Speech by SEC Staff:
Remarks Before the Municipal Securities Rulemaking Board, Disclosure Forum II
by Annette L. Nazareth
Director, Division of Market Regulation
U.S. Securities & Exchange Commission
January 11, 2001
Good afternoon. I am delighted to have been invited to speak to you today about municipal market disclosure at this important and timely Forum. I would like to thank Dan Keating and Kit Taylor for making this opportunity available. Before I begin, I must remind you that my remarks represent my own views, and not necessarily those of the Commission or my colleagues on the staff.
The Office of Municipal Securities:
Alive and Well
This conference to me represents an official "homecoming," in a sense, to both the issues of the municipal securities markets and the people in our industry who devote substantial efforts to this product area. As an attorney in the private sector I had the privilege of working closely with some very thoughtful and diligent business people as we, like many of you, navigated our way through the new world of municipals. And what a changed, and indeed improved world, it became! Rule 15c2-12 and improved continuing disclosure, NRMSIRs, municipal bond transparency all these developments occurred in the last several years. We all spent significant time and effort building internal compliance systems to implement these changes, and those efforts have resulted in a better market and more public confidence than ever before.
As you undoubtedly know, the Office of Municipal Securities was established six years ago to be a focal point for the Commission's increasing activities relating to municipal securities. In the aftermath of Orange County, Chairman Levitt desired to bring the Commission's resources to bear in a more concerted manner to ensure the integrity and orderliness of this significant capital market. He sought to send a particularly strong message to municipal securities issuers and market professionals about the Commission's desire to improve market integrity through guidance, education and, when appropriate, enforcement.
For the past six years, OMS certainly has met each aspect of that mission on behalf of investors. Interpretive releases have addressed municipal industry issues. Participation in professional and issuer forums has fostered more widespread awareness of disclosure responsibilities. Furthermore, almost 100 enforcement actions have been brought in instances of alleged wrongdoing. The business of issuing and trading municipal securities is much improved as a result of the Office's active role. That role must continue, and our mandate in the Division of Market Regulation is to ensure that it does.
The recent departure of Paul Maco as Director of OMS presented an opportunity to consider how best to position the Office so that it will continue its contributions and vigilance on an enduring basis. In order to integrate OMS into the Divisions of the SEC, OMS last month became an independent office within the Division of Market Regulation. And as you may know, we were very pleased to announce on Tuesday that Martha Haines has been named the new Chief of the Office of Municipal Securities. Martha joined the Commission in 1999 as an Attorney Fellow, having served as an attorney and partner at Barnes & Thornburg, Altheimer & Gray, and Chapman and Cutler, all in Chicago. We are very pleased to have someone of Martha's ability and experience, and I trust you will agree that we are fortunate to have recruited her for this important position.
As to integrating OMS into the Division of Market Regulation, I believe the move has many advantages. First, it institutionalizes the Commission's recognition of the importance of the municipal market within the Divisional staff structure. Furthermore, the new configuration will permit us to build on the synergies between the work of OMS and other offices of our Division, particularly in the areas of Rule 15c2-12 and MSRB rulemaking. While undoubtedly there are many issues unique to municipal securities, there are also countless instances where our work in other areas of the fixed income markets could be better informed by our experience in the municipal area. And personally I think it will be great to know about developments at the Commission that relate to municipal securities even before Lynn Hume at the Bond Buyer does! Seriously, I can assure you that OMS will operate as an independent office, with Martha Haines as Chief and the same staff in place, thereby maintaining its unique professional expertise in municipal securities issues. As such, the Office will continue to provide a specialized resource for the Commission and an ongoing resource to the industry.
Turning Now to the Topic of Today's Forum
Improving Disclosure Further: Initiatives and Issues
The term "information age" is bandied about freely these days. But the millennium did not spawn the "information age" for securities. For securities, the "information age" began in the 1930's with the enactment of the statutes comprising the federal securities laws, one of the milestones of the New Deal. The antifraud provisions of the Securities Act of 1933 and the Securities and Exchange Act of 1934, which, as you know, apply to municipal securities as well as corporate securities, were based on a simple principle information disclosure. That principle has not changed over the years, nor has its overriding objective protecting the investor. We are nearing the end of the seventh decade of the "information age" for securities in the U.S. regulatory system, which continues to prove flexible and adaptable to evolving practices and evolving technologies.
Primary market disclosure practices for municipal securities have dramatically improved over the last several decades, with marked progress during the 1990's. We are light years away from the norm that existed well into the 1970's. The 1975 fiscal crisis of New York City was cause for industry professionals and investors alike to begin to re-examine how to more meaningfully meet the requirements of the federal antifraud provisions. Not only did bankers, lawyers and issuers begin ongoing efforts to fully and fairly disclose all information material to investors' decisions, but industry organizations initiated concerted efforts to provide their members with new standards and procedures for good disclosure.
The developments related to the default of the Washington Public Power Supply System in the mid-1980s drew further attention to the need for improved antifraud compliance, and further invigorated industry efforts. Next came the 1994 bankruptcy filing by Orange County, California, which resulted in various SEC enforcement actions, issuance of a 21A report regarding the disclosure responsibilities of issuer officials, and, ultimately, to the establishment of OMS.
Although excruciatingly painful at the time, we can now see that these past troubles resulted in long-term positive changes, particularly in primary market disclosure. The typical official statement of today is much improved and bears little resemblance to the sketchy disclosure document that was the norm in 1975. Of course, the Commission's adoption of Rule 15c2-12 about ten years ago also contributed to this pattern of improvement.
However, many challenges remain to be addressed by both regulators and market participants. The need for dissemination of full and fair material information to investors has been heightened by the emerging domination of individual investors in the municipal market. Today, more than 70 percent of outstanding municipal obligations are held by individuals, either directly or through bond funds in which they have invested. Over 40 percent are held by individuals themselves or in their personal trust accounts. Trading in outstanding municipal securities and the issuance of new municipal securities each generally exceed $8 billion daily.
Secondary market disclosure has a briefer history in the municipal market. It sprang forth as a result of the Commission's promulgation of the amendments to Rule 15c2-12 in 1994. Secondary market disclosure compliance remains somewhat less mature than does primary market disclosure, and seems to give rise to many questions in the industry, particularly when paired with the use of electronic media. Those two areas, secondary market disclosure and electronic information dissemination, are among the principal challenges now facing regulators and market participants.
In addition to the educational, guidance and enforcement activities of the Commission itself that relate to improving disclosure and compliance with the antifraud provisions, there are substantial private-sector dynamics that provide important additional resources such as industry initiatives, internet developments and investor expectations. We are pleased to participate in discussions like this one, that further enlighten and inform municipal disclosure.
Industry Initiatives. Inasmuch as municipal securities are excluded from the registration and reporting requirements of the federal securities laws, there is no regulatory template or checklist for disclosure. Moreover, compliance with the antifraud provisions requires an evaluation of the unique facts and circumstances not a one-size-fits-all prescription. The Commission's ability to provide specific guidance to municipal market participants is therefore much more limited than it is in the corporate securities markets, which are subject to registration and reporting. Because of this, the initiatives of the MSRB and of associations of issuers, lawyers, bankers and dealers to provide guidance to their members and to the industry are critical to ensuring that disclosure is as complete, timely, and accessible as possible.
The considerable efforts over the last few years to spark discussions on many aspects of disclosure have provided helpful resources for market participants. Examples include (1) the MSRB's own discussion paper issued in anticipation of today's meeting, (2) the many standards promulgated and "best practices" formulated by such organizations as the Government Finance Officers Association (in its investor relations papers) and the National Federation of Municipal Analysts (in its sector guidelines), and (3) the recent paper regarding voluntary secondary market disclosure authored by the National Association of Bond Lawyers.
By initiating discussions of market issues, the MSRB and market participants can provoke a continuing reevaluation of the adequacy of disclosure in many specific contexts. Ultimately, by improving accepted industry standards and practices for disclosure, the industry serves both its own interests and those of investors. While the SEC Staff cannot endorse any particular set of guidelines or practices, we do encourage the continued efforts of municipal market participants to improve the adequacy, timeliness and accessibility of disclosure.
Internet Developments. Accessibility takes on added significance in today's environment of rapidly evolving communications technology. The use of electronic media in disclosure of securities information is sometimes labeled "the issue of the year" for 2001. It is becoming clear, however, that internet issues will be with all of us for this entire decade, or longer. It is true that electronic media can be used to create new avenues for creative fraud and raises numerous technical concerns. However, electronic media can also provide significant benefits to the investing public from increased availability of information.
More and more issuers of municipal securities, even small issuers, are establishing web sites, either directly related to primary offerings or secondary market information, or relating more generally to their broader functions as units of local government. I hope to see an expansion of the use of the internet by issuers, conduit borrowers and others to increase the availability of up-to-date financial and other material information to municipal market investors.
The internet also makes new initiatives feasible, such as the MSRB's current project to establish a free central index of municipal disclosure documents. This voluntary initiative may very well lessen concerns with the existing repository, or "NRMSIR," system. Further, the MSRB's expansion of its "CDI Net Web Test" to include interim financial information for land-secured and health-care financings, with user-friendly search features, should also encourage issuers to file voluntary periodic disclosure and encourage investors to use it. Clearly, the imaginative use of the internet offers real potential to improve disclosure.
The Commission is cognizant of many of the questions posed by using electronic media in a disclosure process historically based upon paper documents. In order to address some of those issues under intensive industry discussion, the Commission issued its "Interpretive Release on Electronic Media" last Spring. This afternoon, I would like to clarify an ensuing debate among market participants about the "re-publication theory" referenced in that release. The release observed but did not adopt the view of some legal commentators that a statement may be considered to be "re-published" each time it is accessed by an investor or each day that it appears on a web site. Instead, the Commission expressly requested comment on how to facilitate the availability of historical information on the internet consistent with the federal securities laws. Just as with paper documents that may be available to investors after the date of preparation, there may be appropriate legal and technical tools that can be applied to electronic information in order to indicate that what comes up on the screen speaks only as of a specific date. We are eager to discuss with the industry how to resolve this issue, but on the understanding that investors must be protected from misleading information.
Of course, the various changes in preparation methodologies and distribution techniques employing electronics cannot alter the disclosure standards of the federal securities laws. Developments of new instruments, practices and differing fact situations have been and must continue to be shaped to comply with those standards.
Investor Expectations. The economic muscle of the "buy side" can be an important force shaping disclosure as well. In addition to the strictures of the antifraud provisions and Rule 15c2-12, and the results of various industry initiatives, disclosure by municipal issuers will be governed by the demands of market participants, particularly in the unfolding universe of electronic communication. As the volume of information available to investors in the corporate securities markets continues to increase and become more readily accessible and expected by retail investors, it is likely that investors in the municipal markets will begin to expect similar levels of information. Institutional investors in municipal securities have already begun to voice their frustrations, particularly regarding secondary trading. Ultimately, the expectations of both institutional and retail purchasers for more information in the municipal market may be met through innovative applications of evolving electronic media. Investors are free to use their purchasing power to demand more disclosure. Issuers can be expected to respond in their own self-interest.
Municipal Bond Transparency
One area where the municipal securities industry has distinguished itself relative to its other fixed income brethren is in the area of transparency of pricing information. For several years now, last sale information for municipal securities has been available, albeit in many instances on a delayed basis. And the MSRB not only supported this effort, but actively encouraged and helped implement it by posting the data on its website. It is hard to believe, but we find ourselves in the new millennium without comparable transparency for other fixed income products. But, I believe, all that will change very shortly. We expect the Commission to take action shortly on the NASD's proposal to implement its transparency initiative in the corporate bond markets. The NASD's TRACE proposal requires NASD members to report transactions in most DTC-eligible U.S. corporate bonds, and establishes a facility to collect and disseminate the reported information. The TRACE proposal provides for a phase-in schedule whereby larger issues will be disseminated first, and smaller issues will be phased-in later, once liquidity concerns are assessed. I believe the TRACE system will be a significant development in the fixed-income area. Investors have waited far too long for sunlight to be focused on this darkened area of our markets.
Into the Future: OMS and Market Regulation
A reasonable basis for speculating on the likely activities of OMS in the future would be to look at its record over the past several years, and to expect a similar focus on the issues of the municipal market. Its new position within the Division of Market Regulation provides a firm foundation for enhancing the important role of the Commission in safeguarding the integrity of the municipal securities market and in safeguarding American investors who in municipal securities.