The Importance of Control Structure to Municipal Disclosure
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:
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.
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.