these non-municipal entities to obtain financing at tax-exempt interest rates generally available only to municipal issuers.
The conduit issue is important, but it involves only a portion of the municipal marketplace. The biggest limitation on our ability to regulate and oversee this market stems from the fact that Congress — back in 1933 and 1934 — exempted offerings of municipal securities from the registration requirements and civil liability provisions of the Securities Act of 1933 (“‘33 Act”) and the system of periodic reporting under the Securities Exchange Act of 1934 (“‘34 Act”). Thus, the Commission is constrained in requiring municipal issuers to comply with mandatory disclosure requirements or — as I stated a moment ago — to apply GASB principles.
I have suggested in the past that Congress should repeal the exemptions for municipal securities from the ‘33 and ‘34 Acts. Given the wide range of purposes and structures of the over 50,000 municipal issuers, however, I would certainly not propose to treat municipal securities exactly like corporate securities — and I do not believe that a one-size-fits-all approach would be appropriate. Nonetheless, appropriate legislative change would allow the Commission to take important steps to improve the quality and availability of municipal issuer information to investors.
I look forward to exploring these and many other issues during our field hearings, and to seeing and considering the staff’s ultimate recommendations.
Other Developments in Municipal Securities Regulation
Despite the limitations on our jurisdiction in this area, there are many things that the Commission can do — let me share some of these things with you.
For example, and importantly, the Commission has worked to protect investors in municipal securities for the past 21 years by exerting its authority over entities that underwrite or sell municipal securities. In 1981, the Commission adopted Rule 15c2-12, under the Exchange Act, as a means to foster transparency in the municipal securities market. The rule, as it has been amended over the years, generally prohibits underwriters from purchasing or selling municipal securities unless they have reasonably determined that the municipality or other designated entity has agreed to make certain key information available to investors on an ongoing basis.
Despite the disclosure obligations in the rule, until recently, average investors in municipal securities had no free and convenient way to get important information about the municipal bonds in which they invest. In 2008, the Commission adopted amendments to Rule 15c2-12 that made the MSRB the central repository for ongoing disclosures by municipal issuers. It also approved a separate MSRB rule change, which enabled the MSRB’s Electronic Municipal Market Access system — EMMA — to make these disclosures available to investors similar to the way that the SEC’s EDGAR system does for corporate disclosures.
This past May, the Commission further strengthened Rule 15c2-12, by imposing additional requirements with respect to the disclosure of specified events. The amendments strengthen the rule's requirements with respect to the scope of securities covered, the nature of the events that issuers must have agreed to disclose, and the time period in which disclosure is to be made.
Anti-Fraud and Enforcement
In addition to our authority over intermediaries — we have broad antifraud authority over all participants in the municipal securities market. The Commission has acted under the anti-fraud provisions to bring enforcement actions against people and entities, including issuers of municipal securities. In 1994, along with its changes to Rule 15c2-12, the Commission issued an interpretive release to provide guidance to the market participants concerning the types of municipal market questions that may raise issues under the antifraud provisions.
To strengthen and streamline our enforcement efforts in this area, the Commission recently created a Municipal Securities and Public Pensions Unit as one of five national specialized units organized in the Enforcement Division. Under the leadership of Elaine Greenberg and Mark Zehner of our Philadelphia Office, this unit is expanding our enforcement presence in the municipal area, building a comprehensive program that will develop case law and legal precedent through high-impact cases. It is also proactively seeking to identify market activities that pose the greatest risk of harm to investors and are indicative of potential violations.
The unit currently is focusing its efforts on investigating and pursuing enforcement actions in specific categories of misconduct, including: (1) offering and disclosure fraud; (2) tax or arbitrage-driven fraud; (3) pay-to-play and public corruption violations; (4) public pension accounting and disclosure violations; and (5) valuation and pricing fraud.
You’ve probably all heard about our recent case against the State of New Jersey — the Commission’s first case ever against a state for violations of the federal securities laws. In that case, the Commission charged the State of New Jersey with securities fraud for misrepresenting and failing to disclose to investors that it was underfunding the state’s two largest pension plans. New Jersey agreed to settle the case without admitting or denying the SEC’s findings. We have heard from various participants in the municipal securities market that the New Jersey case was a real eye-opener — and we hope that it serves to inspire more accurate and robust disclosure by municipal securities issuers.
Another recent SEC settlement that should serve to highlight how seriously we view these types of disclosure deficiencies is this week's settlement with four former San Diego officials, who each played a key role in misleading investors in municipal bonds about the city's fiscal problems related to its pension and retiree health care obligations. That settlement represents the first time that the SEC has secured financial penalties against city officials in a muni bond fraud case.
I hope that this brief tour through the municipal securities landscape has been interesting to you. If you have observations or opinions on these issues that you would like to share with us, I would encourage you to do so. We really do value public input on all the issues that we face as regulators. Thank you again to the LA County Bar for having me here today — and thank you all for your attention.
1 The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publications or statements by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission, other Commissioners, or the staff.
2 See Temporary Registration of Municipal Advisors, Release No. 34-62824; File No. S7-19-10 (Sept. 1, 2010), 75 Fed. Reg. 54465 (Sept. 8, 2010).
3 See Self-Regulatory Organizations; Municipal Securities Rulemaking Board; Notice of Filing of Amendment No. 1 to and Order Granting Accelerated Approval of a Proposed Rule Change, as Modified by Amendment No. 1, to Amend Rule A-3, on Membership on the Board, to Comply with the Dodd-Frank Wall Street Reform and Consumer Protection Act, Release No. 34-63025; File No. SR-MSRB-2010-08 (Sept. 30, 2010), 75 Fed. Reg. 61806 (Oct. 6, 2010).
4 See Commissioner Elisse B. Walter, Regulation of the Municipal Securities Market:
Investors Are Not Second-Class Citizens, 10th Annual A. A. Sommer, Jr. Corporate, Securities and Financial Law Lecture, New York, NY (October 28, 2009) available at http://www.sec.gov/news/speech/2009/spch102809ebw.htm (“Sommer Lecture”).
5 See Chairman Mary L. Schapiro, Remarks at Investment Company Institute 2010 General Membership Meeting (as delivered by Andrew J. Donohue), Washington, D.C. (May 7, 2010) available at http://www.sec.gov/news/speech/2010/spch050710mls.htm.
6 See Sommer Lecture, supra note 4.