Speech by SEC Staff:
"Perspectives on Public Transparency"
Martha Mahan Haines
Assistant Director, Office of Municipal Securities,
Division of Market Regulation
U.S. Securities and Exchange Commission
Second Internal Control & Fraud Conference of the
Association of Governmental Accountants
September 11, 20071
The description of this panel poses the question "Will new disclosures raise the stakes on transparency?" In my opinion, they will not. Under the federal securities laws, issuers have been responsible for the information that they provide to investors — including information in financial statements — for more than 70 years. Disclosure documents must not contain a misstatement of a material fact or omit a material fact that is necessary in order for the statements made not to be misleading. Material misstatements and omissions in financial statements provided to investors have always been covered by this standard — known as the antifraud standard. Municipal issuers are not subject to strict liability for misstatements and omissions, but they are, however, responsible for material misstatements and omissions made intentionally, with extreme recklessness, or negligence.
Unfortunately, there have been a number of enforcement actions in which units of government were found to have violated the antifraud provisions of the securities laws with respect to the financial information in their disclosure documents. For example:
- the City of San Diego, California failed to disclose the gravity of its enormous pension and retiree health liabilities or that those liabilities had placed the City in serious financial jeopardy;2
- the City of Miami, Florida failed to disclose an unprecedented cash flow shortage which it had eased, in part, by spending the proceeds of bonds issued for other purposes for operating costs;3
- Maricopa County, Arizona failed to disclose a material decline in its financial condition and operating cash flow, the substantial deficit in its general fund, and increased deficit in another fund;4
- the City of Syracuse, New York falsely claimed a surplus for its general and debt service funds, materially overstated its ending fund balances in those funds, and misled investors by describing certain financial information as audited;5
- Orange County, California made misleading statements and failed to disclose material information about the County's high risk investment pool and financial condition that brought into question the County's ability to repay its securities — facts about which members of its Board of Supervisors were aware, but failed to take appropriate steps to assure were disclosed.6
I suspect that the question that the title of this panel may have intended to ask was whether the new OPEB accounting principle G-45 will increase exposure? I do not believe that it will. First of all, the corporate world had to adapt to similar accounting principles set by FASB a number of years ago, yet based on public reports, I saw no spike in related enforcement actions. Why should the adoption of G-45 have a different result? In fact, because the corporate world went first, municipal issuers and their accountants have a close model which may be useful to consider when implementing G-45.
I have heard numerous complaints about the fact that the actuarial projections of OPEB liability are too uncertain to disclose. Perhaps I am being unfairly cynical, but I hear such complaints most often from governments who, as a result of G-45, must disclose huge OPEB costs that may significantly impact their budgets and force public officials to make hard, highly visible, funding decisions. Those are among the reasons why the information OPEB is so often of obvious materiality to investors. Hiding OPEB costs does not make them go away. Rating agencies and investors will still consider OPEB to be important. Changing state laws to permit such behavior does no favors. Ignoring the elephant in the living room doesn't mean it isn't there. It just makes cleaning up the mess the next guy's problem. Just ask the City of San Diego about the pain recklessly putting problems off to the future can cause when that future ultimately arrives!
Both the Commission and Congress understand the difficulty of making accurate forward looking statements. They do not expect you to be able perfectly to foresee the future. In fact, both the Securities Act of 1933 and the Securities Exchange Act of 1934 have sections specifically establishing a "safe harbor" for forward looking statements. Because municipal issuers are not subject to the registration and reporting régime applicable to public companies, this safe harbor is not applicable to municipal issuers. Nevertheless, it provides useful guidance. In order to fall under the safe harbor, a forward-looking statement must be identified as a forward-looking statement, and be accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward looking statement. Note that I am speaking only in generalities. You should discuss this with counsel in advance of the release of an actual disclosure.
I assume you are all wondering when I'll get to Chairman's statements about governmental accounting in his recent letter to certain Congressional leaders and in staff's related White Paper? I will try to give you an overview of the portions concerning accounting, but suggest that you read the documents themselves, which are on the SEC's Internet site, for a more complete understanding of his position. In short, the Chairman believes that, compared with investors in other securities markets who benefit from numerous disclosure protections, investors in municipal securities are, in too many respects, treated like second-class investors. While these differences in the disclosure requirements for municipal securities may have been justified when the securities laws were first enacted over 70 years ago, the substantial growth of this market, high proportion of retail investors, complex structure of many offerings, and large number of municipal bonds secured by the credit of private entities, not governments, leads to the conclusion that these differences are not longer warranted. Investors, analysts, investment advisers, and broker-dealers in municipal securities all deserve the same level of current, high-quality disclosure and protection in the municipal market as they do in other capital markets.
An estimated 20,000 issuers of municipal securities use a variety of accounting methods that do not conform to GASB standards. Sometimes use of these non-GASB methods are dictated by state law. On occasion, governments that are otherwise compliant with GASB may choose not to apply specific rules with which they disagree or which would make their financial condition appear weaker. The current situation is analogous to each public company setting its own financial accounting standards. Investors in municipal bonds cannot rest assured that their interests are fully protected by the same high accounting standards that operate everywhere else in the U.S. capital markets.
The principles that the Chairman enunciated about governmental accounting are quite simple. All issuers should be required to use "generally accepted" standards for governmental accounting established by an independent accounting standard setter. The use of varying standards by municipal issuers makes it difficult for investors — even sophisticated ones — to understand governmental financial statements and often makes comparisons difficult or impossible. This increases the likelihood of misunderstandings and inhibits the ability of investors to make informed investment decisions.
The Chairman believes that the timely development of high-quality governmental accounting standards should be encouraged and supported — by providing an independent funding mechanism for the Governmental Accounting Standards Board and requiring or permitting Commission oversight of the GASB similar to its oversight of FASB, for example. The GFOA's recent actions, which threaten GASB's continued existence and funding, makes the need to assure GASB's independence obvious.
I suggest to you that the more interesting question is not whether new disclosures will raise the stakes on transparency, but "Will increased transparency raise the stakes on disclosure?" While the answer should, of course, be "No", I suspect that transparency may bring more possible violations to light or at least bring them to light sooner. If increased transparency causes issuer officials to take disclosure more seriously, it would be a good result for everyone. Issuers would avoid meeting representatives of the Commission's Division of Enforcement, saving themselves a great deal of pain, time and money. If investors in municipal securities were assured of the same easy, reliable access to timely, accurate information as investors in the corporate markets are, they would have increased confidence in the market. I expect they might invest more heavily in municipal securities, resulting in lower interest rates for issuers. Furthermore, investment advisors and brokers would be able to make better recommendations to their customers. In order to remain competitive with other markets for the investment dollars of retiring baby boomers, the municipal market needs to make some long overdue changes.
Issuers and issuer organizations assert there is no need for change because nothing is broken. They miss the point. This is like arguing that there is no need for automobiles because a horse and buggy can get you from point A to point B. Most of the U.S. capital markets have undergone, and are presently experiencing, enormous change beneficial to both investors and issuers, yet the municipal market has failed to keep up. Municipal issuers who resist all change lack the vision to see the benefits to all, including issuers, from a more transparent market — one that includes universal use of GAAP set by a completely independent standard setter.