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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Securities Laws and the Municipal Issuer: Points for the Electronic Era

Remarks of

Paul S. Maco

Director, Office of Municipal Securities
U.S. Securities & Exchange Commission

Before the Joint Annual Conference of the National Council of Health Facilities Authorities and the National Association of Higher Education Facilities Authorities
Boise, Idaho
September 13, 2000

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of Mr. Maco and do not necessarily reflect the views of the Commission, the Commissioners, or other members of the Commission's staff.

Good morning. I am delighted to once again have an opportunity to meet with you. As I did before, let me remind you that my comments today reflect my own point of view and may not be shared by my colleagues on the Commission Staff or by the Commission itself.

Within the last year, Commission action on several fronts has generated a good deal of discussion among you and other municipal market participants. This morning I will address several of them, including the adoption of Regulation FD, this Spring’s internet disclosure release, and enforcement actions involving fraudulent disclosure in the secondary market, most notably our actions involving AHERF, the Allegheny Health, Education and Research Foundation.

First, Regulation FD. Recently, there has been a lot of talk among municipal finance professionals about the potential liability of issuers who disclose information to some investors before it is available to other investors. A lot of the discussion centers on a rule recently adopted by the Commission known as Regulation FD (Fair Disclosure)1. The first thing that you should know about Reg. FD is that it does not apply to municipal securities; it is not based on the antifraud provisions of the securities laws. It does apply to the selective disclosure of material nonpublic information by companies registered with the Commission. It addresses a very specific problem found in the world of equity securities. For example, a registered company might invite a group of analysts to participate in a conference call in which the last quarter’s earnings are disclosed to those analysts, but not to the public in general until a later time.

Regulation FD is designed to promote the full and fair disclosure of information by issuers, and to clarify and enhance existing prohibitions against insider trading. The Commission does not believe that allowing issuers to disclose material information selectively is in the best interests of investors or the securities markets generally. The Commission wants all investors to compete on a level playing field and, to the maximum extent practicable, to have access to an issuer's material disclosures at the same time.

Now if there is one thing that you should take home from our meeting, it is this: Regulation FD does not apply to municipal securities. However, as is often the case with other Commission regulations, rules and positions for registered securities, in some situations, Reg. FD might be a useful source of guidance for municipal securities issuers and practitioners. For example, if you want to "speak to the market" because you are concerned that information may have been revealed to a few, but not all, investors, why not promptly send a notice to the NRMSIRS and take a cue from Reg. FD by issuing a press release?

Now, Internet Disclosure. The Commission, from time to time, provides guidance relating to topics of general interest to the business and investment communities by issuing "interpretive" releases containing its views on a topic and interpreting the federal securities laws and its own regulations in connection with the topic. In such a release this Spring, the Commission explained its view on the use of electronic media.2 There are several points I am going to make about this release, but I first want to clear up a misunderstanding – again in the talk in the municipal community - about the concept of republication.

Using the example of a press release, the Commission observed that "a statement may be considered to be "republished" each time that it is accessed by an investor or, for that matter, each day that it appears on the web site. Commentators have suggested that if a statement is deemed to be republished, it may potentially give rise to liability under Section 10(b) of the Exchange Act and Rule 10b-5." (emphasis added). After this observation, the Commission the requests comment "on how to facilitate the availability of historical information on the Internet consistent with the federal securities laws." Some in the municipal finance community have taken these words to mean that the Commission adopts the concept of republication and related liability. But the release doesn’t say that. It does say that commentators have suggested as much, but doesn’t go so far as to agree with them. Rather, the Commission asks the question I mentioned a few minutes ago, seeking input from market participants to suggest approaches that may avoid liability while providing historical information. The commentators cited by the Commission observe that plaintiffs in several class action lawsuits have filed pleadings on this basis, and the market should be aware that private parties are already arguing the republication theory of liability in the courts. The Commission, I repeat, has not taken a position on this point.

Use of Electronic Media has several points specifically for municipal issuers. As you recall, Rule 15c2-12 requires municipal securities underwriters of primary offerings to, among other things, obtain and review an official statement that the municipal securities issuer deems final; send the final official statement to any potential customer; and in negotiated sales, send the most recent preliminary official statement, if one exists, to any potential customer.

Under Rule 15c2-12, a final official statement can be a single document or set of documents. In a municipal securities offering, if a municipal securities issuer puts its official statement on its web site and also establishes hyperlinks to other web sites, a question arises as to what constitutes the final official statement that a municipal securities underwriter has an obligation to obtain and send to potential customers. For purposes of satisfying its obligations under Rule 15c2-12, a municipal securities underwriter may rely on the municipal securities issuer to identify which of the documents on, or hyperlinked from, the issuer's web site comprise the preliminary, deemed final and final official statements, even if the issuer's web site contains other documents or hyperlinks to other web sites.

Hyperlinks embedded within an official statement itself, however, will be considered part of the official statement, even if a municipal securities issuer has not specifically identified the embedded hyperlinked information. For any municipal securities offering subject to Rule 15c2-12, the paper and electronic versions of each of the preliminary, deemed final and final official statements must be the same.

The Commission did not address the implications of online municipal securities offerings, but encouraged comment on this topic.

The Commission reminded municipal securities issuers and other municipal securities market participants, however, of the potential issue that arises if the municipal securities offering also involves an offering of a separate security that is not being sold pursuant to the exemption from registration contained in Section 3(a)(2) of the Securities Act3. If the municipal securities offering involves an offering of a separate security that is being sold in reliance on an exemption from registration contained in Section 4(2) of the Securities Act4, or Regulation D, 15 U.S.C. §77d(2)5, or in a registered offering, the discussion in the release of Online Private Offerings applies. Municipal securities offering participants wishing to offer municipal securities online are cautioned to evaluate carefully whether any separate security is being sold.

Finally, in the release, municipal securities issuers are reminded that, whether or not the offering of their securities is exempt from Rule 15c2-12, the anti-fraud provisions of the federal securities laws apply to their official statements and other disclosures.

Shortly after issuing the interpretive release Use of Electronic Media, the Commission instituted proceedings and announced settlements in actions arising out of AHERF.

AHERF, at its height, was the largest nonprofit health care organization in Pennsylvania. From 1987 to 1997, AHERF expanded rapidly, acquiring other non-profit healthcare organizations, including several in the Philadelphia metropolitan area: the Medical College of Pennsylvania, United Hospitals, Inc., Hahnemann University Hospital and the Graduate Health System. The acquired entities became direct or indirect subsidiaries of AHERF. As an umbrella holding company, AHERF managed and provided centralized corporate support services for the acquired entities, but did not assume liability for their pre-existing debt. The obligation to repay debt within AHERF was placed on collections of one or more of its non-profit subsidiaries known as "obligated groups." By 1997, AHERF had five obligated groups: Allegheny General Hospital, Allegheny University Medical Centers, Delaware Valley, Allegheny Hospitals, Centennial, and Allegheny Hospitals, New Jersey. On July 21, 1998, AHERF and four of its subsidiaries filed for protection under Chapter 11 of the U.S. Bankruptcy Code. By the time of the bankruptcy in July 1998, AHERF's obligated groups were responsible for, at least, thirteen bond issues, with outstanding debt of more than $900 million.

The individual issues ranged from $12.7 million to $306 million, the latter incurred on behalf of Delaware Valley in a 1996 refinancing of its older bonds (the "Delaware Valley refinancing"). At least $400 million of AHERF bonds were not credit enhanced, meaning that they were not supported by a letter of credit or bond insurance. The obligated groups, through AHERF as their agent, provided to nationally recognized municipal securities information repositories annual Secondary Market Disclosure Reports containing audited financial statements, debt coverage ratios and other information with respect to certain of its obligated groups. These Disclosure Reports were made available to the public through the repositories and were the most easily accessible source of information for investors and potential investors in AHERF bonds. The obligated groups also were required by contract to periodically disclose financial information to, among others, credit enhancers and bond trustees, and some of the agreements required certifications by company officers as to the accuracy of the submitted information.

From at least December 1996 through February 1998, AHERF and some of its subsidiaries collectively known as the Delaware Valley Obligated Group issued annual financial statements and municipal securities disclosure reports that materially misrepresented, among other things, AHERF's and Delaware Valley's net income. AHERF, through certain members of its senior management and in violation of Generally Accepted Accounting Principles ("GAAP"): (i) overstated Delaware Valley's 1996 net income before extraordinary item and change in accounting principle by approximately $40 million by failing to adjust Delaware Valley's bad debt reserves to account for uncollectible accounts receivable; (ii) overstated Delaware Valley's and its own 1997 net income through the inappropriate transfers of approximately $99.6 million in reserves that were utilized to address the bad debt reserve shortfall not addressed in 1996, as well as an additional shortfall in 1997; and (iii) overstated its 1997 net income by misclassifying certain restricted trust funds. The misclassification of the restricted funds and the transfers resulted in the overstatement of AHERF's consolidated net income for the period ended June 30, 1997 by approximately $114.3 million. Significantly, both Delaware Valley and AHERF would have posted substantial net losses for fiscal year 1997 without the fraudulent activity.

To date, the Commission has instituted injunctive proceedings in federal district court against David W. McConnell, the former chief financial officer of AHERF, and Charles P. Morrison, the former chief financial officer of AHERF's Delaware Valley region and an AHERF senior vice president, charging them with securities fraud. Simultaneously with the filing of the Complaint, McConnell consented, without admitting or denying the allegations of the Complaint, to a permanent injunction enjoining him from violating Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and ordering him to pay a civil monetary penalty of $40,000. The case against Morrison remains pending.

The Commission also instituted and settled three administrative proceedings as a result of its inquiry into this matter. Without admitting or denying the Commission's findings, two other members of AHERF's senior management, Albert Adamczak and Stephen H. Spargo, agreed to orders to cease and desist from committing or causing any violation and any future violation of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and barring them pursuant to Rule 102(e) of the Commission's Rules of Practice from appearing or practicing before the Commission as an accountant, with the right to reapply after three years. On June 30, 2000, the Commission entered an Order to which AHERF consented, without admitting or denying the Order’s findings. The Order found that AHERF had violated the antifraud provisions of federal securities law and ordered AHERF to cease and desist from committing or causing any violations and any future violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.

The AHERF materials may be found on the Commission’s web site at www.sec.gov/enforce.htm. The Commission’s investigation into this matter continues.

Now, Secondary Market Disclosure.

AHERF is the second instance of enforcement action in the municipal market involving fraud in secondary market disclosure. The first was the administrative proceedings involving the City of Miami, Florida and certain of its former officials filed last fall. Federal courts have long supported their application to disclosures to the secondary market and the Commission’s reiteration of this point in the 1994 Interpretive Release was widely discussed and received broad coverage in both the national and municipal market trade press. The Commission summed-it-up in the AHERF Order:

"Section 10(b) of the Exchange Act and Rule 10b-5 thereunder make it unlawful to make any untrue statement of material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading. Any issuer that releases information to the public that is reasonably expected to reach investors and trading markets will be subject to the antifraud provisions. [citing Texas Gulf Sulphur6]. The antifraud provisions are equally applicable to disclosures in the secondary market for municipal securities [referring to the March 1994 Interpretive Release]. 7

The City of Miami proceedings regarding secondary market disclosure involve the City of Miami itself and two of its former officials, the City Manager and the Director of Finance. Earlier this Spring, the former City Manager Cesar Odio, without admitting or denying the findings, consented to the entry of an Order finding that he had violated the antifraud provisions through his activities with respect to certain offerings of the City of Miami and his signing of the Letter of Transmittal contained in the 1994 CAFR which misrepresented the City's true financial condition. The other official involved in the enforcement proceeding is Manohar Surana, the Former City Finance Director. Proceedings against the City of Miami and Surana are still pending. Post-hearing briefs have been recently submitted to the Administrative Law Judge hearing the matter.

The AHERF and Miami enforcement actions convey important reminders to the healthcare sector and to the municipal market in general. The message to issuers and to those who assist them in preparing information to be disclosed in the secondary market, is that the antifraud provisions apply to the trading of outstanding as well as new issues of municipal securities. Beyond this point, each instance is considered within the facts and circumstances presented. Searching for safe harbors that do not exist may be far less practical and far more risky than rigorous understanding and strict adherence to the antifraud provisions themselves.

Discussion of secondary market disclosure leads to an element that may help to place AHERF in a larger context. In March of 1994, the Commission noted in its Interpretive Release that "for some conduit entities, annual information may not be sufficient and investors may need more frequent periodic financial information" including healthcare financings in the group. Unlike many housing issuers that have moved to a quarterly basis following guidelines developed by the National Council of State Housing Agencies, most health care conduits are on the annual basis set out as the minimum under a contract compliant with Rule 15c2-12. A consistent complaint of the National Federation of Municipal Analysts since the early days of the Rule has been the tardiness with which information is provided to the secondary market under 15c2-12 by health care conduits in particular.

Information released to the market has to be complete and accurate to comply with the antifraud provisions. That is the case under the law at the time of any such release. Good practice may dictate further that material information be released promptly. Compliance with a Rule 15c2-12 contract requires at least annual reporting of financial information. Healthcare issuers may wish to consider whether they should report publicly on a more frequent basis. This would be entirely consistent with Rule 15c2-12 – as the housing sector has shown, nothing in the Rule stands in its way.

A year ago, one rating agency reported: " Moody's believes that U.S. not-for-profit hospitals overall will continue to experience financial difficulties over the near term. Over the intermediate term, we expect ratings volatility. We believe that even some of the strongest entities in our portfolio will experience weakening credit quality." The situation has been deteriorating since, with press reports of increasing downgrades in the sector.

A volatile situation can only increase the risk of misleading disclosure that falls short of providing all the material information known to an issuer at the time the disclosure is made. The needs of investors – those in newly issued bonds as well as those trading in the secondary market -- for current, not stale, information are heightened at such times. AHERF serves as a good reminder of the application of the antifraud provisions to secondary market disclosure in general, and to health care conduit borrowers and those who help prepare their disclosure.

My last point today is – the Second Annual Municipal Securities Roundtable, which will be held this year on October 12 in the William O. Douglas Conference Room at Commission headquarters in Washington. Our purpose in starting these roundtables is a simple one: to help you make the best use of the disclosure framework and continue to improve communication with your investors. Five years ago we established the framework for municipal market disclosure by amending Rule 15c2-12 to provide for continuing secondary market disclosure, joining the mechanical steps for primary offering disclosure already existing under that Rule and Municipal Securities Rulemaking Board Rules. What happens within this framework is up to issuers, investors, underwriters, advisers and counsel to determine, keeping in mind, of course, the applicability of the antifraud provisions to all communications to investors. The roundtables bring different groups of market participants, such as issuers, bond lawyers and investors, face to face to discuss their perspectives on current market practices, and to the extent perspectives differ, provide an opportunity to begin to bridge the difference.

The roundtables provide us a chance to observe how well our message is understood – while the securities laws are pretty straightforward in the municipal market, we have an opportunity to step back and ask: "do folks get it?" If clarification and guidance are needed, we have the opportunity to provide it.

Health Care Finance figured prominently in last year’s roundtable – the transcript of which is also on our website — and likely will figure prominently this year as well. We hope many of you will join us. Thank you.


1SEC, Rule FD, Selective Disclosure and Insider Trading, Release Nos. 33-7881, 34-43154, IC-24599, File No. S7-31-99, 17 CFR Parts 240, 243, and 249.
2Use of Electronic Media, Release Nos. 33-7856, 34-42728, IC-24426; File No. S7-11-00.
315 U.S.C. §77c(a)(2).
415 U.S.C. §77d(2).
5 15 U.S.C. §77d(2).
6SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968), cert. denied sub nom, Coates v. SEC, 394 U.S. 976 (1969).
7See Statement of the Commission Regarding Disclosure Obligations of Municipal Securities Issuers and Others, Exchange Act Rel. No. 33-7049, 1994 SEC LEXIS 700 (March 9, 1994). .