Securities Laws and the Municipal Market: Points Every Market Participant Should Keep in Mind Paul S. Maco Director, Office of Municipal Securities U.S. Securities and Exchange Commission Before the Florida Government Finance Officers Association Naples, Florida June 7, 1999 --------------------------------------------------------------- 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 the author and do not necessarily reflect the views of the Commission or of the author's colleagues on the Commission staff. --------------------------------------------------------------- Our presentation today is one of many efforts we have underway to remind all participants of the application of the federal securities laws in the municipal market. The Office of Municipal Securities has put together the text of over 140 Commission enforcement proceedings involving municipal market participants referred to in the presentation. This compilation exceeds five hundred pages, offering you and your advisors one hundred forty-four illustrations of "facts and circumstances." Several observations may be made from an overview of these cases, although I should point out that, individually, each case speaks very well for itself. First, the cases involve a variety of issuers, including general obligation issuers, together with issuers of revenue and conduit bonds. Stale and misleading accounting frequently is at the heart of disclosure problems. A good number of the cases involve health care facilities and dirt bond projects. As efforts to prepare voluntary disclosure guides for these sectors are underway, the clear message of these cases should not be overlooked by health care institutions or developers. Many of the financial advisor and underwriter cases, including recent yield burning settlements, contain findings of professionals breaching their fiduciary duty - often towards you, the issuer. Many of the cases involve hidden payments, kickbacks and other corrupt practices. As we warn you right up front, the 500 page compilation is a small part of the picture. Many key cases interpreting the antifraud provisions do not even remotely involve a municipal bond. You will not find them in the compilation, but your advisors should be familiar with them. Many actions under the securities laws involving municipal bonds have been brought by private litigants. You will not find them here either. Again, your lawyers should be familiar with them. The compilation was included in materials for the recent Washington Workshop of the National Association of Bond Lawyers. We plan to provide it to the Section of State and Local Government Law of the American Bar Association and the International Municipal Lawyers Association. You may want to find out if your counsel is familiar with these proceedings and other basics of the securities laws before you look to them for advice on securities law matters. Enforcement is only one part of the Commission's efforts to improve the municipal market in the United States. By now, I expect that you are familiar with the framework for secondary market disclosure put in place almost five years ago by Rule 15c2-12. Combined with enforcement activity, our efforts to end pay to play, by dealers, lawyers and others through MSRB Rule G-37 and voluntary initiatives have made progress in attacking corruption and conflict of interest in the municipal market. These efforts are making what The Economist only a few years ago called "America's notoriously corrupt municipal bond market" a thing of the past. Even though municipal borrowing in the United States has been going on for almost two hundred years, the importance of timely and accurate information to investors and to markets bears continuing emphasis. Price transparency, reliable accounting, accurate disclosure in primary and secondary markets and markets free from conflicts of interest and corruption, are concerns of markets and investors worldwide. It should be no surprise that they are of concern at home in our municipal bond market or that they have been the focus of Commission efforts over the last five years. There are several ideas I will offer you today - on Y2K, Electronic Disclosure, Internet disclosure, and continuing disclosure - and information you may find surprising about the municipal market. Our enforcement actions carry messages too -- including don't run with scissors or play Russian Roulette. I hope you carry these thoughts with you when this conference is over and you return to the important work you do every day. Now first, for that surprising news. In testimony before Congress a few weeks ago, the municipal bond market was held up as an example for the corporate bond market to follow. The issue is price transparency - the ability of an investor to know the trading price of his or her bonds. In transparency, the closer market information is to right now, the better. Today, at the end of each day, every broker-dealer buying or selling municipal securities reports its trades to the MSRB. Overnight, the trade data is processed and at 6:00 am on the following business day, the trading data is released - price and volume for every municipal bond that traded four or more times during the trading day. The Bond Market Association now posts this information on its website, where anyone with access to the internet may obtain it. The MSRB has announced that it will shortly expand this data. Investors not only benefit from recent price information, but also from the increased ability of regulators to oversee the market as a result of the reporting system. Regulators now have access to virtually all trades in the municipal market - and the tracks of any fraudulent trading activity. Last fall, Chairman Levitt called on the NASD to not only equal but exceed the next day reporting for municipal bonds and put in place real time reporting for corporate bond transactions. The NASD has taken up the challenge, but as we enter the next century, municipal market transparency is the model. It's hard to mention the next century without bringing up Y2K. You should be aware that last summer the Commission issued a release discussing disclosure responsibilities of issuers on Y2K matters. A portion of this release specifically addresses municipal issuers. Generally, the release reminds municipal issuers that the effect of the Y2K problem may be material to investors - and gives a heads up that such information may need to be disclosed in order to avoid trouble under the antifraud provisions. Issuers, and those assisting issuers in preparing disclosure, should consider Y2K issuers in preparing all disclosure documents, whether an official statement, a CAFR or other filing under a continuing disclosure covenant or other disclosure reasonably expecting to reach investors and the trading market. Boilerplate, it should be clear, does not help in Y2K or any other disclosure topic. Boilerplate itself can be misleading. Don't give in to the temptation to substitute it for meaningful disclosure. You may have heard discussion this past year of use of electronic official statements. Perhaps you have used one yourself. The Commission has stated in an interpretive release that electronic delivery of official statements by broker dealers is permissible under Rule15c2-12 - provided certain standards are met, including notice, access and evidence to show delivery. Some customers may not have access to means of electronic communications - today, households with internet access still do not exceed 50% - so paper remains part of the process for most practical purposes. Dealers still must file papers official statements under G-36 - with the MSRB, although the MSRB has indicated dealers may comply electronically with certain other MSRB rules. Issuers should be sensitive to dealer obligations under the MSRB rules, in this as in other contexts. This is a good point for a reminder that regardless of whether your disclosure is on paper or transmitted electronically, the antifraud provisions apply. Keep this in mind with respect to Internet - and other -- disclosure. If a statement is made reaching markets or investors, the anti fraud provisions apply, regardless of whether the statement is on paper, or delivered electronically. The following question may prove a useful rule of thumb for you: "If it violates the law on paper, how is it suddenly legal when on the internet?" Analysts have frequently complained of delayed and stale continuing disclosure in sectors such as health care. Hospital and other conduit borrowers should be aware the anti-fraud provisions apply to such disclosure and stale, misleading disclosure carries with it potential liability under the antifraud provisions. The cases we have brought on bad disclosure in official statements provide guidance to other disclosure - including annual reports under 15c2-12 and other statements. Stale and misleading accounting information can create as much trouble for you in a report filed with a central repository as it can in an official statement in a primary offering. Two easy ways to avoid this problem: (1) provide on a timely bases and (2) if necessary, provide an update. An issuer providing stale disclosure into the secondary market is playing Russian Roulette with the antifraud provisions. I promised to talk a bit about our enforcement actions and the messages they carry. Earlier, we quickly reviewed enforcement actions brought by the Commission in the municipal market over the last thirty years. This past year, the Commission brought several enforcement actions against issuers of municipal securities, including the settled proceedings involving 39 issuers in Mississippi found to have violated the antifraud provisions. The message is if you authorize something to be disclosed to investors, be sure you're comfortable with it. As the Commission's order states: "Issuers may not blindly rely on professionals such as bond counsel, to ensure that factual representations being made by the issuers are accurate." In other words, you can't just hire someone and go to the beach. Recent enforcement actions include a number of cases against professionals, including financial advisers and lawyers, who have defrauded issuers as well as investors. We have also brought cases against financial advisors who mislead issuers by failing to disclose the full extent of the fee's received in a transaction. The recently settled action with Lazard Freres is another example of a financial adviser-issuer relationship that proved costly to the issuer. If you haven't read it yet, you should. In addition, several actions have been taken against dealers who misled issuers about the risks of investments sold to those issuers. The message is - know the professionals you hire. If you hire someone to assist you in disclosure preparation - be sure they are competent to do so - before you rely on them. If your lawyers do not understand the securities laws, you are put at risk. I think of the T-shirt offered in the PBS Catalogues captioned - "Runs with Scissors" - this should not be appropriate wear for you. Lately, there have been reports of underwriters engaged in what's termed a "race to the bottom." In an effort to secure business, the story goes, underwriters are promising to require less disclosure from issuers than their competition currently with the assignment. I can't decide who is more foolish in this situation - the underwriter or the issuer hiring the underwriter. If in the race to the bottom, the fraud line is crossed, they shouldn't be surprised to find us waiting with open arms. We have also heard complaints from investors that some official statements include disclaimers such as "In making an investment decision, investors must rely upon their own examination of the terms of the offering and the Borrower." It should be clear to you after this mornings presentation that such a statement is inconsistent with and does not override the antifraud provisions. Another example: "No representation, warranty or guarantee is made by the Underwriter as to the accuracy or completeness of any information in this Official Statement." Any Underwriter considering using such language should recall the express words of the Commission in the March interpretive release five years ago: " In light of the underwriter's obligation, as discussed in prior releases, to review the official statement and to have a reasonable basis for its belief in the accuracy and completeness of the official statement's key representations, disclaimers by underwriters of responsibility for the information provided by the issuer or other parties, without further clarification regarding the underwriter's belief as to accuracy, and the basis therefor, are misleading and should not be included in official statements." We're undertaking new efforts to reach issuers as well, to educate them as to their disclosure responsibilities. Many issuers, particularly small ones, do not have the opportunity or the budget to participate in national or evening regional conferences. This January, we began an effort, jointly with the National League of Cities, NABL, GFOA ad TBMA to reach small issuers. We are beginning in Mississippi. We will go elsewhere. On this point - as well as others, I welcome you guidance on how best to communicate our message to issuers. If there is additional work we can do, ask us. We'll take you upon the offer if it's all practicable. The SEC is a permanent part of the landscape in the municipal market. Participants need to understand that. A few have questioned when our enforcement actions will end. I suggest the answer to that question is not in our hands, but in the hands of participants in the municipal market. With stale disclosure, races to the bottom and efforts to disclaim responsibilities imposed by law, that day may not be anytime soon. We will be delighted, of course, if your own disclosure practices make us like the Maytag repairman in those old commercials: on the job but with little to do in the municipal market because everything is working so well. * I promised you a few thoughts you could take home with you - and I've given them to you. In case you missed them here they are again: I hope you put them to good use: * Keep Y2K issues in mind when preparing your disclosure. * Remember, the antifraud provisions apply to all disclosure - including that you make pursuant to 15c2-12 contracts - and file with central repositories - and information you place on the Internet that may reasonably be expected to reach investors. * Remember: if it's not legal on paper, why would it be legal in the internet? * Don't play Russian Roulette. Avoid problems with secondary market disclosure, particularly financial information by providing it on a timely basis and if necessary providing an update. * Issuers are primarily responsible for their disclosure. Be sure you're comfortable with it before you approve it. You can't just go to the beach. * Don't run with scissors. Be sure the professionals who advise you to prepare disclosure know the securities laws - If your lawyers do not understand the securities laws, you are put at risk. * And finally - do your best to make us like that Maytag Repairman! Thank you.