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U.S. Securities and Exchange Commission

The Importance of Control Structure to Municipal Disclosure

Stanley Keller

One of the key lessons from Sarbanes-Oxley in the corporate securities world is that effective disclosure controls and procedures and internal controls, especially over financial reporting, along with appropriate governance structures, do make a difference. They are a necessary part of the system designed to ensure quality and timely disclosures and financial reporting by creating a disciplined approach, a focused process, constructive but skeptical oversight, and accountability.

The question is how these lessons can be translated and applied to municipal disclosure, recognizing that governmental entities are quite different than private corporations. We have seen a number of SEC municipal enforcement actions that have cited inadequate practices and procedures as a contributor to faulty disclosure, ranging from the action against San Diego to the recent action against the State of New Jersey. SEC officials have spoken from time to time on the subject, for example, then Enforcement Director Linda Thomsen’s 2007 speech entitled “Lessons Learned from San Diego.”

I will use San Diego, for which I was the Independent Consultant and Monitor under the City’s SEC Consent Order, to illustrate what could be done — not as a model, because there is no one size fits all given the great variability of governmental structures, cultures, complexity of the situation and frequency to market, and one could say the San Diego situation was unique. However, it is an example from which others can draw lessons to adapt to fit their needs.

Without getting into too much detail at this point — for that you can look at my Final Report as Independent Consultant to the City* — here are key elements of what San Diego put in place:

  • Written disclosure controls and procedures.
  • A Disclosure Practices Working Group (the equivalent of a disclosure committee).
  • Creation of a legislative Audit Committee with citizen financial experts to provide oversight.
  • A process for review of the annual financial statements and related disclosures.
  • Certification requirements.
  • Establishment of an independent internal audit function.
  • Creation of a legislative budget office.
  • Initiation of an internal control over financial reporting system.
  • Training of key personnel.
  • Having qualified internal and external professional advisers.
  • Finally, and not least, restructuring of the governance system so that there was clear responsibility, accountability and expertise.

As I said, this is not a model to be replicated by rote, but rather a menu of choices to be selected from and adapted. In my judgment, less important than the actual structures put in place, is the process of evaluating how the existing disclosure and financial reporting system works and considering in a focused way how it can be improved.

What can the SEC do to foster this process of focusing on and developing a disclosure controls and internal controls regime? There are a number of possibilities.

  • First, I would not discount the impact of use of the bully pulpit through Commission and staff pronouncements and other means, such as speeches, roundtables and advisory committees.
  • Second, there are always enforcement actions to get people’s attention when they are justified.
  • Next, using the existing scheme of regulating the municipal sector through regulation of municipal underwriters, the Commission could make clear that an underwriter, in order to have a reasonable belief as to the municipal issuer’s key representations, should consider the issuer’s control environment. This approach was recently followed to enhance continuing reporting. If more formal action were necessary, I believe the Commission could use Rule 15c2-12 to add this requirement to a municipal underwriter’s ability to act as underwriter, for example, by requiring it to obtain a report from the issuer on its disclosure procedures and internal controls, not a certification as to adequacy.
  • Use of voluntary commitments to provide annual disclosure and certification regarding controls to the MSRB EMMA system.
  • Of course, imposition of control requirements on municipal issuers directly, akin to those under Sarbanes-Oxley, could be established under a new regulatory regime with necessary legislative change, but I do not see that as necessary at this time in order to make progress on development of effective control structures.

Whatever approach is followed, I think it is important that the Commission not take a prescriptive approach but rather encourage development of control structures that work for individual issuers. Indeed, this could be done on a phased basis that focuses first on the largest and most frequent issuers. The objective should be to get these issuers to focus on their disclosure procedures and internal controls, with an eye towards improving them in a manner that works best for them.

I hope these are helpful thoughts because I do believe that improved disclosure controls and procedures and internal controls is a key step to enhance the quality of municipal disclosure and financial reporting.

* Available at http://dockets.sandiego.gov/sirepub/pubmtgframe.aspx?meetid=642&doctype=Agenda



Modified: 09/27/2010