SAN FRANCISCO — An analyst painted a grim picture of the state of disclosure in the municipal bond market, after Securities and Exchange Commissioner Elisse Walter Tuesday kicked off the SEC’s first regional municipal securities field hearing here.
Mary Colby, managing director and head of municipal research at Charles Schwab Investment Management, told SEC officials that continuing disclosure practices remain “spotty,” especially among a large number of infrequent and small borrowers.
In addition to the oft-repeated refrain among analysts that annual financial information from these borrowers typically is stale, arriving 270 days after the end of their fiscal years, Colby said some borrowers don’t even meet this deadline. She was testifying on behalf of the National Federation of Municipal Analysts.
Colby warned, for example, that at least one large county in the Midwest routinely takes 13 months to file its annual financials, though she did not identify the issuer. Sources said it is Cook County, Ill.
In addition, an increasing number of issuers fail to disclose material information, such as unscheduled draws on debt-service reserve funds or credit enhancement policies, she said, adding, that “the failure to file adverse tax opinions has been a perennial problem.”
The most “frustrating and difficult” situation occurs when issuers host electronic investor roadshows and discuss information, such as financial projections, that are not in their offering documents and are not available in printable format for investors.
“Although the information is there for you to see and they want it to influence your decision, in no way can you keep it for yourself,” she said.
Colby’s remarks came as Walter and other SEC officials suggested that muni investors should have the same rights as investors in other securities to receive information that is not materially misleading and does not contain material omissions. But Walter stressed that she is keeping an open mind and that her views will likely change throughout the course of the field hearings.
Colby’s concerns were tempered somewhat by some of the issuer officials who testified at the hearing.
Brian Mayhew, chief financial officer of the Bay Area Toll Authority here who testified on the same panel as Colby, said that governmental borrowers release far more information than corporate issuers.
“In my financial statements, which some people feel are inadequate, the footnotes are bigger than the entire financial statement of General Electric,” he said. He added that he does not believe companies like GE release minutes of their board meetings on their websites as muni borrowers do.
“We’re government,” he said. “Transparency is what we do.”
Mayhew urged the SEC not to push for one-size-fits-all disclosure or accounting standards for municipal issuers, or compare muni accounting and disclosure standards directly with those in the corporate market.
On accounting standards, he said the SEC should recognize that governments use so-called modified accrual accounting, by which they only record revenue when it is received and on an annual basis, rather than the corporate-style full accrual method, in which every sale in a given month is booked as revenue for that period.
He also asked the SEC to recognize that unlike corporations, municipalities adhere to individual fund accounting, which prevents blending of multiple revenue sources.
Colby noted that the NFMA is currently developing guidelines with the Government Finance Officers Association on interim disclosures that could be released before financials are audited, a move announced earlier this year and meant to blunt investor concerns about the staleness of continuing financial disclosures.
But Mayhew said BATA already releases such unaudited information, particularly monthly financial updates to its board.
As market groups move forward with voluntary standards for interim disclosures, John McNally, a partner at Hawkins Delafield & Wood LLP in Washington and president-elect of the National Association of Bond Lawyers, said he urges his clients to be careful. Interpretive guidance released by the SEC in 1994 warns issuers could be liable under the securities laws for any inaccurate information they release that is reasonably likely to reach investors. As a result, issuers must be cautious in releasing unaudited financial information, he said.
Noting that the SEC is working on the first update of that guidance, he urged staff to consider providing language that would assure issuers they will not run afoul of the securities laws for releasing unaudited financial information.
Though they vowed to keep an open mind, SEC officials’ questions seemed to signal some of their specific concerns about the market. Meredith Cross, director of the agency’s corporation finance division, wondered whether there is anything the SEC can do to improve retail investors’ understanding of ratings.
Amy Starr, senior special counsel within corporate finance, asked if there should be “some basic, uniform disclosure principles, beyond antifraud, that would help municipal market participants provide meaningful disclosures that are more easily understood by retail and other investors.”
She also asked if there should be “some sort of standardization of disclosures in municipal securities offerings,” and if these principles should be mandatory or voluntary. Colby said yes, and asked that they apply to all outstanding muni bonds. Mayhew said yes, but said they should be not be retroactive.
California Treasurer Bill Lockyer focused his remarks largely on ratings of state and local debt. He warned that despite Moody’s Investors Service and Fitch Ratings’ migration to a global rating scale for munis, “there is still a long way to go” to achieve fairness for muni bond ratings. He urged the SEC to hold the agencies “accountable for their products.”
For instance, Lockyer said a Standard & Poor’s study from earlier this year said that only 0.33% of munis in the A-minus category have defaulted over a 15-year period, compared to 3.16% for similarly rated corporate bonds during the same period.
“One has to climb up five notches on the corporate rating scale to AA-plus to find the same average default rate over 15 years as the rate for A-minus rated municipal bonds,” he wrote in testimony.
Lockyer added that the rigorousness of the SEC’s implementation of the “uniform rating” provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act “will determine whether taxpayers get relief from the high price of discriminatory ratings.” He warned that the provisions are convoluted and “raise at least as many questions as answers.”
Speaking on a later panel, Mark Blake, San Francisco’s deputy city attorney who is counsel on the city’s bond sales, agreed with critics like Lockyer who say that ratings agencies unfairly penalized municipal bonds by holding them to separate rating scales. But he doesn’t agree with the solution Fitch and Moody’s have adopted.
“Moves to a single scale are intellectually appealing,” he said. But “I think ironically, they head in the wrong direction. Municipal bonds and corporate securities are by their nature not comparable.”
Blake said municipal bonds should be rated on a distinct, and simpler, scale based on metrics tied to default risk. He suggested a simple pass-fail system, or a three-part scale — red, white, or blue.
“That may not be a sophisticated rating system but perhaps governments, including the government I represent, are not that complicated,” he said.
Ahead of yesterday’s hearing, the SEC said it plans to hold additional hearings in Chicago in November, Washington, D.C., in December, Tallahassee, Fla., in January, and Austin in February. Walter also announced another hearing will be held in Birmingham, Ala., which is part of beleaguered Jefferson County, though the timing of it has not been set.
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