Amendment to Municipal Securities Disclosure

Federal RegisterJun 10, 2010

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240 and 241

[Release No. 34-62184A; File No. S7-15-09]

RIN 3235-AJ66

Amendment to Municipal Securities Disclosure

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule and interpretation.

SUMMARY:

The Securities and Exchange Commission (“Commission” or “SEC”) is adopting amendments to Rule 15c2-12 (“Rule 15c2-12” or “Rule”) under the Securities Exchange Act of 1934 (“Exchange Act”) relating to municipal securities disclosure. The amendments revise certain requirements regarding the information that a broker, dealer, or municipal securities dealer acting as an underwriter in a primary offering of municipal securities must reasonably determine that an issuer of municipal securities or an obligated person has undertaken, in a written agreement or contract for the benefit of holders of the issuer's municipal securities, to provide to the Municipal Securities Rulemaking Board (“MSRB”). Specifically, the amendments require a broker, dealer, or municipal securities dealer to reasonably determine that the issuer or obligated person has agreed to provide notice of specified events in a timely manner not in excess of ten business days after the event's occurrence; amend the list of events for which a notice is to be provided; and modify the events that are subject to a materiality determination before triggering a requirement to provide notice to the MSRB. In addition, the amendments revise an exemption from the Rule for certain offerings of municipal securities with put features (defined below as “demand securities”). The Commission also is providing interpretive guidance intended to assist municipal securities brokers, dealers, and municipal securities dealers in meeting their obligations under the antifraud provisions of the federal securities laws.

DATES:

Effective Date:

August 9, 2010, except Part 241 will be effective June 10, 2010.

Compliance Date:

December 1, 2010 with respect to § 240.15c2-12.

FOR FURTHER INFORMATION CONTACT:

Martha Mahan Haines, Assistant Director and Chief, Office of Municipal Securities, at (202) 551-5681; Nancy J. Burke-Sanow, Assistant Director, Office of Market Supervision, at (202) 551-5620; Mary N. Simpkins, Senior Special Counsel, Office of Municipal Securities, at (202) 551-5683; Molly M. Kim, Special Counsel, Office of Market Supervision, at (202) 551-5644; Rahman J. Harrison, Special Counsel, Office of Market Supervision, at (202) 551-5663; and Steven Varholik, Special Counsel, Office of Market Supervision, at (202) 551-5615, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-6628.

SUPPLEMENTARY INFORMATION:

The Commission is adopting amendments to Rule 15c2-12 under the Exchange Act.

17 CFR 240.15c2-12.

I. Executive Summary

On July 24, 2009, the Commission published for comment amendments to Rule 15c2-12 to improve the quality and timeliness of information about municipal securities that are outstanding in the secondary market.

The proposed amendments would have required a broker, dealer, or municipal securities dealer to reasonably determine that the issuer or obligated person has undertaken, in a written agreement or contract for the benefit of holders of the issuer's municipal securities (“continuing disclosure agreement”), to provide notice to the MSRB of specified events in a timely manner not in excess of ten business days after the event's occurrence. The proposal also would have amended the list of events for which a notice is to be provided and would have modified the events that are subject to a materiality determination before triggering the obligation to submit a notice to the MSRB. In addition, the amendments would have revised an exemption from the Rule for certain offerings of demand securities.

See

Securities Exchange Act Release No. 60332 (July 17, 2009), 74 FR 36831 (July 24, 2009) (“Proposing Release”). The comment period for the proposed amendments expired on September 8, 2009.

The Commission received twenty-nine comment letters in response to the proposed amendments from a wide range of commenters.

The respondents included the MSRB; state and local governments; mutual funds; trade organizations representing broker-dealers, government financial officials, and bond lawyers; and individual investors. Of the comment letters received, four expressed support for the proposed amendments; ten expressed support, but suggested modifications to certain provisions of the proposed amendments; three supported some of the proposed amendments and objected to others; and eight opposed the proposed amendments. In addition, four comment letters neither expressed support for nor opposed the proposed amendments.

Copies of all comments received on the proposed amendments are available on the Commission's Internet Web site, located at

http://www.sec.gov/comments/s7-15-09/s71509.shtml.

Comments are also available for Web site viewing and printing in the Commission's Public Reference Room, 100 F Street, NE., Washington, DC 20549, on official business days between the hours of 10 a.m. and 3 p.m. Exhibit A, which is attached to this release, contains a citation key to the comment letters received by the Commission on the proposed amendments.

Some of the main concerns raised in the comment letters include: (i) The burden and costs associated with the proposed maximum ten business day time frame for submission of event notices; (ii) application of the proposed amendments to remarketings of demand securities;

and (iii) the proposed removal of the materiality condition from various disclosure events that trigger submission of an event notice to the MSRB. A number of commenters offered alternative approaches to the proposal to address their concerns and made suggestions regarding implementation of the proposed amendments. Also, some commenters addressed two proposals submitted by the MSRB relating to modifications to its Electronic Municipal Market Access (“EMMA”) system.

See infra

note 28 and accompanying text for a description of demand securities.

See

Securities Exchange Act Release Nos. 60314 (July 15, 2009), 74 FR 36300 (July 22, 2009); 61238 (December 23, 2009), 75 FR 492 (January 5, 2010); 60315 (July 15, 2009), 74 FR 36294 (July 22, 2009); and 61237 (December 23, 2009), 75 FR 485 (January 5, 2010). The EMMA system is a component of the MSRB's central municipal securities document repository for the collection and availability of continuing disclosure documents over the Internet.

See http://emma.msrb.org.

This release describes and addresses only those portions of the comment letters that are relevant to the proposed amendments. The portions of the comment letters that discuss the MSRB proposals relating to the EMMA system are being considered separately in the Commission's orders approving the MSRB proposals.

See

Securities Exchange Act Release Nos. 62182 (May 26, 2010) (SR-MSRB-2010-09) and 62183 (May 26, 2010) (SR-MSRB-2010-10) (pursuant to delegated authority).

The Commission has carefully considered all the comments it received regarding the proposed amendments and, as discussed below, is adopting the amendments substantially as proposed, with some modifications in response to comments. The amendments are intended to enhance the quality and availability of information about outstanding municipal securities. For

the reasons discussed in this release,

the Commission believes that the amendments are consistent with the Commission's mandate to, among other things, adopt rules reasonably designed to prevent fraudulent, deceptive, or manipulative acts or practices in the market for municipal securities. In addition, the Commission is issuing interpretive guidance that is substantially the same as the guidance set forth in the Proposing Release and that is intended to assist municipal securities brokers, dealers, and municipal securities dealers in meeting their obligations under the antifraud provisions of the federal securities laws.

See also

Proposing Release,

supra

note 2, 74 FR 36831.

II. Background

Rule 15c2-12 is intended to enhance disclosure, and thereby reduce fraud, in the municipal securities market by establishing standards for obtaining, reviewing, and disseminating information about municipal securities by their underwriters.

In 1989, the Commission adopted paragraphs (a) and (b)(1)-(4) of Rule 15c2-12

to require brokers, dealers, and municipal securities dealers (“Participating Underwriters”) acting as underwriters in primary offerings of municipal securities of $1,000,000 or more (subject to certain exemptions set forth in paragraph (d) of the Rule) to obtain, review, and distribute to potential customers copies of the issuer's official statement.

In 1994, the Commission adopted paragraph (b)(5) of the Rule (“1994 Amendments”),

which became effective in 1995 and was amended in 2008.

Paragraph (b)(5) prohibits Participating Underwriters from purchasing or selling municipal securities covered by the Rule in a primary offering, unless the Participating Underwriter has reasonably determined that an issuer or an obligated person

of municipal securities has undertaken in a continuing disclosure agreement to provide specified information to the MSRB in an electronic format as prescribed by the MSRB.

The information to be provided consists of: (1) Certain annual financial and operating information and audited financial statements (“annual filings”);

(2) notices of the occurrence of any of eleven specific events (“event notices”);

and (3) notices of the failure of an issuer or obligated person to make a submission required by a continuing disclosure agreement (“failure to file notices”).

See

Securities Exchange Act Release No. 26985 (June 28, 1989), 54 FR 28799 (July 10, 1989) (“1989 Adopting Release”). For additional information relating to the history of the Rule,

see

Securities Exchange Act Release Nos. 34961 (November 10, 1994), 59 FR 59590 (November 17, 1994) (“1994 Amendments Adopting Release”) and 59062 (December 5, 2008), 73 FR 76104 (December 15, 2008) (“2008 Amendments Adopting Release”).

See

1989 Adopting Release,

supra

note 8.

17 CFR 240.15c2-12(a).

17 CFR 240.15c2-12(b)(5).

See

1994 Amendments Adopting Release and 2008 Amendments Adopting Release,

supra

note 8.

The term “obligated person” means “any person, including an issuer of municipal securities, who is either generally or through an enterprise, fund, or account of such person committed by contract or other arrangement to support payment of all, or part of the obligations of the municipal securities to be sold in the Offering (other than providers of municipal bond insurance, letters of credit, or other liquidity facilities).”

See

17 CFR 240.15c2-12(f)(10).

On December 5, 2008, the Commission adopted amendments to Rule 15c2-12 (“2008 Amendments”) to provide for a single centralized repository, the MSRB, for the electronic collection and availability of information about outstanding municipal securities in the secondary market. Specifically, the 2008 Amendments require a Participating Underwriter to reasonably determine that the issuer or obligated person has undertaken in its continuing disclosure agreement to provide the continuing disclosure documents: (1) Solely to the MSRB; and (2) in an electronic format and accompanied by identifying information, as prescribed by the MSRB.

See

2008 Amendments Adopting Release,

supra

note 8.

See also

Securities Exchange Act Release No. 58255 (July 30, 2008), 73 FR 46138 (August 7, 2008) (“2008 Proposing Release”). The 2008 Amendments became effective on July 1, 2009.

17 CFR 240.15c2-12(b)(5)(i)(A) and (B).

17 CFR 240.15c2-12(b)(5)(i)(C). Currently, the following events, if material, require notice: (1) Principal and interest payment delinquencies; (2) non-payment related defaults; (3) unscheduled draws on debt service reserves reflecting financial difficulties; (4) unscheduled draws on credit enhancements reflecting financial difficulties; (5) substitution of credit or liquidity providers, or their failure to perform; (6) adverse tax opinions or events affecting the tax-exempt status of the security; (7) modifications to rights of security holders; (8) bond calls; (9) defeasances; (10) release, substitution, or sale of property securing repayment of the securities; and (11) rating changes. In addition, Rule 15c2-12(d)(2) provides an exemption from the application of paragraph (b)(5) of the Rule with respect to certain primary offerings if, among other things, the issuer or obligated person has agreed to a limited disclosure obligation.

See

17 CFR 240.15c2-12(d)(2). As discussed in detail in Section III.C. below, the Commission is adopting amendments to the Rule to eliminate the materiality determination for certain of these events.

17 CFR 240.15c2-12(b)(5)(i)(D). Annual filings, event notices, and failure to file notices are referred to collectively herein as “continuing disclosure documents.”

Since the adoption of the 1994 Amendments, the amount of outstanding municipal securities has more than doubled to $2.8 trillion.

Notably, despite this large increase in the amount of outstanding municipal securities, direct investment in municipal securities by individuals remained relatively steady from 1996 to 2009, ranging from approximately 35% to 39% of outstanding municipal securities.

At the end of 2009, individual investors held approximately 35% of outstanding municipal securities directly and up to another 34% indirectly through money market funds, mutual funds, and closed end funds.

There is also substantial trading volume in the municipal securities market. According to the MSRB, almost $3.8 trillion of long and short term municipal securities were traded in 2009 in over 10 million transactions.

Further, there are approximately 51,000 state and local issuers of municipal securities, ranging from villages, towns, townships, cities, counties, and states, as well as special districts, such as school districts and water and sewer authorities.

According to statistics assembled by the Securities Industry and Financial Markets Association (“SIFMA”), the amount of outstanding municipal securities grew from approximately $1.26 trillion in 1996 to $2.81 trillion at the end of 2009.

See SIFMA Holders of U.S. Municipal Securities

(available at

http://www.sifma.org/uploadedFiles/Research/Statistics/SIFMA_USMunicipalSecuritiesHolders.pdf)

(“SIFMA Report”). As noted in the Proposing Release, the amount of outstanding municipal securities was $2.69 trillion at the end of 2008, according to statistics assembled by SIFMA.

See

Proposing Release,

supra

note 2, 74 FR at 36834, n. 16 and accompanying text.

See

SIFMA Report,

supra

note 18. As noted in the Proposing Release, direct investment in municipal securities by individuals from 1996 to 2008 ranged from approximately 35% to 39% of outstanding municipal securities, according to statistics assembled by SIFMA.

See

Proposing Release,

supra

note 2, 74 FR at 36834, n. 17 and accompanying text.

See

SIFMA Report,

supra

note 18. As noted in the Proposing Release, at the end of 2008, individual investors held approximately 36% of outstanding municipal securities directly and up to another 36% indirectly through money market funds, mutual funds, and closed end funds, according to statistics assembled by SIFMA.

See

Proposing Release,

supra

note 2, 74 FR at 36834, n. 18 and accompanying text.

See

MSRB,

Real-Time Transaction Reporting, Statistical Patterns in the Municipal Market, Monthly Summaries 2009

(available at

http://www.msrb.org/msrb1/TRSweb/MarketStats/statistical_patterns_in_the_muni.htm

). As noted in the Proposing Release, in 2008, almost $5.5 trillion of long and short term municipal securities were traded in 2008 in nearly 11 million transactions.

See

Proposing Release,

supra

note 2, 74 FR at 36834, n. 19 and accompanying text.

See, e.g.,

Report on Transactions in Municipal Securities

prepared by Office of Economic Analysis and Office of Municipal Securities, the Division of Market Regulation, Commission, (July 1, 2004) (available at

http://www.sec.gov/news/studies/munireport2004.pdf

In addition, municipal bonds can and do default. In fact, at least 917 municipal bond issues went into monetary default during the 1990s, with a defaulted principal amount of over $9.8 billion.

Bonds for healthcare,

multifamily housing, and industrial development, together with land-backed debt, accounted for more than 80% of defaulted dollar amounts.

In 2007, a total of $226 million in municipal bonds defaulted (including both monetary and covenant defaults).

In 2008, 140 issuers defaulted on $7.6 billion in municipal bonds.

There are reports that approximately $5 billion in municipal bonds are in default today.

See

Standard and Poor's,

A Complete Look at Monetary Defaults in the 1990s

(June, 2000) (available at

http://www.kennyweb.com/kwnext/mip/paydefault.pdf

) (“Standard and Poor's Report”).

See also

Moody's Investors Service,

The U.S. Municipal Bond Rating Scale: Mapping to the Global Rating Scale And Assigning Global Scale Ratings to Municipal Obligations

(March, 2008) (available at

http://www.moodys.com/cust/content/content.ashx?source=StaticContent/Free%20pages/Credit%20Policy%20Research/documents/current/102249_RM.pdf

) (regarding municipal defaults of Moody's rated municipal securities).

See

Standard and Poor's Report,

supra

note 23.

See also

Proposing Release,

supra

note 2, 74 FR at 36834.

See Joe Mysak,

Subprime Finds New Victim as Muni Defaults Triple,

Bloomberg News, May 30, 2008.

See

Joe Mysak,

Municipal Defaults Don't Reflect Tough Times: Chart of Day,

Bloomberg News, May 28, 2009 (also noting that since 1999, issuers have defaulted on $24.13 billion in municipal bonds).

See, e.g.,

Mary Williams Walsh,

State Debt Woes Grow Too Big to Camouflage,

The New York Times, March 30, 2010.

The Commission's experience with the operation of the Rule over the past 20 years, changes in the municipal market since the adoption of the 1994 Amendments, and recent market events have suggested the need for the Commission to reconsider certain aspects of the Rule. In particular, the Commission proposed amendments to the Rule's exemption for primary offerings of municipal securities in authorized denominations of $100,000 or more which, at the option of the holder thereof, may be tendered to the issuer or its designated agent for redemption or purchase at par value or more at least as frequently as every nine months until maturity, earlier redemption, or purchase by the issuer or its designated agent (“demand securities”).

17 CFR 240.15c2-12(d)(1)(iii).

As the Commission discussed in the Proposing Release, at the time the Rule was adopted in 1989, demand securities were relatively new to the municipal market.

Approximately $13 billion of variable rate demand obligations (“VRDOs”)

were issued in 1989.

However, by 2009, it has been reported that approximately $32 billion of VRDOs were issued,

with trading in VRDOs representing approximately 34% of trading volume of all municipal securities.

Further, it has been reported that as of early 2009, the outstanding amount of VRDOs was estimated at approximately $400 billion.

During the fall of 2008, the VRDO market experienced significant volatility.

As the size, volatility, and complexity of the VRDO market and the number of investors have grown, so have the risks associated with less complete disclosure. Moreover, representatives of the primary purchasers of VRDOs—money market funds—have expressed concerns suggesting that the exemption in Rule 15c2-12 for these securities may no longer be justified.

These developments highlight the need for the Commission to improve the availability to investors of important information regarding demand securities.

See

Proposing Release,

supra

note 2, 74 FR at 36834-5.

The Commission is not currently aware of any demand securities that were not issued as VRDOs.

The MSRB describes VRDOs as “[

f]loating rate obligations that have a nominal long-term maturity but have a coupon rate that is reset periodically (

e.g.,

daily or weekly). The investor has the option to put the issue back to the trustee or tender agent at any time with specified (

e.g.,

seven days') notice. The put price is par plus accrued interest.”

See http://www.msrb.org/MSRB1/glossary/view_def.asp?vID=4310.

See Two Decades of Bond Finance: 1989-2008,

The Bond Buyer/Thomson Reuters 2009 Yearbook 4 (Matthew Kreps ed., Source Media, Inc.) (2009).

See

Thomson Reuters, “A Decade of Municipal Bond Finance” (available at

http://www.bondbuyer.com/marketstatistics/decade_1

According to the MSRB, trading volume in VRDOs in 2009 was approximately $1.3 trillion. Total trading volume in 2009 for all municipal securities was approximately $3.8 trillion.

See

E-mail between Martha M. Haines, Assistant Director and Chief, Office of Municipal Securities, Division, Commission, and Marcelo Vieira, Director of Research, MSRB, January 26, 2010. As noted in the Proposing Release, in 2008, approximately $115 billion of VRDOs were issued, with trading in VRDOs representing approximately 38% of trading volume of all municipal securities.

See

Proposing Release,

supra

note 2, 74 FR at 36834, n. 27 and accompanying text.

See

Andrew Ackerman,

Regulation: MSRB Files Disclosure Proposals; Board Offers Four New Rules to SEC,

The Bond Buyer, July 15, 2009.

See also

Proposing Release,

supra

note 2, 74 FR at 36834 and n. 27.

See

Diya Gullapalli,

Crisis On Wall Street: Muni Money-Fund Yields Surge—Departing Investors Send 7-Day Returns Over 5%,

Wall Street Journal, September 27, 2008; Andrew Ackerman,

Short-Term Market Dries Up: Illiquidity Leads to Lack of Bank LOCs,

The Bond Buyer, October 7, 2008. (“The reluctance of financial firms to carry VRDOs is evident in the spike in the weekly [SIFMA] municipal swap index, which is based on VRDO yields and spiked from 1.79% on Sept. 10 to 7.96% during the last week of the month. It has since declined somewhat to 5.74%.”).

See also

Proposing Release,

supra

note 2, 74 FR at 36834, n. 33.

See, e.g.,

Letter from Karrie McMillan, General Counsel, Investment Company Institute (“ICI”), to Florence E. Harmon, Secretary, Commission (July 25, 2008) (available at

http://www.sec.gov/comments/s7-13-08/s71308-44.pdf

); comments of participants in the 2001 SEC Municipal Market Roundtable—“Secondary Market Disclosure for the 21st Century,” (available at

http://www.sec.gov/info/municipal/roundtables/thirdmuniround.htm

) (Leslie Richards-Yellen, Principal, The Vanguard Group: “ * * * what I'd like to see change the most is the inclusion of securities that have been carved out of Rule 15c2-12. I would like securities such as money market securities to be within the ambit of Rule 15c2-12. In addition, I'd like to see the eleven material events be expanded. The first eleven were very helpful. The ICI drafted a letter and we've added another twelve for the industry to think about and cogitate on * * *”, and Dianne McNabb, Managing Director, A.G. Edwards & Sons, Inc: “I think that in summary, we could use more specificity as far as what needs to be disclosed, the timeliness of that disclosure, such as the financial statements, more events, I think that we would agree that there are more events * * *”); and National Federation of Municipal Analysts,

Recommended Best Practices in Disclosure for Variable Rate and Short-Term Securities,

February, 2003 (recommendations for continuing disclosures of specified information) (available at

http://www.nfma.org/publications/short_term_030207.pdf

);

see

Proposing Release,

supra

note 2, 74 FR at 36834, n. 15.

See also

ICI Letter at 5 (“We support the proposed amendment to improve VRDO disclosure * * *. Specifically, the availability of continuing disclosure information regarding VRDOs would greatly benefit investors by enhancing their ability to make and monitor their investment decisions and protect themselves from misrepresentations and questionable conduct in this segment of the municipal securities market.”), and Fidelity Letter at 2. Fidelity indicated in its letter that it assisted in the preparation of the ICI Letter and expressed support for all of the statements made in the ICI Letter.

The Commission believes that investors and other municipal market participants today should be able to obtain continuing disclosure information regarding demand securities so that they can make more knowledgeable investment decisions and effectively manage and monitor their investments so as to reduce the likelihood of fraud facilitated by inadequate disclosure. Accordingly, the Commission is modifying the exemption in the Rule, as discussed below, for demand securities

by requiring

Participating Underwriters to reasonably determine that the issuer of demand securities, or any obligated person, has undertaken in a written agreement to provide continuing disclosure documents to the MSRB.

See

17 CFR 240.15c2-12(d)(1)(iii). Specifically, the Commission is eliminating the exemption for primary offerings of demand securities contained in paragraph (d)(1)(iii) of the Rule and adding new paragraph (d)(5) to the Rule. Paragraph (d)(5) of the Rule, as revised, exempts primary offerings of demand securities from all of the provisions of the Rule except those relating to a Participating Underwriter's obligations pursuant to paragraph (b)(5) of the Rule and relating to recommendations by brokers, dealers, and municipal securities dealers pursuant to paragraph (c) of the Rule. As discussed in Section III.A. below, the Commission is adopting a modified version of its initial proposal to cover demand securities issued on or after the amendments' compliance date. As a result of these changes, Participating Underwriters, in connection with a primary offering of demand securities, will need to reasonably determine that the issuer or obligated person has entered into a continuing disclosure agreement with respect to the submission of continuing disclosure documents to

the MSRB. In addition, brokers, dealers, and municipal securities dealers recommending the purchase or sale of demand securities will need to have procedures in place that provide reasonable assurance that they would receive prompt notice of event notices and failure to file notices.

See

17 CFR 240.15c2-12(c).

As discussed in detail below, the Commission is adopting, substantially as proposed, the amendments to Rule 15c2-12. In sum, the Commission is modifying, substantially as proposed, the Rule's exemption for demand securities by deleting current paragraph (d)(1)(iii) and adding new paragraph (d)(5) to the Rule, thereby applying the continuing disclosure requirements of paragraphs (b)(5) and (c) of the Rule

to a primary offering of demand securities. The amendments also modify, as proposed, paragraph (b)(5)(i)(C) of the Rule, thereby requiring all Participating Underwriters to reasonably determine that the issuer or obligated person has undertaken in a continuing disclosure agreement to provide event notices to the MSRB in a timely manner not in excess of ten business days, rather than merely in “a timely manner.”

See supra

notes 11 through 16 and accompanying text for a description of paragraph (b)(5) of the Rule. Paragraph (c) of the Rule requires a broker, dealer, or municipal securities dealer that recommends the purchase or sale of a municipal security to have procedures in place that provide reasonable assurance that it will receive prompt notification regarding any event notice and any failure to file notice related to the municipal security.

See

17 CFR 240.15c2-12(c).

In addition, the Commission is adopting, with a few revisions from the proposal in the Proposing Release, an amendment to paragraph (b)(5)(i)(C) of the Rule relating to adverse tax events. Under the amendment, as revised from the proposal in the Proposing Release, this event item includes “the issuance by the IRS of proposed or final determinations of taxability, Notices of Proposed Issue (IRS Form 5701-TEB) or other material notices or determinations with respect to the tax status of the security or other material events affecting the tax status of the security.” The amendments also add, as proposed, the following events to paragraph (b)(5)(i)(C) of the Rule: (1) Tender offers; (2) bankruptcy, insolvency, receivership or similar event of the issuer or obligated person; (3) the consummation of a merger, consolidation, or acquisition involving an obligated person or the sale of all or substantially all of the assets of the obligated person, other than in the ordinary course of business, the entry into a definitive agreement to undertake such an action or the termination of a definitive agreement relating to any such actions, other than pursuant to its terms, if material; and (4) appointment of a successor or additional trustee, or the change of name of a trustee, if material.

Finally, the amendments delete the general materiality condition from paragraph (b)(5)(i)(C) of the Rule. In connection with the deletion of the general materiality condition from paragraph (b)(5)(i)(C) of the Rule, the amendments also add a materiality condition to select events contained in paragraph (b)(5)(i)(C) of the Rule. For those events in paragraph (b)(5)(i)(C) of the Rule that do not contain a materiality condition, Participating Underwriters will now need to reasonably determine that an issuer or obligated person has undertaken in a written agreement to provide notice of such events in all circumstances. These events include: (1) Principal and interest payment delinquencies with respect to the securities being offered; (2) unscheduled draws on debt service reserves reflecting financial difficulties; (3) unscheduled draws on credit enhancements reflecting financial difficulties; (4) substitution of credit or liquidity providers, or their failure to perform; (5) defeasances; and (6) rating changes.

III. Discussion of Amendments and Comments Received

A. Modification of the Exemption for Demand Securities

As discussed in the Proposing Release, generally there are no continuing disclosure agreements for demand securities today because primary offerings of these securities are currently exempt from the Rule.

When the Rule was adopted in 1989, the Commission exempted demand securities from its coverage in response to concerns that the Rule “might unnecessarily hinder the operation of the market”

for VRDOs, or similar securities. Paragraphs (b)(1) through (b)(4) of the Rule require a Participating Underwriter to review an official statement that the issuer “deems final” before it may bid for, purchase, offer, or sell municipal securities in an offering, deliver preliminary and final official statements to any potential customer, on request, and contract with the issuer to receive an adequate number of the final official statements to fulfill its regulatory responsibilities. Although remarketings of VRDOs may be primary offerings,

the Commission did not impose the requirements of paragraphs (b)(1) through (b)(4) of the Rule on Participating Underwriters of each remarketing—which could occur as frequently as weekly, and sometimes even daily, for each outstanding demand security—in part because of the burden this could impose on Participating Underwriters to comply with the Rule's provisions.

The Commission, in the 1994 Amendments Adopting Release, did not specifically address the application of paragraph (b)(5) of the Rule, which currently requires Participating Underwriters to reasonably determine that an issuer of municipal securities or an obligated person

has undertaken in a continuing disclosure agreement to provide specified information to the MSRB, to remarketings of demand securities.

See

Proposing Release,

supra

note 2, 74 FR at 36836.

See

1989 Adopting Release,

supra

note 8, 54 FR at 28808, n. 68.

See also

Proposing Release,

supra

note 2, 74 FR at 36836.

See

Rule 15c2-12(f)(7) for the definition of “primary offering.” 17 CFR 240.15c2-12(f)(7). Making a determination concerning whether a particular remarketing of demand securities is a primary offering by the issuer of the securities requires an evaluation of relevant provisions of the governing documents, the relationship of the issuer to the other parties involved in the remarketing transaction, and other facts and circumstances pertaining to such remarketing, particularly with respect to the extent of issuer involvement.

See

1989 Adopting Release,

supra

note 8, 54 FR at 28808 and n. 68.

See also

Proposing Release,

supra

note 2, 74 FR at 36836.

See

17 CFR 240.15c2-12(f)(10).

See

1994 Amendments Adopting Release,

supra

note 8.

As discussed above, the Commission today is modifying the Rule's exemption for demand securities because its experience with the operation of the Rule and market changes since the adoption of the 1994 Amendments have suggested a need to reconsider its scope. The increased issuance, trading volume, and outstanding dollar amount of VRDOs indicate that many more investors currently own such securities than when the Rule was adopted in 1989.

Further, despite the periodic

ability to tender VRDOs to issuers for repurchase, some investors, such as mutual funds, appear to hold VRDOs for long periods of time and therefore have a need for continuing disclosure information about the issuer or obligated person.

As stated in the Proposing Release, the increased investment interest and activity in VRDOs during 2008 may be attributable, in part, to the turmoil in the market for auction rate securities (“ARS”) that began in February 2008.

See

Proposing Release,

supra

note 2, 74 FR at 36834 and 36835, n. 48.

See

Proposing Release,

supra

note 2, 74 FR at 36835, n. 45.

Accordingly, the Commission believes that developments since 1989 warrant narrowing the Rule's provision exempting demand securities from continuing disclosure obligations in order to improve the availability of information to investors. Indeed, representatives of money market funds, the primary purchasers of demand securities, have expressed difficulty or, on some occasions, the inability to obtain information that they believe is necessary to oversee their investments in demand securities.

By narrowing the exemption for demand securities, the Commission intends to improve the availability of continuing disclosures, not only to institutional investors, such as mutual funds, that acquire these securities for their portfolios, but also to individual investors who own, or who may be interested in owning, demand securities. The availability of information regarding demand securities, in turn, should help institutional and individual investors make more informed decisions with respect to investments in those securities and should reduce the likelihood that such investors will be subject to fraud facilitated by inadequate disclosure. The Commission believes that broader requirements for consistent and accurate disclosure of important information should enhance the efficiency of the relevant capital market segments by better allocating capital at appropriate prices.

See

Proposing Release,

supra

note 2, 74 FR at 36836.

Consequently, the Commission is deleting the exemption for demand securities

set forth in paragraph (d)(1)(iii) of the Rule and adding new paragraph (d)(5) to the Rule, thereby making the continuing disclosure provisions of paragraphs (b)(5)

and (c)

of the Rule apply to a primary offering

of demand securities.

This change applies to any primary offering of demand securities (including a remarketing that is a primary offering) occurring on or after the compliance date of the amendments.

However, as more fully discussed below,

the Commission is revising the amendment from that proposed to include a “limited grandfather provision” (as defined below) for remarketings of currently outstanding demand securities.

Specifically, the continuing disclosure provisions will not apply to remarketings of demand securities that are outstanding in the form of demand securities on the day preceding the compliance date of the amendments and that continuously have remained outstanding

in the form of demand securities.

See supra

note 28 and accompanying text.

See supra

note 14 and accompanying text.

See supra

note 38 for a description of Rule 15c2-12(c).

See

Rule 15c2-12(f)(7) for the definition of primary offering. 17 CFR 240.15c2-12(f)(7).

See supra

note 41.

As noted in Section III.G., the compliance date of the amendments to the Rule adopted herein is December 1, 2010.

See infra

notes 111 and 112 and accompanying text, as well as the paragraph following the accompanying text.

See infra

note 112 and accompanying text for discussion of comments related to the limited grandfather provision.

“Outstanding” generally means bonds that have been issued but have not yet matured or been otherwise redeemed.

See, e.g,

MSRB Glossary of Municipal Security Terms at

http://www.msrb.org/msrb1/glossary/glossary_db.asp?sel=o.

Thus, as amended, paragraph (d)(2)(B)(5) of the Rule states that “[w]ith the exception of paragraphs (b)(1) through (b)(4), this section shall apply to a primary offering of municipal securities in authorized denominations of $100,000 or more if such securities may, at the option of the holder thereof, be tendered to an issuer of such securities or its designated agent for redemption or purchase at par value or more at least as frequently as every nine months until maturity, earlier redemption, or purchase by an issuer or its designated agent;

provided, however, that paragraphs (b)(5) and (c) shall not apply to such securities outstanding as of November 30, 2010 for so long as they continuously remain in authorized denominations of $100,000 or more and may, at the option of the holder thereof, be tendered to an issuer of such securities or its designated agent for redemption or purchase at par value or more at least as frequently as every nine months until maturity, earlier redemption, or purchase by an issuer or its designated agent”

(emphasis added to indicate revised language) (“limited grandfather provision”).

The Commission also is slightly modifying the text of paragraph (d)(2)(B)(5) of the Rule from the version in the Proposing Release to clarify that demand securities remain exempt from paragraphs (b)(1)-(4) of the Rule, consistent with the Commission's description and discussion of the amendment in the Proposing Release.

In the Proposing Release, the Commission requested comment on whether it is appropriate to revise the Rule's exemption for demand securities. The Commission specifically requested comment regarding investors' and other municipal market participants' need for continuing disclosure information relating to demand securities and the extent to which the amendment would provide benefits to these individuals. The Commission also requested comment regarding the effect of the amendment on Participating Underwriters, issuers, obligated persons, and others.

Commenters were generally supportive of applying the continuing disclosure provisions of paragraph (b)(5) of the Rule to demand securities, so that a Participating Underwriter of these securities will be required to reasonably determine that the issuer or obligated person has entered into a continuing disclosure agreement to submit continuing disclosure documents to the MSRB.

A number of commenters agreed that applying continuing disclosure obligations to demand securities is “critical” to assist investors in making informed investment decisions.

One commenter noted that the market for VRDOs was among the sectors most affected by the recent market turmoil and, consequently, there is good reason to increase the availability of information about these securities to investors.

Similarly, another commenter stated that, during the recent market downturn, investors in VRDOs were well served by those issuers or obligated persons who voluntarily provided continuing

disclosure documents, despite the Rule's exemption.

See

California Letter at 1, CHEFA Letter at 2, Connecticut Letter at 1, DAC Letter at 3, e-certus Letter I at 11, Fidelity Letter at 3, Folts Letter at 1, ICI Letter at 2, NFMA Letter at 1, RBDA Letter at 2, and SIFMA Letter at 2.

Although the Commission is eliminating certain exemptions, demand securities will continue to be exempt from paragraphs (b)(1)-(4) of the Rule. In other words, a Participating Underwriter of a demand security will continue to be exempt from the obligation to review an official statement that the issuer “deems final” before it may bid for, purchase, offer, or sell municipal securities. Some commenters urged the Commission to eliminate the exemption for demand securities from these provisions.

See

Fidelity Letter at 3 and RBDA Letter at 2, and SIFMA Letter at 2. One commenter expressed concern that not requiring Participating Underwriters to comply with these provisions with regard to demand securities suggests that the information required in the continuing disclosure documents may not be material for investors at the initial issuance of the demand securities.

See

SIFMA Letter at 2. The Commission believes that it is important for investors to have adequate information in order to make informed investment decisions. The Commission also notes that many official statements are prepared for demand securities.

See

http://www.emma.msrb.org.

See

ICI Letter at 5.

See also

SIFMA Letter at 2 and RBDA Letter at 2.

See

RBDA Letter at 2.

See also

Fidelity Letter at 2.

See

CHEFA Letter at 2.

Further, two commenters noted that application of paragraph (b)(5) of the Rule to demand securities might not significantly increase the disclosure burdens for many issuers and obligated persons.

One commenter noted that, because many VRDO issuers are already subject to continuing disclosure undertakings for their fixed rate debt, extending these obligations to VRDOs would impose minimal additional burdens, while enhancing disclosure to a much broader segment of investors.

Two commenters also noted that, as issuers of VRDOs, they have for a number of years voluntarily entered into continuing disclosure undertakings for those securities.

See

Connecticut Letter at 1 and NFMA Letter at 1.

See

NFMA Letter at 1.

See

California Letter at 1 and Connecticut Letter at 1.

Two commenters, however, disputed the assessment that extending paragraph (b)(5) to demand securities would not significantly increase the disclosure burdens for issuers and obligated persons.

These commenters focused particularly on the impact the amendment would have on borrowers who access tax-exempt debt markets through demand securities that are fully backed by direct-pay letters of credit (“LOC-backed demand securities”). One of the commenters noted that many of these are non-governmental conduit borrowers

who have no previous undertakings to provide continuing disclosure information and, for such entities, complying with paragraph (b)(5) of the Rule would not merely be an extension of preexisting obligations but a new and significant burden.

Moreover, the two commenters opposing the proposed change stated that many obligated persons with respect to LOC-backed demand securities do not prepare annual filings, such as audited financial statements, in the ordinary course of their business.

They therefore believed that eliminating the exemption from paragraph (b)(5) would impose costs and burdens that could potentially force some conduit borrowers using LOC-backed demand securities to withdraw from the tax-exempt bond market.

See

CRRC Letter at 3-5 and NABL Letter at A-10.

A “conduit borrower” is an obligated person for whose benefit a state, political subdivision, municipality, or governmental agency or authority may issue tax-exempt municipal bonds. The security for this type of issue is customarily the credit of the conduit borrower or pledged revenues from the project financed, rather than the credit of the issuer.

See, e.g.,

definitions of “conduit financing,” “conduit borrower,” and “issuer” in Glossary of Municipal Securities Terms (Second Edition—January 2004) of the MSRB, available at

http://www.msrb.org/msrb1/glossary/glossary_db.asp?sel=c

See

NABL Letter at A-2, n. 1.

See

CRRC Letter at 5 and NABL Letter at A-2.

See

CRRC Letter at 5 and NABL Letter at A-10. Two commenters also expressed concern that, in complying with the revised Rule, smaller and not-for-profit obligated persons could encounter similar costs and burdens.

See

NABL Letter at A-2 (noting that many small businesses and non-profit organizations utilize LOC-backed demand securities in accessing the tax-exempt debt markets) and SIFMA Letter at 2-3.

See also

Section VI.B.2(c).

As the Commission stated in the Proposing Release, it does not anticipate a significant increase in disclosure burdens with respect to demand securities.

Those issuers with outstanding demand securities—including LOC-backed demand securities—will have the limited grandfather provision available to them, and thus likely will not be subject to an undertaking to provide continuing disclosures for those securities. The Commission acknowledges that, if issuers of demand obligations, or obligated persons, have not previously issued securities that were subject to the Rule (

i.e.,

municipal securities other than demand securities), they will be entering into a continuing disclosure agreement for the first time and thereby will incur some costs and burdens to provide continuing disclosure documents to the MSRB.

However, as the Commission noted in proposing these amendments, a number of issuers of VRDOs, and obligated persons, already have outstanding fixed rate municipal securities, and some of these securities likely are subject to continuing disclosure agreements under the Rule.

Because any existing continuing disclosure agreement obligates an issuer or an obligated person to provide annual filings, event notices, and failure to file notices with respect to these fixed rate securities, providing disclosures by such issuers or obligated persons with respect to VRDOs is not expected to be a significant additional burden.

As the Commission stated in proposing these amendments,

it believes that any additional burden on issuers and obligated persons

with respect to demand securities is, on balance, justified by the enhancements to investor protection that should result from the improved availability of information with respect to these securities as a result of the amendments.

As noted above, a number of commenters supported this view.

See

Proposing Release,

supra

note 2, 74 FR at 36837.

Id.

See

Proposing Release,

supra

note 2, 74 FR at 36837.

See infra

Section V.D. for a discussion regarding burden on issuers and obligated persons that do not currently provide annual filings, event notices, or failure to file notices.

See

Proposing Release,

supra

note 2, 74 FR at 36837.

The Commission estimates that the amendment to modify the exemption from the Rule for a primary offering of demand securities would increase the number of issuers with municipal securities offerings that are subject to the Rule annually by 20%.

See infra

Section V.D.

For discussion of the burdens associated with the modification of the Rule as it relates to demand securities,

see supra

Section V.D.

See, e.g.,

CHEFA Letter at 2, Connecticut Letter at 1, e-certus Letter I at 11, Folts Letter at 1, ICI Letter at 5, NFMA Letter at 1, RBDA Letter at 2, and SIFMA Letter at 2.

Regarding the concern that any new disclosure burdens may induce some obligated persons to withdraw from the tax-exempt municipal market because they do not prepare annual filings in the ordinary course of their business, the Commission notes that, for purposes of the Rule, annual filings are required only to the extent provided in the final official statements. Specifically, annual filings are composed of: (1) Audited financial statements, when and if available; and (2) other financial and operating data of the type included in the official statement. Pursuant to the undertaking contemplated by the Rule, annual financial information must be submitted for “each obligated person for whom financial information or operating data is presented in the final official statement. * * * ”

Annual financial information is defined as “financial information or operating data * * * of the type included in the final official statement with respect to an obligated person. * * * ”

As the Commission previously stated, the definition of annual financial information specifies both the timing of the information—that is, once a year—and, by referring to the final official statement, the type of financial information and operating data that is to be provided.

If financial information or operating data concerning an obligated person is included in the final official statement, then annual financial information would consist of the same type of financial information or operating data.

17 CFR 240.15c2-12(b)(5)(i)(A).

17 CFR 240.15c2-12(f)(9).

See

1994 Amendments Adopting Release,

supra

note 8, 59 FR at 59598.

Id. See

paragraph (f)(3) of the Rule for the definition of “final official statement.” 17 CFR 240.15c2-12(f)(3).

Further, pursuant to paragraph (b)(5)(i)(B) of the Rule, audited financial statements need to be submitted, pursuant to the issuer's and obligated person's undertaking in a continuing disclosure agreement, only “when and if available.”

This limitation, which is consistent with the Commission's position in the 1994 Amendments Adopting Release, should mitigate some concerns of those obligated persons that do not prepare audited financial statements in the ordinary course of their business.

Further, although not all issuers or obligated persons, in the ordinary course of their business, prepare audited financial statements or other financial and operating information of the type included in annual filings, a number of issuers and obligated persons do.

17 CFR 240.15c2-12(b)(5)(i)(B).

As discussed in the 1994 Amendments Adopting Release, the 1994 Amendments “[do] not adopt the proposal to mandate audited financial statements on an annual basis with respect to each issuer and significant obligor. Instead, the amendments require annual financial information, which may be unaudited, and may, where appropriate and consistent with the presentation in the final official statement, be other than full financial statements. * * * However, if audited financial statements are prepared, then when and if available, such audited financial statements will be subject to the undertaking and must be submitted to the repositories. Thus * * * the undertaking must include audited financial statements only in those cases where they otherwise are prepared.”

See

1994 Amendments Adopting Release,

supra

note 8, 59 FR at 59599.

See http://www.emma.msrb.org

for audited financial statements or other financial and operating information submitted to EMMA.

The Commission acknowledges that issuers or obligated persons of demand obligations that assemble financial and operating data for the first time in response to their undertakings in a continuing disclosure agreement may incur incremental costs beyond those costs incurred by those issuers or obligated persons that already assemble this information. Also, smaller issuers or obligated persons may have relatively greater burdens than larger issuers or obligated persons. However, the overall burdens for these demand securities issuers or obligated persons in preparing financial information are expected to be commensurate with those of issuers or obligated persons that already are preparing financial information as part of their continuing disclosure undertakings.

The Commission believes that the burdens that will be incurred in the aggregate by issuers or obligated persons, as a result of the amendments with respect to demand securities, may not be significant and, in any event, are justified by the benefits to investors of enhanced disclosure.

The Commission further believes that the operations of an issuer or obligated person generally entail the preparation and maintenance of at least some financial and operating data.

Further, issuers or obligated persons that assemble financial and operating data for the first time may face a greater burden than those issuers or obligated persons that already assemble this information. The amendments therefore initially may have a disparate impact on those issuers or obligated persons, including small entities, entering into a continuing disclosure agreement for the first time, as compared with those that already have outstanding continuing disclosure agreements.

See infra

Section V.D. As discussed therein, some commenters believed that the amendment could force some small entities to withdraw from the tax-exempt market because: (1) Disclosure of small issuers' or obligated persons' financial information would provide their large, national competitors with information about these small issuers or obligated persons, which they believed could result in a competitive disadvantage to them; and (2) small issuers or obligated persons would have to prepare costly audited financial statements.

See, e.g.,

CRRC Letter at 3-4 and WCRRC Letter at 1. As discussed above, the undertakings contemplated by the amendments (and Rule 15c2-12 in general) require annual financial information only to the extent provided in the final official statement, and audited financial statements only when and if available.

The Commission also stated in the Proposing Release, and reiterates herein, its belief that the application of paragraph (b)(5) to demand securities will not significantly burden Participating Underwriters in connection with the initial issuance and remarketing of demand securities. Any primary offering, including a remarketing of demand securities that is a primary offering (other than those subject to the limited grandfather provision), that occurs on or after the compliance date of the Rule will require a Participating Underwriter (including a Participating Underwriter serving as a remarketing agent)

to make a determination that an issuer or an obligated person has entered into a continuing disclosure agreement. Subsequent determinations for remarketings of the same issue of demand securities should not be burdensome because, once the Participating Underwriter has made such a determination for a particular issue of demand securities, at the time of a subsequent remarketing, the Participating Underwriter will be aware of the existence of the continuing disclosure agreement. Furthermore, remarketing agents that did not previously participate in an offering of such securities could confirm that an issuer or an obligated person has entered into an undertaking by obtaining an official statement from the issuer, the MSRB,

or from a variety of vendors. Such an official statement by definition must include a description of the issuer's undertakings.

In addition, a remarketing agent could obtain a copy of the actual continuing disclosure agreement from the issuer or obligated person at the time that it enters into a contract to act as a remarketing agent.

A remarketing agent is a broker-dealer responsible for reselling to new investors securities (such as VRDOs) that have been tendered for purchase by their owner. The remarketing agent also typically is responsible for resetting the interest rate for a variable rate issue and also may act as tender agent.

See

Proposing Release,

supra

note 2, 74 FR at 36836, n. 53. Further, a remarketing agent often serves as the Participating Underwriter in the initial issuance of the demand security.

The MSRB makes official statements for public offerings of municipal securities available on the Internet through its EMMA system for free.

See

Securities Exchange Act Release No. 59061 (December 5, 2008), 73 FR 75778 (December 12, 2008) (File No. SR-MSRB-2008-05) (order approving the MSRB's proposed rule change to make permanent a pilot program for an Internet-based public access portal for the consolidated availability of primary offering information about municipal securities).

See also

supra

note 5 and MSRB Rule G-32.

17 CFR 240.15c2-12(f)(3).

One commenter believed the elimination of the exemption for LOC-backed demand securities would substantially increase a Participating Underwriter's burden in offering and remarketing these securities because the Participating Underwriter must: (1) Determine whether information concerning the obligated person is material and (2) if material, review the offering document to assure that it includes financial or operating data about the obligated person. In addition, this commenter stated that a Participating Underwriter would be required by the antifraud provisions of the Securities Act of 1933 and the Exchange Act to reasonably investigate key representations about the obligated person in the offering document before passing the securities along to investors and periodically repeat its “due diligence” of the obligated person before acting as a remarketing agent for primary offerings of such demand securities.

See

NABL Letter at A-11. However, such obligations of a Participating Underwriter already exist under the antifraud provisions of the federal securities laws.

Some commenters argued that the amendment is too broad.

Specifically, these commenters stated that the amendment should not apply to conduit borrowers of LOC-backed demand securities, but rather to the letter of credit providers.

They stated that, for

these securities, a bond trustee draws on the letters of credit issued by banks or financial institutions, rather than the underlying borrowers, for all payments of interest and principal, and to repurchase the securities if and when they are tendered.

Consequently, information in disclosure documents for some LOC-backed demand securities relates to the entities issuing the letters of credit, and not the conduit borrowers.

These commenters argued that, if the Commission applies paragraph (b)(5) of the Rule to LOC-backed demand securities,

the obligation to provide continuing disclosures should be imposed on the banks and financial institutions that provide credit enhancements, and not on the conduit borrowers.

See

CRRC Letter at 2, NABL Letter at 2, and WCRRC Letter at 1 (endorsing CRRC Letter in its entirety). One of these commenters maintained that the Commission should not adopt the amendment relating to demand securities without Congressional authority. The commenter stated that the Commission does not have the “statutory authority to regulate the content of prospectuses used to offer exempt securities, except possibly under the authority of the antifraud provisions of the federal securities laws.”

See

NABL Letter at A-7. The Commission notes that the amendments do not address the contents of prospectuses used to offer exempt securities and, instead, are being adopted, among other things, pursuant to its authority under Section 15(c)(2)(D) of the Exchange Act, 15 U.S.C. 78

(c)(2)(D), which grants the Commission authority to define, and to prescribe means reasonably designed to prevent, such acts and practices as are fraudulent, deceptive or manipulative.

See

CRRC Letter at 2 and NABL Letter at 2.

Separately, another commenter remarked about the responsibilities of an issuer with respect to the

underlying obligor of a demand security. The commenter stated that, “if it is the SEC's intention to have issuers disclose information either in the official statement or on a continuing basis regarding the underlying obligor,” issuers would be significantly burdened because they do not have such information first-hand.

See

GFOA Letter at 2. The Commission notes that its rulemaking does not amend provisions of Rule 15c2-12 relating to official statements. The Commission notes that, as with other conduit borrowings, issuers may require an obligated person of demand obligations to execute a continuing disclosure agreement as a condition of issuance, such that the underlying obligor bears the responsibility of providing continuing disclosures to the MSRB.

Id. See

also

NABL Letter at A-1.

See

CRRC Letter at 2 and NABL Letter at A-2 and A-6.

See

CRRC Letter at 2-3 and NABL Letter at 1-2.

See

CRRC Letter at 3.

As noted in the Proposing Release, the Commission believes that information regarding conduit borrowers is material to investors in credit enhanced offerings and therefore should be included in the official statements.

As the Commission has stated before in the context of municipal securities offerings as well as other types of securities offerings, the existence of credit enhancement is not a substitute for information about the underlying obligor or other obligated entity.

For example, Regulation AB, relating to disclosures in offerings of asset-backed securities, requires disclosure about the underlying pool of assets in addition to disclosures about credit enhancement and credit enhancement providers.

Furthermore, for VRDOs, as well as fixed rate securities, many governmental issuers and conduit borrowers routinely provide full disclosure about themselves in official statements, suggesting that they consider this information to be useful to investors.

100

The Commission also notes that it is possible for the issuers of credit enhancements, including letters of credit providers, to default on their obligations

101

or to have their ratings downgraded.

102

The possibility of such occurrences supports the likelihood that investors would consider information concerning the underlying obligor important to making investment decisions.

See

Proposing Release,

supra

note 2, 74 FR at 36844, n. 113, citing 1989 Adopting Release,

supra

note 8, 54 FR at 28812.

See

1989 Adopting Release,

supra

note 8, 54 FR at 28812 (“The presence of credit enhancements generally would not be a substitute for material disclosure concerning the primary obligor on municipal bonds.”)

17 CFR 229.1100-1123.

100

For example, governmental obligors, non-profit health care facilities, colleges, and universities routinely provide disclosures about themselves in official statements.

See, e.g.,

Connecticut Letter at 1; Official Statement dated November 4, 2009 for VRDOs issued by the Arizona Health Facilities Authority for the benefit of Catholic Healthcare West (available at

http://emma.msrb.org/EP346945-EP47480-EP669523.pdf

); Official Statement dated August 22, 2008 for VRDOs issued by the Health and Educational Authority of the State of Missouri for the benefit of Saint Louis University (available at

http://emma.msrb.org/OSPreview/OSPreview.aspx?documentId=MS271933&transactionId=MS274477

); Official Statement dated October 12, 1994 for VRDOs of the City of Akron Ohio for its Sanitary Sewer System (available at

http://emma.msrb.org/OSPreview/OSPreview.aspx?documentId=MS80311&transactionId=MS105003

); and Official Statement dated April 15, 2005 for VRDOs of the Redevelopment Agency of the City and County of San Francisco Community Facilities District No. 7 for Hunters Point Shipyard Phase One Improvements (available at

http://emma.msrb.org/MS233193-MS208501-MD405363.pdf

101

Since 1995, the Federal Deposit Insurance Corporation (“FDIC”) has taken the position that it may not honor unsecured letters of credit issued by financial institutions that are placed in FDIC receivership.

See

FDIC Statement of Policy regarding Treatment of Collateralized Letters of Credit after Appointment of the FDIC as Conservator or Receiver, 60 FR 27976, May 26, 1995, effective May 19, 1995.

102

See

Proposing Release,

supra

note 2, 74 FR at 36839. In addition to the ratings downgrades of almost all issuers of municipal bond insurance over the past two years, the ratings of many issuers of letters of credit on municipal bonds were downgraded by one or more credit rating agencies.

See, e.g.,

Jack Herman,

S&P Downgrades Ratings or Revises Outlooks on 22 Banks,

The Bond Buyer, June 19, 2009 (“Standard & Poor's Wednesday downgraded its ratings or revised its outlooks on 22 U.S. banks—more than half of which have provided letters of credit on municipal securities—to reflect the ongoing change in the banking industry.”); Dan Seymour,

1st-Half Credit Enhancers See a Topsy-Turvy World,

The Bond Buyer, July 16, 2009.

With respect to demand securities, one commenter stated that the Rule should not be amended to apply continuing disclosure requirements to demand securities, because owners of demand securities can choose to terminate their investment by exercising the option to put such securities for repurchase at face value or more, at least as frequently as every nine months.

103

The commenter argued that these investors can therefore sufficiently protect their investments.

104

Further, the commenter noted that when investors need financial and operating data to evaluate their investments, they are able to get such information from conduit borrowers, who typically provide the information voluntarily in order to support pricing and remarketing.

105

The commenter also questioned the need for the amendment when investors, as a condition to purchasing or maintaining an investment in demand securities, are free to demand undertakings to provide notices of certain events.

106

103

See

NABL Letter at A-4—A-6.

104

Id.

105

See

NABL Letter at A-8.

106

See

NABL Letter at A-8 and A-9.

The Commission does not believe that an investor's ability to tender a demand security for repurchase obviates the need for continuing disclosures. While a holder of demand obligations, such as VRDOs, may tender these securities for repurchase at par value,

107

when the investor is unable to obtain necessary information to make an informed decision as to whether to continue to hold demand securities, the investor may have no other option but to tender. However, the Commission does not believe that such outcome is in the interest of the investing public or the municipal securities market. Without adequate information about the issuer or obligated person, including annual financial information and audited annual financial statements, it would be difficult for an investor to evaluate whether to buy, hold, sell, or put the security. Moreover, most holders of VRDOs are money market funds

108

subject to the requirements of Rule 2a-7 under Investment Company Act of 1940 (“Investment Company Act”),

109

with an obligation to monitor the securities in their funds.

110

The availability of continuing disclosure information should facilitate the fulfillment of these obligations. The Commission also notes that one commenter, whose membership includes many money market funds, stated that “the availability of continuing disclosure information regarding VRDOs would greatly benefit investors by enhancing their ability to make and monitor their investment decisions and protect themselves from misrepresentations and questionable

conduct in this segment of the municipal securities market.”

111

107

See

17 CFR 240.15c2-12(d)(1)(iii).

108

See, e.g.,

Standard & Poor's,

Variable Rate Demand Obligations—A Primer: A Short Guide to Variable Rate Demand Obligations and the S&P National AMT-Free Municipal VRDO Index,

November 1, 2009 (available at

http://www2.standardandpoors.com/spf/pdf/index/VRDO_Primer.pdf

109

17 CFR 270.2a-7.

110

17 CFR 270.2a-7(c)(3)(iv).

111

See

ICI Letter at 6.

See also

Fidelity Letter at 2.

Some commenters sought clarification with respect to the proposed amendment relating to demand securities. Specifically, some commenters asked the Commission to clarify the meaning of “primary offering” with respect demand securities

112

and asked for guidance to distinguish remarketings that are primary offerings requiring continuing disclosure agreements from those that are not primary offerings.

113

These comments appear to be based upon the concern that the amendments could require a broker, dealer, or municipal securities dealer to obtain continuing disclosure documents for demand securities that were issued prior to the compliance date of the amendments.

112

See

Kutak Letter at 2, NABL Letter at 4-5 and A-11, and SIFMA Letter at 2.

113

Id.

The Commission acknowledges that, although there may be beneficial effects from subjecting outstanding demand obligations to paragraphs (b)(5) and (c) of the Rule, regardless of their date of initial issuance, doing so may be unduly burdensome and costly for certain market participants. For example, if all outstanding issuances of demand securities, such as VRDOs which generally are long-term securities,

114

became subject to paragraph (b)(5)(i)(C) of the Rule, it would be necessary for a Participating Underwriter, in the first remarketing of each issue of demand securities following the compliance date of the amendments, to reasonably determine that an issuer or obligated person has executed a continuing disclosure agreement. For such an agreement to be consistent with the Rule, a Participating Underwriter must reasonably determine that the issuer or obligated person has agreed to provide “[a]nnual financial information for each obligated person for whom financial information or operating data is presented in the final official statement, or, for each obligated person meeting the objective criteria specified in the undertaking and used to select the obligated persons for whom financial information or operating data is presented in the final official statement.”

115

However, for outstanding issues of demand securities, referring back to information included in the final official statement may be problematic because that document may be many years old. Without the limited grandfather provision, issuers and obligated persons would be required under continuing disclosure agreements to update annual financial information that may no longer be prepared or available. In addition, application of the amendments to remarketings of demand securities occurring on or after the compliance date could necessitate a large number of issuers and obligated persons of demand securities to enter into continuing disclosure agreements in a very short time period, which could delay remarketings and temporarily negatively impact the market for demand securities.

114

See supra

Section II. for statistics on the amount of outstanding VRDOs.

115

17 CFR 240.15c2-12(b)(5)(i)(A).

The Commission has considered the potentially significant difficulties and costs associated with implementing the amendment with respect to outstanding demand securities and the potential negative implications this may have on the demand securities market and investors.

116

As a result, the Commission has revised its original proposal to include a limited grandfather provision so that paragraphs (b)(5) and (c) of the Rule are not applicable to demand obligations outstanding in the form of demand securities immediately prior to the compliance date of these amendments, and that have remained continuously outstanding in the form of demand securities.

117

The Commission believes that the adoption of the limited grandfather provision strikes an appropriate balance between the need to improve disclosure available to investors and the recognition that the practical effects of applying paragraphs (b)(5) and (c) of the Rule to outstanding issues of demand securities could unduly burden certain issuers and obligated persons and thus may adversely impact the market. Although the Commission recognizes that the amendment to demand securities now is narrower than what was originally proposed, the Commission does not believe that the change detracts from the benefits of greater information about new issuances of demand obligations that the amendment will foster. The Commission believes that the burdens of continuing disclosure obligations, noted above, with respect to these securities justify the benefits, and the grandfather provision is consistent with other amendments that have been applied on a prospective basis.

118

Further, the Commission notes that some issuers and obligated persons of demand securities also have issued fixed rate municipal securities, and thus are subject to existing continuing disclosure obligations.

116

See infra

Section VI.B. for a detailed description of costs associated with implementing this change.

117

Two commenters also expressed confusion regarding the application of paragraph (b)(5)(i)(A) of the Rule to demand securities. Paragraph (b)(5)(i)(A) requires that continuing disclosure agreements include annual financial information for each obligated person for whom financial information or operating data is presented in the final official statement. These commenters specifically questioned how Participating Underwriters would comply with the requirement in the limited instances where no final official statement was or is produced with respect to a demand security or when the final official statement that is produced contains no information regarding the underlying obligor.

See

NABL Letter at 2-3 and A-9 and SIFMA Letter at 2. The Commission believes that demand securities are purchased primarily by tax-exempt money market funds and that money market funds typically require official statements.

See, e.g.,

Kutak Letter at 2 (commenting that VRDOs are typically targeted to money market funds) and NABL Letter at A-1 (acknowledging that demand securities are an important part of the investment portfolio of most tax-exempt money market funds).

118

See also

infra

Section VI.B.4.

In conclusion, the Commission continues to believe that any additional burden imposed on Participating Underwriters, issuers, obligated persons, the MSRB, or others as a result of the amendment to the Rule relating to demand securities is justified by the benefits to investors of enhanced disclosure with respect to this important and widely-held type of security. Eliminating the exemption for demand securities, subject to the limited grandfather provision regarding demand securities outstanding as of the day prior to the amendments' compliance date, will improve the availability of information about these securities and should reduce the likelihood that investors will be subject to fraud facilitated by inadequate disclosure. Further, access to more information will assist money market funds

119

in complying with their obligations under Rule 2a-7 of the Investment Company Act.

120

The Commission also believes that the amendment will assist a broker, dealer, or municipal securities dealer in fulfilling its responsibilities to its customers,

121

specifically by facilitating the disclosure of important facts and complying with suitability and other sales practice obligations.

122

119

See supra

note 47.

120

17 CFR 270.2a-7.

121

For example, a broker, dealer, or municipal securities dealer with access to annual filings and event notices submitted to the MSRB will be able to use information disclosed in these filings and notices when deciding to recommend the purchase or sale of a particular demand security.

See, e.g.,

MSRB Rule G-17.

122

See, e.g.,

the MSRB,

Reminder of Customer Protection Obligations in Connection with Sales of Municipal Securities,

Interpretative Notice of Rule G-17, dated May 30, 2007 (available at

http://www.msrb.org/msrb1/rules/notg17.htm

B. Time Frame for Submitting Event Notices Under a Continuing Disclosure Agreement

The Commission is adopting the amendment to paragraph (b)(5)(i)(C) of the Rule

123

to require a Participating Underwriter to reasonably determine that the issuer or obligated person has agreed in its continuing disclosure agreement to submit event notices to the MSRB “in a timely manner not in excess of ten business days after the occurrence of the event,” rather than “in a timely manner” as the Rule currently provides. The Commission also is adopting a substantially similar revision to the limited undertaking in paragraph (d)(2)(ii)(B) of the Rule.

124

123

17 CFR 240.15c2-12(b)(5)(i)(C).

124

17 CFR 240.15c2-12(d)(2)(ii)(B).

See supra

note 16 for a description of Rule 15c2-12(d)(2).

Eighteen commenters provided their views on the proposed ten business day time period for the submission of event notices pursuant to a continuing disclosure agreement.

125

The majority of commenters opposed the proposal. Some commenters opposed establishing any outside time frame,

126

while others specifically objected to the proposed ten business day time period, particularly in the context of certain events.

127

One commenter cited the 1994 Amendments Adopting Release, in which the Commission stated that, at that time, it had not established a specific time frame with respect to submission of event notices because of the wide variety of events and circumstances the issuer could face.

128

This commenter believed that this rationale “was sound logic in 1994, and that it should still apply in 2009.”

129

Another commenter stated that it disagreed “with the SEC that there is systemic abuse with material events not being filed in a timely manner”

130

and argued that the Commission “should not mandate a specific time frame for submissions.”

131

125

See

Halgren Letter, Los Angeles Letter, Portland Letter, CRRC Letter, WCRRC Letter, NFMA Letter, CHEFA Letter, NAHEFFA Letter, SIFMA Letter, Connecticut Letter, Kutak Letter, ICI Letter, Fidelity Letter, California Letter, San Diego Letter, NABL Letter, GFOA Letter, and Metro Water Letter.

See also

1994 Amendments Adopting Release,

supra

note 8, 59 FR at 59601.

126

See

NABL Letter at 5-6, GFOA Letter at 2-3, and Metro Water Letter at 1-2.

127

See

Halgren Letter, Los Angeles Letter, Portland Letter, CRRC Letter, WCRRC Letter, NFMA Letter, CHEFA Letter, NAHEFFA Letter, SIFMA Letter, Connecticut Letter, Kutak Letter, California Letter, and San Diego Letter.

See also

the discussion below in this section regarding commenters' concerns about becoming aware of and submitting notices for events such as rating changes and trustee changes.

128

See

NABL Letter at 5-6.

129

Id.

130

See

GFOA Letter at 2.

131

Id.

Four commenters expressed support for the ten business day time frame.

132

Two of these commenters stated that the proposal “would replace the imprecise `timely manner' language in the current Rule.”

133

These commenters also noted that “the absence of a specific time period with respect to `timely' has resulted in event notices being submitted months after the events have occurred,”

134

which has been detrimental “to investors who need this information to make informed investment decisions about when, and which, municipal securities to buy and sell.”

135

Further, they emphasized that they “strongly support the establishment of a definitive timeframe by which event notices must be filed, and have repeatedly called for improvements to the timeliness of municipal securities disclosure.”

136

132

See

NFMA Letter at 1-2, SIFMA Letter at 3, ICI Letter at 6-7, and Fidelity Letter at 2. Fidelity indicated in its letter that it assisted in the preparation of the ICI Letter II and expressed support for all of the statements made in the ICI Letter.

See

Fidelity Letter at 2.

133

See

ICI Letter at 6 and Fidelity Letter at 2.

134

Id.

135

Id.

136

Id.

These commenters noted that timely submission of event notices directly impacts the pricing of a municipal bond. They posited that “reducing the time between the event and the required notice better informs the market that an event occurred, which is essential to evaluating a bond's credit quality and pricing.”

137

They further noted that a definitive time frame provides more timely information to pricing evaluation services and relieves them of dependence on bondholders to disclose the required information to them.

138

These commenters asserted that “without the proper notification, bonds could be priced incorrectly until the disclosure had been made.”

139

137

Id.

138

Id.

139

Id.

As discussed in detail below, the Commission has considered the commenters' views and suggestions on this issue and continues to believe that the benefits of enabling investors to receive promptly information about important events affecting the issuer justify the incremental costs imposed on issuers and obligated persons as a result of the amendments. It has come to the Commission's attention,

140

as supported by some commenters,

141

that some event notices currently are not submitted until months after the events have occurred. Market participants, on the other hand, have emphasized the importance of the prompt availability of such information.

142

140

See

Proposing Release,

supra

note 2, 74 FR at 36837, n. 69.

See, e.g.,

Elizabeth Carvlin,

Trustee for Vigo County, Ind., Agency Taps Reserve Fund for Debt Service,

The Bond Buyer, April 2, 2004, at 3 (reporting the filing of a material event notice regarding a draw on debt service reserve fund that occurred in February); Alison L. McConnell,

Two More Deals Under Audit By TEB Office,

The Bond Buyer, April 5, 2006 (event notice of tax audit filed nine months after audit was opened); Susanna Duff Barnett,

IRS Answers Toxic Query; Post 1986 Radioactive Waste Debt Not Exempt,

The Bond Buyer, November 2, 2004 (material event notice filed October 29, 2004 regarding IRS technical advice memorandum dated August 27, 2004 that bonds issued to finance certain radioactive solid waste facilities were taxable; related preliminary adverse determination letter was issued in January, 2002); and Michael Stanton,

IRS: Utah Pool Bonds Taxable; Issuer Disputes Facts of Case,

The Bond Buyer, December 8, 1997 (issuer's receipt of August, 1997 IRS technical advice memorandum concluding certain bonds were taxable was disclosed on December 5, 1997).

See also

Peter J. Schmitt,

Estimating Municipal Securities Continuing Disclosure Compliance: A Litmus Test Approach

(available at

http://www.dpcdata.com/html/about-researchpapers.html).

141

See supra

note 134 and accompanying text.

142

See

Proposing Release,

supra

note 2, 74 FR 36838, n. 70.

See, e.g.,

National Federation of Municipal Analysts,

Recommended Best Practices in Disclosure for General Obligation and Tax-Supported Debt

(December 2001) (“Any material event notices, including those required under SEC Rule 15c2-12, should be released as soon as practicable after the information becomes available.”) (available at

http://www.nfma.org/disclosure.php

); Peter J. Schmitt, Letter to the Editor,

To the Editor: MuniFilings.com: The Once and Future Edgar?,

The Bond Buyer, October 9, 2007, Commentary, Vol. 362, No. 32732, at 36 (“[F]iling issues are the sole cause of lack of transparency and disclosure availability in the industry. These filing issues include * * * late filing. * * *”).

The Commission believes that delays in providing notice of the events set forth in paragraph (b)(5)(i)(C) of the Rule undermine the effectiveness of the Rule. Delays can, among other things, deny investors important information that they need to make informed decisions regarding whether to buy, sell or hold municipal securities. As noted above, two commenters echoed this sentiment by noting the importance of having timely submission of event notices to maintain the transparency of a municipal security's credit quality and pricing.

143

The Commission anticipates that, in providing for a maximum time frame, the amendments should foster the availability of more current information about municipal securities, and thereby help promote greater transparency and further enhance investor confidence in the municipal securities market. Furthermore, more up-to-date information about municipal securities is likely to improve the transparency in the market, should increase the efficiency of markets in allocating capital at appropriate prices

that reflect the creditworthiness of issuers, which benefits issuers and investors alike, and should reduce the likelihood that investors will be subject to fraud facilitated by inadequate disclosure.

143

See

ICI Letter at 6 and Fidelity Letter at 2.

The Commission further believes that more timely information will aid brokers, dealers, and municipal securities dealers in satisfying their obligation to have a reasonable basis to recommend the purchase or sale of municipal securities. The Commission notes that the amendment requires Participating Underwriters to reasonably determine that issuers and obligated persons have contractually agreed to submit event notices in timely manner no later than “ten business days after the occurrence of the event,” rather than simply in a “timely manner.” On the other hand, there will be a significant benefit to investors and municipal market participants, because they will have a greater assurance that information about municipal securities will be available within a specific time frame of an event's occurrence. Indeed, while issuers and obligated persons under continuing disclosure agreements entered into prior to the compliance date of these amendments would have committed to submit event notices in a timely manner, this amendment will help to make the timing of such submissions more certain in the case of issuers and obligated persons that enter into continuing disclosure agreements on or after the compliance date of these amendments.

144

The Commission notes that the ten business day time frame will not apply to continuing disclosure agreements entered into with respect to primary offerings that occurred prior to the compliance date of these amendments or to remarketings of demand securities that qualify for the limited grandfather provision.

See infra

Section III.G.

One commenter suggested that the Commission leave the current “timely” language in the Rule but provide examples of instances that it considers to be “timely.”

145

The Commission believes that the suggestion solely to provide guidance would not effectively accomplish the Commission's goal of improving the timeliness of submissions. Moreover, as the Commission noted in the Proposing Release, there have been significant delays in the submission of event notices.

146

As expressed by two commenters, “the absence of a specific time period” with respect to what constitutes timely submission of event notices has been a contributing factor to delays in submitting notices.

147

While one commenter cautioned the Commission against “trying to create a uniform standard for various events that are very different from each other,”

148

it is the Commission's view that providing a specified time frame will provide clarity regarding the standard to be included in continuing disclosure agreements for timely submission of event notices in all circumstances. In some cases, however, particularly when issuers or obligated persons know about events well in advance, investors may view timely disclosure as occurring within a day or a few days of the event.

145

See

NABL Letter at 6.

146

See supra

note 140.

147

See

ICI Letter at 6 and Fidelity Letter at 3.

148

See

GFOA Letter at 2.

Although a number of commenters did not oppose a specified time frame for submission of event notices, they also did not support the ten business day proposal. Some of their concerns were: (i) The impracticability of meeting the time frame because of limited staff and resources, especially for smaller issuers;

149

(ii) the increased burdens and costs in connection with the additional monitoring and compliance necessary to submit notices within ten business days;

150

(iii) the difficulty in reporting events within ten business days when the issuer does not control the information (

e.g.,

rating changes, changes to the trustee, and changes to the tax status of bonds as a result of an IRS audit);

151

and (iv) the use of the “occurrence of the event” as the trigger for the obligation to submit a notice.

152

149

See

CRRC Letter, WCRRC Letter, Portland Letter at 2, NAHEFFA Letter at 2-4, Metro Water Letter at 1-2, CHEFA Letter at 2, and NABL Letter at 5-6.

150

See

Halgren Letter, Los Angeles Letter at 1, CRRC Letter, WCRRC Letter, NAHEFFA Letter at 2-4, CHEFA Letter at 2, and NABL Letter at 5-6.

151

See

Connecticut Letter at 1-2, California Letter at 1-2, San Diego Letter at 1-2, NAHEFFA Letter at 2-4, CHEFA Letter at 2, Kutak Letter at 2, and GFOA Letter at 2-3.

152

See

California Letter at 1-2, NAHEFFA Letter at 2-4, CHEFA Letter at 2, San Diego Letter at 1-2, GFOA Letter at 3, Kutak Letter at 2, and NABL Letter at 5-6.

Many of these commenters focused their comments on their concerns about the difficulties associated with providing notice of specified events, particularly rating changes and trustee changes, within ten business days of their occurrence.

153

These commenters noted that rating changes and trustee changes are not within the issuer's control and that, with respect to rating changes, rating organizations do not directly notify issuers of rating changes.

154

As a result, these commenters believed that it would be difficult for most issuers to submit an event notice for a rating change within ten business days of its occurrence without incurring substantial costs associated with monitoring for rating changes.

153

See

Halgren Letter, Los Angeles Letter at 1-2, NAHEFFA Letter at 2-4, San Diego Letter at 1-2, CHEFA Letter at 2, Kutak Letter at 2, California Letter at 1-2, NABL Letter at 8, and GFOA Letter at 3-4.

154

Id.

Some commenters, who expressed concern about the ability of an issuer to learn of the event and then submit an event notice within the ten business day time frame, proposed alternative time periods ranging from 30 to 45 days from the event's occurrence.

155

Others, however, recommended that the Commission reduce the time frame.

156

Two of these commenters advocated a time frame of five business days from the occurrence of the event, which they noted is the amount of time permitted for submitting similar notices in the taxable debt market.

157

Another commenter recommended a time frame of four business days from the occurrence of the event.”

158

155

See

Halgren Letter, Portland Letter at 2, NAHEFFA Letter at 4, and CHEFA Letter at 2.

156

See

ICI Letter at 7, Fidelity Letter at 2, and e-certus Letter at 8.

157

See

ICI Letter at 7 and Fidelity Letter at 3.

158

See

e-certus Letter I at 8.

Several commenters who opposed the ten business day time frame suggested a number of modifications. Some of these commenters proposed changing the trigger for submission of an event notice from the occurrence of the event to the issuer's actual knowledge of the event.

159

A number of commenters recommended removing “rating changes” from the list of disclosure events and requiring rating organizations to submit their rating changes directly to the MSRB's EMMA system.

160

Finally, one commenter suggested that, instead of specifying a time period, the Commission should modify the Rule to: (1) State that “issuers should disclose material events in a timely manner which in the normal course of business would be 10 business days;” (2) allow the ten business days to run from the time the issuer learned of the event, or 30 calendar days from the event itself; and (3) ensure that in the instances where issuers do not have control of the information (

e.g.,

a rating change due to the rating change of the credit enhancer), the issuer should not be responsible for submitting the information.

161

159

See

Kutak Letter at 2, California Letter at 1-2, San Diego Letter at 1-2, and CHEFA Letter at 2.

160

See

Halgren Letter, Portland Letter at 2, Los Angeles Letter at 1-2, California Letter at 3, CHEFA Letter at 2, GFOA Letter at 3-4, and NABL Letter at 8.

161

See

GFOA Letter at 3.

The Commission has considered commenters' concerns about the potential costs and burdens associated with the ten business day time period for submission of event notices. The Commission also has considered commenters' suggestion that the triggering event should be actual knowledge of the event rather than the event's occurrence. As the Commission noted in the Proposing Release, however, the events currently specified in paragraph (b)(5)(i)(C) of the Rule, and the additional event items included in the amendments, are significant and should become known to the issuer or obligated person expeditiously.

162

For example, events such as payment defaults, tender offers, and bankruptcy filings generally involve the issuer's or obligated person's participation.

163

Other events (

e.g.,

failure of a credit or liquidity provider to perform) are of such importance that an issuer or obligated person likely will become aware of such events,

164

or will expect an indenture trustee, paying agent, or other transaction participant to bring them to the issuer's or obligated person's attention, within a very short period of time.

165

Indeed, issuers and obligated persons could seek to obtain contractual agreements to be advised of the occurrence of such events by those persons or entities that may be expected to have direct knowledge of the occurrence.

162

See supra

note 16 for a description of events currently contained in Rule 15c2-12(b)(5)(i)(C).

See infra

Section III.E. for a description of events added to the Rule by these amendments.

163

In addition, as the Commission noted in the Proposing Release, involvement of the issuer or obligated person is often required for substitution of credit or liquidity providers; modifications to rights of security holders; release, substitution, or sale of property securing repayment of the securities; and optional redemptions.

See

Proposing Release,

supra

note 2, 74 FR at 36838, n. 73. The Commission received no comments on this statement.

See also

Form Indenture and Commentary, National Association of Bond Lawyers, 2000.

164

For example, as the Commission noted in the Proposing Release, issuers or obligated persons should have direct knowledge of principal and interest payment delinquencies, determinations of taxability from the IRS, tender offers that they initiate, and bankruptcy petitions that they file. The Commission received no comments on this statement.

165

The Commission believes, as noted in the Proposing Release, that indenture trustees generally would be aware of principal and interest payment delinquencies; material non-payment related defaults; unscheduled draws on credit enhancements reflecting financial difficulties; the failure of credit or liquidity providers to perform; and adverse tax opinions. The Commission received no comments on this statement. The Commission notes that issuers and obligated persons may wish to consider negotiating a provision to include in indentures to which they are a party to require a trustee promptly to notify the issuer or obligated person in the event the trustee knows or has reason to believe that an event specified in paragraph (b)(5) of the Rule has or may have occurred.

Consistent with the Commission's discussion in the Proposing Release, rating changes may affect the market price of the security, and thus bondholders and prospective investors should have access to this information.

166

While the Commission recognizes that an event such as a rating change is not directly within the issuer's control, Participating Underwriters today must reasonably determine that the issuer or obligated person has undertaken in a continuing disclosure agreement to provide notice of rating changes, if material.

167

While the Commission notes that the obligation to provide notice of rating changes is not new for those issuers that have issued municipal securities subject to a continuing disclosure agreement, the ten business day time frame may cause some issuers to monitor more actively for rating changes than they do today. The amendments revise the Rule to require the Participating Underwriter to reasonably determine that the continuing disclosure agreement provide for submission of event notices, including rating changes and trustee changes (if material), within ten business days after the event's occurrence.

166

See

Proposing Release,

supra

note 2, 74 FR at 36840.

167

See

infra Section IV., discussing the obligations of underwriters of municipal securities under the antifraud provisions of the federal securities laws.

Several commenters raised concerns about meeting the ten business day time frame because of limited resources and staff, particularly with respect to smaller issuers,

168

and the increased burdens and costs associated with monitoring such events within the specified time frame. The Commission recognizes that some issuers, particularly smaller issuers, may require a greater effort initially to comply with their undertakings in continuing disclosure agreements that reflect the revised Rule.

169

The Commission notes that information about rating changes by organizations that rate municipal securities is readily accessible by issuers through the rating agencies' Internet Web sites. In addition, issuers may be able to subscribe to a service that provides them with prompt rating updates for their securities. For other events that may be outside of the issuer's control, such as a trustee change, issuers can contractually arrange to be notified of such an event immediately.

170

Accordingly, the Commission continues to expect that issuers and obligated persons generally will become aware of the Rule's disclosure events (or can make arrangements to ensure that they become aware) within ten business days after the event's occurrence and accordingly should be able to comply with their undertakings to submit event notices to the MSRB within the ten business day time frame.

171

168

See

CRRC Letter, WCRRC Letter, Portland Letter at 2, NAHEFFA Letter at 2-4, Metro Water Letter at 1-2, CHEFA Letter at 2, and NABL Letter at 5-6.

169

The Commission recognizes that issuers that enter into continuing disclosure agreements for the first time, particularly smaller issuers, initially may need to become familiar with the steps necessary to ascertain whether there has been a rating change, and that there are burdens associated with this.

170

For example, under a trust indenture, the trustee may be obligated to notify an issuer before the trustee changes its name.

See infra

Section IV., discussing the obligations of underwriters of municipal securities under the antifraud provisions of the federal securities laws.

171

As noted in the Proposing Release, those issuers or obligated persons required by Section 13(a) or Section 15(d) of the Exchange Act to report certain events on Form 8-K (17 CFR 249.308) would already make such information public in a Form 8-K.

See

Proposing Release,

supra

note 2, 74 FR at 36838, n. 76. The Commission believes that such persons should be able to file material event notices, pursuant to the issuer's or obligated person's undertakings, within a short time after the Form 8-K filing.

See

15 U.S.C. 78m and 78

(d). The Commission received no comments on these statements.

The Commission believes that, on balance, the ten business day time frame is appropriate. By specifying a ten business day time frame, the Commission intends to strike a balance between the need for event notices to be disseminated promptly and the need to allow adequate time for an issuer or obligated person to become aware of the event and to prepare and file the notice. The Commission believes that the ten business day time frame provides a reasonable amount of time for issuers to comply with their undertakings, while also allowing event notices to be made available to investors, underwriters, and other market participants in a timely manner.

C. Materiality Determinations Regarding Event Notices

1. Deletion of the Materiality Condition Generally

The Commission proposed to delete in certain instances the materiality condition found in paragraph (b)(5)(i)(C) of the Rule. Based on the Commission's experience with paragraph (b)(5)(i)(C), the Commission believes that notice of certain events currently listed therein need not be preceded by a materiality determination. These events include: (1) Principal and interest payment delinquencies with respect to the

securities being offered; (2) unscheduled draws on debt service reserves reflecting financial difficulties; (3) unscheduled draws on credit enhancements reflecting financial difficulties; (4) substitution of credit or liquidity providers, or their failure to perform; (5) defeasances; and (6) rating changes.

A number of commenters expressed support for deletion of the materiality condition.

172

Two of these commenters stated that “these disclosure events are of such high consequence and relevance to investors in informing their investment decisions that they should be disclosed as a matter of course.”

173

Another commenter noted that “these events should always be provided to investors because their occurrence is always important to investors and other market participants.”

174

One commenter stated that the proposal “to delete a materiality qualifier is not useful, but also would not unduly burden issuers or obligated persons except in three circumstances.

175

172

See

NFMA Letter at 2, SIFMA Letter at 3, e-certus Letter at 8, ICI Letter at 7-8, and Fidelity Letter at 3.

See also

California Letter at 2 and San Diego Letter at 2 (each of these commenters support elimination of the materiality qualifier for each of the six events set forth in the Proposing Release except for the event relating to rating changes);

see infra

Section III.C.2.e. for a discussion of rating changes.

173

See

ICI Letter at 7-8 and Fidelity Letter at 3.

174

See

SIFMA Letter at 8.

175

See

NABL Letter at 6-7. The three circumstances for which this commenter suggested retaining a materiality condition are: (i) Unscheduled draws of debt service reserves that reflect financial difficulties for LOC-backed demand securities; (ii) failed remarketings of LOC-backed demand securities; and (iii) defeasances. The Commission addresses each of these three circumstances later in this release.

See infra

Section III.C.2.

Three commenters opposed the proposed change.

176

One commenter stated that the elimination of the materiality condition for all the events included in paragraph (b)(5)(i)(C) of the Rule would “increase issuers' administrative burden for monitoring the possible occurrence of these events.”

177

This commenter also believed that removal of the general materiality provision may result in the disclosure of non-material events.

178

Another commenter, while acknowledging the importance of these six events, argued that the materiality condition should be retained because “there is a risk that dividing event notices into two categories may introduce confusion where none now exists.”

179

Further, one commenter remarked that “establishing materiality is important in order to ensure that relevant information is passed to investors” and is “best made on a case by case basis, along with advice of counsel.”

180

176

See

Metro Water Letter at 2, Connecticut Letter at 2, and GFOA Letter at 4.

177

See

Metro Water Letter at 2.

178

Id.

179

See

Connecticut Letter at 2.

180

See

GFOA Letter at 4.

The Commission believes that a materiality determination remains appropriate for specific events, as discussed below.

181

However, under the amendments, for each event that no longer is subject to a materiality condition, a Participating Underwriter must reasonably determine that the issuer or obligated person has agreed to submit a notice to the MSRB within ten business days of the event's occurrence, without regard to its materiality. The Commission believes that each of these events by its nature is of such importance to investors that it should always be disclosed. In particular, these events are likely to have a significant impact on the value of the underlying securities. Moreover, the Commission believes that notice of these events should reduce the likelihood that investors will be subject to fraud facilitated by inadequate disclosure.

182

181

The discussion in this section pertains to materiality determinations for events currently specified in paragraph (b)(5)(i)(C) of the Rule. For events to be added to the Rule by these amendments, the Commission discusses in Section III.E. below whether the materiality determination has been included for each such event.

182

The Commission applied the same rationale discussed in this paragraph to determine which of the new event items that are being added to the Rule by these amendments should contain a materiality condition.

Further, the Commission continues to believe that the removal of the materiality condition for the aforementioned events is not expected to significantly increase the burden on issuers and obligated persons. Because of the significant nature of these events and their importance to investors in the marketplace, the Commission believes that issuers and obligated persons generally are already providing notice of most of these events pursuant to existing continuing disclosure agreements. It is the Commission's view that removing the materiality condition for these six disclosure events will help ensure that important information about significant events regarding municipal securities is promptly provided to investors and other market participants in all instances. The availability of this information to investors will enable them to make informed investment decisions and should reduce the likelihood that investors will be subject to fraud facilitated by inadequate disclosure. Furthermore, this information will assist brokers, dealers and municipal securities dealers in satisfying their obligation to have a reasonable basis to recommend municipal securities to investors. Deletion of the materiality condition also could simplify a determination by an issuer or obligated person with respect to whether a notice must be filed and facilitate their providing such notice promptly. Accordingly, the Commission is adopting the amendment as proposed.

2. Deletion of Materiality Condition for Specific Events

As noted above, some commenters generally supported the proposed revision to the Rule eliminating the general materiality condition from all events, but expressed concerns regarding its elimination for specific events. The Commission discusses these comments below but, for the reasons discussed, is adopting the amendment, as proposed.

a. Principal and Interest Payment Delinquencies

One commenter suggested that, in light of the Commission's proposed amendment to delete the materiality condition from specified events, the definition of “principal and interest payment delinquency” should be clarified to take into account contractual grace periods and similar operational considerations, so that “minor operational variances” would not require event disclosure.

183

Other commenters opposed the deletion of the materiality condition from the principal and interest payment delinquency event because otherwise it may include reporting of certain delays in payment that are the result of circumstances outside of the issuer's control or are very limited in time (

e.g.,

technological glitches; a short-term disruption of the Federal Reserve Wire system; an error or lapse by the trustee or paying agent that is quickly corrected; or clerical error at the Depository Trust Company that is quickly corrected).

184

Two of these commenters noted that these circumstances may result in a “very short-term delay in crediting payments to bondholders” and that “in the past [they] would have treated such an event as not material.”

185

Further, these two commenters argued that requiring submission of notices in these circumstances “would create an

unwarranted implication that the issuer has suffered financial adversity.”

186

183

See

Kutak Letter at 3.

184

See

California Letter at 2, San Diego Letter at 2, and GFOA Letter at 4.

185

See

California Letter at 2 and San Diego Letter at 2.

186

Id.

The Commission notes that a payment default often negatively affects the market value of a municipal security and may have adverse consequences for an investor who has an immediate need for such funds. The Commission therefore believes that notice of any payment default with respect to securities covered by the Rule, including those defaults that are quickly remedied or that result from a technological glitch or similar error, is important information for investors. The Commission notes that issuers and obligated persons may include the reason for a payment default in the event notice submitted to the MSRB. Delayed payment—even for a short period of time—may impact investors' investment decisions by inhibiting their ability to promptly reinvest such payment or by leaving them unsure whether to buy, hold, or sell municipal securities. Accordingly, the Commission believes that notice of principal and interest payment delinquencies on municipal securities should always be provided to aid investors in making investment decisions and help protect them from fraud, as well as to assist brokers, dealers, and municipal securities dealers in satisfying their obligation to have a reasonable basis to recommend a municipal security.

b. Unscheduled Draws on Debt Service Reserves or Credit Enhancements Reflecting Financial Difficulties

Unscheduled draws on debt service reserves and credit enhancements often adversely impact the market value of a municipal security and, in the Commission's view, should always be made available to investors and other market participants.

187

These events likely indicate that the financial condition of a municipal securities issuer or obligated person has deteriorated and that there is, potentially, an increased risk of a payment default or, in some cases, premature redemption. Bondholders and other market participants also would be concerned with the sufficiency of the amount of debt service and other reserves available to support an issuer or obligor through a period of temporary difficulty, as well as the present financial condition of the provider of any credit enhancement.

187

See

Proposing Release,

supra

note 2, 74 FR at 36839.

One commenter suggested that a materiality condition should be retained for unscheduled draws on debt-service reserves for LOC-backed demand securities.

188

This commenter argued that materiality is necessary in this limited instance because the proposed amendment “would require notice of unscheduled draws on debt service reserves that reflect financial difficulties of the obligated person, even when not material to an investment in the securities because they are traded on the strength of a bank letter of credit.”

189

188

See

NABL Letter at 6-7.

189

Id.

The Commission notes that notice is needed only when an unscheduled draw on debt-service reserves or credit enhancement indicates financial difficulties “with respect to the securities.” Thus, an issuer or obligor must consider, under the facts and circumstances of a particular municipal security and its relevant governing documents, whether or not such unscheduled draw reflects financial difficulties with respect to that security—a limitation that should help address some concerns about removal of the materiality condition.

The same commenter also suggested retaining the “if material” condition for LOC-backed demand securities because the deletion of this condition, coupled with the modification to the exemption for demand securities, “would require notice of each failure to remarket securities when they are put, even though not material to an investor due to the existence of a letter of credit or other liquidity facility.”

190

Id.

The Commission does not agree with this commenter's conclusion. One purpose of a letter of credit or other liquidity facility for demand securities is to provide liquidity in the event that a new investor is not found at the time the securities are tendered for repurchase. A draw in such a situation does not necessarily reflect financial difficulties “with respect to the securities” of the credit enhancement provider or the obligated person, but may reflect underlying market conditions, as evidenced by failed remarketings during 2008 and 2009.

191

In the event of a draw that does not reflect financial difficulties with respect to the securities, a notice would not be provided. A determination regarding the existence of financial difficulties must be made on a case-by-case basis, depending on the facts and circumstances surrounding such draws and failed remarketings.

191

See, e.g.,

Richard Williamson,

HOUSING: HFAs Still Facing VR Debt Woes; No Relief Till 2011 Even With U.S. Aid,

The Bond Buyer, October 7, 2009; Frank Sulzberger and Andrew Flynn,

Lessons From Tough Times: Understanding VRDO Failures,

The Bond Buyer, July 21, 2008 (“Until the recent credit crisis, few bonds had ever experienced a remarketing failure and when they did, liquidity providers were able to step in with little risk to their balance sheet. * * * In a normal market, the remarketing agent might step in and buy the tendered bonds, in order to prevent an actual draw on an LOC or credit facility. But this time around, the volume of the tenders and restrictions on their own liquidity made this choice difficult, if not impossible, for many remarketing agents.”)

Finally, one commenter, who supported the deletion of the materiality condition, recommended deleting the phrase “reflecting financial difficulties” for events relating to unscheduled draws on debt-service reserves or credit enhancements.

192

This commenter suggested that, even with the removal of the materiality condition from these event items, the phrase “reflecting financial difficulties” may allow an issuer, in certain circumstances, to make a judgment regarding whether the occurrence of such an event would require disclosure.

193

192

See

Fidelity Letter at 2.

193

See

Fidelity Letter at 2.

Although the Commission continues to believe that the disclosure of unscheduled draws is important to investors and other market participants, the Commission also recognizes that, in some circumstances, such draws are not the result of financial difficulties that would impact the creditworthiness of an issuer or obligated person, or the price of a municipal security. Accordingly, the Commission believes that the phrase “reflecting financial difficulties” should be retained in the Rule at this time.

c. Substitution of Credit or Liquidity Providers, or Their Failure to Perform

One commenter opposed eliminating the materiality condition from this event, in light of the proposed ten business day frame for submitting event notices to the MSRB.

194

This commenter acknowledged the importance of disclosing this information, but believed that as a result of the recent market turmoil, determining whether the occurrence of this event is material as a condition to providing notice remains important.

195

194

See

GFOA Letter at 4. The commenter expressed concern about the removal of materiality condition in the context of the ten business day time frame. As the Commission noted earlier in this release, the events contained in paragraph (b)(5)(i)(C) of the Rule, which includes the substitution of credit or liquidity providers, or their failure to perform, are significant events that an issuer should become aware of within a very short period of time.

See supra

Section III.B.

195

See

GFOA Letter at 4.

The Commission believes that the identity of credit or liquidity providers and their ability to perform is important

information for investors.

196

The Commission understands that credit ratings of municipal securities are typically based on the higher of the obligor's rating or the rating of the credit provider

197

and that, with occasional exceptions, credit enhancement is obtained from a credit provider with a higher rating than that of the obligor. When a credit enhancer such as a bond insurer is downgraded, the market value and the liquidity of the securities that it has enhanced generally decline.

198

Similarly, the identity and ability of a liquidity provider to perform typically is critical to investors. Investors in demand securities, for example, depend on liquidity providers to satisfy holders' right to tender their securities for repurchase in a timely manner. Furthermore, substitution of credit or liquidity providers requires direct involvement of an issuer or obligated person.

199

Thus, an issuer or obligated person would be aware of the impending occurrence of such an event and should be able to provide notice of the event within the ten business day time frame. As a result, the Commission believes that notice of substitution of credit or liquidity providers, or their failure to perform, should always be provided to aid investors in making investment decisions and protecting themselves from fraud and to assist brokers, dealers and municipal securities dealers in satisfying their obligation to have a reasonable basis to recommend municipal securities.

196

Two commenters recommended that the event notice pertaining to substitution of credit or liquidity providers or their failure to perform should be expanded to include any renewal, or modification, of any credit or liquidity facility or other agreements supporting or otherwise material to a municipal security.

See

ICI Letter at 8 and Fidelity Letter at 3. These commenters noted that changes to, or violations of, any of the credit or liquidity agreements pertaining to a municipal security can modify the security, thereby causing a mandatory tender event or impacting the prospects for its remarketing. In their view, these events can have significant implications for investors. The Commission, in this rulemaking, is taking a targeted approach at this time. The Commission will take these comments into account should it consider further improvements that could be made to the Rule.

197

See, e.g.,

Proposing Release,

supra

note 2, 74 FR at 36839, n. 80.

198

See, e.g.,

Proposing Release,

supra

note 2, 74 FR at 36839, n. 81.

199

See, e.g.,

Richard Williamson,

Houston Metro Seeks LOC for Light Rail,

The Bond Buyer, April 16, 2008; and Elizabeth Carvlin,

Trends in the Region: Bond Contracts Stand at Center of Detroit Airport Dispute,

The Bond Buyer, September 11, 2002.

d. Defeasances

One commenter expressly favored maintaining the materiality condition for notice of defeasances.

200

This commenter believed that removal of the materiality condition “would require notice of defeasances of securities regardless of how short the remaining term of the securities, and therefore would require an issuer to give notice whenever it creates a thirty-day or shorter escrow for refunded bonds in order to avoid giving notice of redemption before an issue of refunding bonds is closed.”

201

200

See

NABL Letter at 7. A defeasance typically is understood as the termination of the rights and interests of the bondholders and of their lien on the pledged revenues or other security in accordance with the terms of the bond contract for an issue of securities.

See, e.g.,

the MSRB's definition of defeasance at

http://www.msrb.org/msrb1/glossary/glossary_db.asp?sel=d.

201

See

NABL Letter at 7.

Typically, because defeased municipal securities are secured by escrows of cash, or Treasury securities, sufficient to pay principal and interest to maturity or the appropriate call date, the value of municipal securities increases significantly when they are defeased. Information about such changes in the value of municipal securities—positive as well as negative—is important to investors in making investment decisions, such as whether to sell their securities prior to the defeasance date and, if so, whether the sale price is appropriate. Also, notice of a defeasance should reduce the likelihood that investors will be subject to fraud facilitated by inadequate disclosure, by providing them with information concerning the defeasance so that they can better assess the value of their defeased municipal securities. Further, the Commission is of the view that, regardless of the length of the escrow period, notice of defeasance is justified, because of the significance of the event and because investors should be provided sufficient time to plan the re-investment of their funds. Consequently, the Commission believes that notice of defeasance should not be subject to a materiality condition and should be provided to the MSRB in each instance.

e. Rating Changes

202

See also

supra

Section III.B. for a discussion of rating changes in the context of the ten business day time frame.

One commenter recommended that the term “rating change” should be defined if the materiality condition is removed from this event item.

203

The commenter suggested that the Rule should be limited to those changes, for which the issuer or obligated person has actual knowledge, in the highest published rating relating to a given security, whether the underlying rating or the credit-enhanced rating.

204

The commenter also stated that the term “rating change” should exclude changes in outlook, as well as changes in credit ratings of parties other than the issuer or obligated person, unless the issuer or obligated person has received specific notice of the change in such other party's rating.

205

Some commenters argued that the proposed deletion of the materiality condition for this event item, together with the ten business day time frame to submit event notices to the MSRB, would create a substantially larger burden for issuers.

206

The same commenters believed that rating changes should be removed from the list of disclosure events in the Rule entirely, and that rating organizations should be responsible for providing this information directly to the MSRB.

207

203

See

Kutak Letter at 3-4.

204

Id.

205

Id.

206

See

Halgren Letter, Los Angeles Letter at 1-2, NAHEFFA Letter at 2-4, San Diego Letter at 1-2, California Letter at 1-2, NABL Letter at 8, and GFOA Letter at 3-4.

207

See supra

note 153 and accompanying text.

The Commission notes that, as a practical matter, changes in credit ratings today are likely to impact the price of municipal securities, and thus investors in these securities, as well as market professionals, analysts, and others, should have access to this information.

208

As discussed earlier, the continuing disclosure agreements that issuers have entered into pursuant to Participating Underwriters' obligations under the Rule already require them to submit event notices to the MSRB for rating changes, if material. The Commission acknowledges that removal of the materiality condition may increase the number of event notices submitted in connection with rating changes.

209

However, the removal of the materiality condition from this event item will simplify the submission of event notices for ratings changes by removing the burden on issuers to make a determination as to whether or not such a change is material and thus requires submission of a event notice. The Commission notes that rating agencies typically indicate a rating change by changing the widely understood symbols used to indicate

rating categories, which should make a determination of the occurrence of a rating change very straightforward.

210

Under the amendments, a notice of a rating change by any rating agency would be included even if another rating agency has not revised its rating of the municipal security.

208

The Commision recently adopted amendments to its rules and forms, and is considering other amendments, to remove certain references to credit ratings by nationally recognized statistical rating organizations, in order to discourage undue investor reliance on them.

See, e.g.,

Securities Exchange Act Release Nos. 58070 (July 1, 2008), 73 FR 40088 (July 11, 2008), and 60789 (October 5, 2009), 74 FR 52358 (October 9, 2009).

209

See infra

Section V.D. for discussion of the paperwork burden in connection with deletion of materiality condition.

210

Ratings are expressed as letter grades that range, for example, from `AAA' to `D', and may include modifiers such as +, −, or numbers (

e.g.,

1, 2, 3) to communicate the agency's opinion of relative level of credit risk.

See, e.g.,

http://www.moodys.com/, http://www.standardandpoors.com/

and

http://www.fitchratings.com/

. For purposes of Rule 15c2-12, “ratings change” does not include indicators of an increased likelihood of an impending ratings change, such as “negative credit watch.”

Three commenters argued that information about rating changes is already accessible to investors through the media or Internet.

211

In the Commission's view, investors would benefit from being able to access a central source to determine whether there has been a rating change with respect to a particular municipal security, rather than relying on the media or accessing each rating organization's Internet Web site. Two of these commenters suggested a limited exemption from the Rule for rating changes involving municipal securities that are the result of rating changes involving the bond insurer or credit enhancer.

212

The Commission does not believe that an exemption for bond insurers and credit enhancers from the Rule is appropriate. As discussed above, ratings for particular securities generally reflect the rating of the provider of credit enhancement, if any, in addition to the obligated person (or other source of payment).

213

If a credit-enhanced municipal bond is downgraded because of a rating change involving the bond insurer or credit enhancer, that is likely to impact the price of the security and is important information that should be disclosed to investors.

211

See

Portland Letter at 2, San Diego Letter at 2, and California Letter at 3.

212

See

Portland Letter at 2 and California Letter at 3.

213

See supra

Section III.C.2.b.

3. Retention of Materiality Condition for Specified Events

Finally, the Commission is adopting, as proposed, amendments to paragraph (b)(5)(i)(C) and subparagraphs (2), (7), (8), and (10) thereunder with regard to the Participating Underwriter's obligations by specifying that a materiality determination is retained for event notices regarding (1) non-payment related defaults; (2) modifications to rights of security holders; (3) bond calls; and (4) the release, substitution, or sale of property securing repayment of the securities.

Two commenters opposed retaining the materiality condition for notice of non-payment related defaults and for bond calls, which currently are set forth in paragraphs (b)(5)(i)(C)(2) and (8) of the Rule, respectively.

214

These commenters remarked that violation of a legal covenant is an important component of an investor's analysis of a bond; disclosure of such events should not be discretionary; and bond calls are always material to investors.

215

214

See

ICI Letter at 8 and Fidelity Letter at 3.

215

Id.

The Commission believes that a materiality condition should be retained for notice of non-payment related defaults and bond calls, respectively. Regularly scheduled sinking fund redemptions (a type of bond call) that occur when scheduled, for example, are ordinary course events that typically are known to bondholders.

216

For such redemptions, the specific amounts to be redeemed and dates for such redemptions generally are included in official statements and usually this information will not be material to investors as they are already apprised of the occurrence of such redemptions in advance. The occurrence of other kinds of calls, such as optional calls and extraordinary calls, however, generally is not known to bondholders in advance. These typically are important events for investors because they may directly affect the value of the municipal security. Thus, such calls may be material and would need to be disclosed.

216

The fact that a security may be redeemed prior to maturity in whole, in part, or in extraordinary circumstances is essential to an investor's investment decision about the security and is one of the facts a broker-dealer must disclose at the time of trade.

See MSRB Interpretative Notice Concerning Disclosure of Call Information to Customers of Municipal Securities,

MSRB, March 4, 1986.

With respect to non-payment related defaults, under some circumstances, the occurrence of such defaults may not rise to the level of importance that they would need always to be disclosed to investors. For example, failure to comply with loan covenants to deliver updated insurance binders to the trustee or to take other ministerial actions by an annual deadline, if not cured within the period provided for in the loan documents, may constitute events of default, but such defaults may not be material to investors. On the other hand, failure to comply with covenants to maintain certain financial ratios or cash on hand, for example, may be of great importance to investors as they may be early warnings of a decline in the operations or financial condition of the issuer or obligated person. The Commission believes that this materiality determination is similarly appropriate in the context of modifications of rights of security holders and the release, substitution, or sale of property securing repayment of the securities. Accordingly, the Commission continues to believe that information about the four events for which the materiality conditions are retained is not necessarily important to investors and other market participants in all instances, and thus the Commission is retaining the materiality condition for these events.

D. Amendment Relating to Event Notices Regarding Adverse Tax Events Under a Continuing Disclosure Agreement

Currently, paragraph (b)(5)(i)(C)(6) of the Rule pertains to “adverse tax opinions or events affecting the tax-exempt status of the security.” The Commission is adopting, with certain modifications from that proposed, an amendment to paragraph (b)(5)(i)(C)(6) of the Rule to require that Participating Underwriters reasonably determine that the issuer or obligated person has entered into a continuing disclosure agreement to submit a notice for “[a]dverse tax opinions, the issuance by the Internal Revenue Service of proposed or final determinations of taxability, Notices of Proposed Issue (IRS Form 5701-TEB) or other material notices or determinations with respect to the tax status of the security, or other material events affecting the tax status of the security.” As discussed below, in adopting this amendment, the Commission is making certain changes to the text of the amendment from that which was proposed

217

to clarify the use of the word “material” in this event item and to replace the phrase “tax-exempt status” with “tax status” to focus the disclosure on information relevant to investors, whether the municipal security is taxable or tax-exempt.

217

In the Proposing Release, the Commission proposed modifying paragraph (b)(5)(i)(C)(6) of the Rule so that continuing disclosure agreements would provide for the submission of a notice for “[a]dverse tax opinions, the issuance by the Internal Revenue Service of proposed or final determinations of taxability, Notices of Proposed Issue (IRS Form 5701-TEB) or other material notices or determinations with respect to the tax-exempt status of the securities, or other events affecting the tax-exempt status of the security.”

See

Proposing Release,

supra

note 2, 74 FR at 36868.

Four commenters expressed support for the proposed modifications to the list of adverse tax events included in the

Proposing Release.

218

One of these commenters noted that investors have a strong interest in being informed of actions taken by the IRS that present a material risk to the tax-exempt status of their holdings.

219

Several other commenters expressed concerns regarding the proposed items to be added to the disclosure for adverse tax events, particularly in light of the proposed removal of the materiality condition from this provision.

220

One commenter recommended that the materiality condition be retained for all items in paragraph (b)(5)(i)(C)(6) of the Rule, other than a final determination of taxability.

221

Other commenters, however, stated that the materiality condition should be retained for notice of all tax-related events.

222

One commenter noted that the municipal market may be flooded with notices due to the generality and vagueness of the proposed tax disclosure items.

223

This commenter further remarked that this provision will result in a “flood of notices” that could confuse and mislead investors, result in liquidations of municipal securities by multiple sellers simultaneously, or desensitize the market to such notices.

224

218

See

SIFMA Letter at 3, NFMA Letter at 2, San Diego Letter at 2, and California Letter at 2.

219

See

SIFMA Letter at 3.

220

See

NABL Letter, Metro Water Letter, Connecticut Letter, Kutak Letter, and GFOA Letter.

221

See

NABL Letter at 7.

222

See

Metro Water Letter at 3, Connecticut Letter at 2, Kutak Letter at 4-7, and GFOA Letter at 4.

223

See

Kutak Letter at 4-7.

224

Id.

In addition, three commenters expressed concerns about the impact of the disclosure of event notices during the IRS's audit process.

225

One commenter believed that an issuer's disclosure of event notices during the audit process could cause its bonds to be viewed unfavorably in the market and thus could result in higher borrowing costs for the issuer.

226

Another commenter noted that disclosure of a pending audit “would have adverse consequences to the issuer long before the IRS finally determines whether any tax code violations actually have occurred,”

227

while a third commenter indicated that disclosure of an audit would “confuse investors who may not be well versed in the IRS audit process.”

228

225

See

Kutak Letter at 5, GFOA Letter at 4, and Metro Water Letter at 3.

226

See

Kutak Letter at 5.

227

See

Metro Water Letter at 3.

228

See

GFOA Letter at 4.

The Commission previously has noted that “an `event' affecting the tax-exempt status of a security may include the commencement of litigation and other legal proceedings, including an audit by the Internal Revenue Service * * * .”

229

While the Commission continues to believe that “an event affecting the tax-exempt status of the security” can include an audit (and thus an audit should be the subject of an event notice when it is material), it agrees with the comment that not all audits indicate a risk to the security's tax status. At times, IRS staff conducts audits as part of project initiatives where it is not examining a specific problem or bond issue.

230

On the other hand, some audits are targeted to examining specific bonds when, for example, IRS staff has received information from the public that has raised IRS staff concern.

231

Thus, a determination by the issuer or obligated person in possession of the facts concerning the audit of a particular bond issue regarding whether a particular audit is material (and, thus, is an “other material event affecting the tax status of the security”) is appropriate. In contrast, proposed and final determinations of taxability and Notices of Proposed Issue, which are determinations by the IRS that the IRS believes that a security is or may be taxable and has begun a formal administrative process in that regard, suggests that there could be a significant risk to the tax status of that security.

232

Accordingly, the Commission believes that proposed and final determinations of taxability and Notices of Proposed Issue are of such importance to investors that they always should be disclosed pursuant to a continuing disclosure agreement.

229

See

1994 Amendments Adopting Release,

supra

note 8, 59 FR at 59600.

See also

Proposing Release,

supra

note 2 74 FR at 36840.

230

See, e.g.,

IRS FY 2010 Tax-Exempt Bonds Work Plan,

IRS (available at

https://www.irs.gov/pub/irs-tege/fy_2010_teb_workplan.pdf

231

Id.

232

See

Proposing Release,

supra

note 2, 74 FR at 36841.

Retail and institutional investors consider the tax status of a municipal security, specifically the issuance of IRS notices, to be of great importance when making the decision to invest in tax-exempt bonds as opposed to other fixed-income securities.

233

This is a view supported by several commenters.

234

The financial significance of the municipal security's tax-exempt status is reflected directly in the interest rate on a tax-exempt municipal bond, which generally is significantly lower than the interest rate on a comparable taxable bond.

235

Accordingly, investors are particularly sensitive to factors that could affect the tax-exempt status of interest earned on their municipal securities, because that status goes directly to the value of their investment.

236

Further, a determination by the IRS staff that interest on a security purchased as tax-exempt may, in fact, be taxable may not only reduce the security's market value, but also may adversely affect each investor's federal and, in some cases, state income tax liability.

237

A security's tax-exempt status is also important to many mutual funds whose governing documents, with certain exceptions, limit their investment to tax-exempt municipal securities.

238

Mutual funds may liquidate securities that become taxable, which could have adverse consequences for the fund and its holders and could cause adverse effects if many holders attempt at the same time to liquidate similar securities, which at times could be illiquid. Therefore, retail and institutional investors alike are very interested in events that could adversely affect the tax status of the bonds that they own or may wish to purchase.

233

See

Proposing Release,

supra

note 2, 74 FR at 36841, n. 89.

234

See

NFMA Letter at 2 and SIFMA Letter at 3.

See also

California Letter at 2, and San Diego Letter at 2.

235

See, e.g.,

SIFMA, “About Municipal Bonds—The Advantages of Tax Exemption,” available at:

http://www.investinginbonds.com/learnmore.asp?catid=8&subcatid=53&id=233;

Morgan Stanley Smith Barney, “Tax-Free Municipal Bonds—Frequently Asked Questions,” (question 4. Why is it better for me to own municipals when municipal bond rates are lower than taxable bond (Treasury bonds, corporate bonds) rates?), available at:

http://www.morganstanleyindividual.com/markets/bondcenter/school/faq/default.asp#4.

236

See

Proposing Release,

supra

note 2, 74 FR at 36841, n. 90.

237

For example, investors in such a circumstance may have to include interest on such a security as income when computing their federal income taxes for current and future tax years and may have to pay additional taxes for prior tax years.

See

Proposing Release,

supra

note 2, 74 FR at 36841.

238

See

Proposing Release,

supra

note 2, 74 FR at 36841, n. 92.

Moreover, as the Commission noted in the Proposing Release, despite the possibility that the issuance of proposed and final determinations of taxability and Notices of Proposed Issue could adversely affect the tax-exempt status of a bond and thus could significantly affect the pricing of such municipal security,

239

it has been reported that notices regarding such tax events are not always submitted.

240

The Commission

believes that the issuance of proposed and final determinations of taxability and Notices of Proposed Issue by the IRS are important information that should be made available to investors and, accordingly, should be part of the continuing disclosure agreement obtained by a Participating Underwriter. The Commission believes that the IRS has issued a relatively small number of such determinations with respect to municipal securities when considered in light of the size of this market sector.

241

As a result, few issuers or obligated persons should be affected by adding proposed and final determinations of taxability and Notices of Proposed Issue to this event item. One commenter noted that disclosure of the issuance of proposed or final determinations of taxability and of material audits often results in a higher interest rate for VRDOs, resulting in an increased cost to the issuer.

242

That change in the interest rate supports the view that investors place a high degree of importance on events that may impact the tax status of their bonds. Thus, the Commission believes that disclosure in all instances of proposed and final determinations of taxability, Notices of Proposed Issue, and other material events affecting the tax status of a security, such as material audits, would help apprise investors of important information with respect to these securities.

239

See

Proposing Release,

supra

note 2, 74 FR at 36842, n. 100.

240

See

Proposing Release,

supra

note 2, 74 FR at 36842, n. 101.

See, e.g.,

Susanna Duff Barnett,

IRS Answers Toxic Query; Post 1986 Radioactive Waste Debt Not Exempt,

letter was issued in January, 2002).

See also

supra

note 140.

241

See

Proposing Release,

supra

note 2, 74 FR at 36853, which notes that for Paperwork Reduction Act purposes, 130 event notices relating adverse tax events, including IRS determinations, are estimated to be submitted to the MSRB.

242

See

Kutak Letter at 5.

Two commenters expressed specific concerns regarding the deletion of the materiality condition for submission of notices relating to adverse tax events.

243

One commenter believed that submitting a notice for all proposed tax determinations could limit the issuer's ability to negotiate with the IRS.

244

Another commenter remarked that without a materiality condition, disclosure of adverse tax events may mislead and confuse investors and could affect perceptions with respect to all of the issuer's securities, imposing interest and other costs that could limit future market access.

245

Other commenters, however, supported the proposed deletion of the materiality condition.

246

243

See

Metro Water Letter at 3 and Kutak Letter at 4-7.

244

See

Metro Water Letter at 3.

245

See

Kutak Rock Letter at 4-7.

246

See

ICI Letter at 2, NFMA Letter at 2 and SIFMA Letter at 3.

As noted above, the Commission disagrees that disclosure of adverse tax events would “unnecessarily alarm investors,” as one commenter argued.

247

Because investors place a high degree of importance on the tax status of their municipal securities, and the tax status of a security significantly affects the market price of a security, the Commission believes that disclosing a potential threat to that status is necessary and that investors have a keen interest in being informed of such events. Furthermore, the Commission believes that the failure to disclose adverse tax events potentially could mislead investors who would have no reason to know or other means to discover that the tax status of their bonds may be in doubt and the market value of those securities may be at risk.

247

See

Connecticut Letter at 2.

One commenter noted that the text of the amendment in the Proposing Release included a materiality condition for one provision that impliedly applies to other provisions of paragraph (b)(5)(i)(C)(6) of the Rule.

248

This commenter suggested that the Commission clarify that the materiality condition applies to all tax events, except for a final determination of taxability.

249

As discussed above, the Commission does not believe that it is appropriate to provide for a materiality condition in the case of proposed or final IRS determinations of taxability. In the Commission's view, these IRS determinations are of such importance to investors that they always should be disclosed. However, in response to this commenter's recommendation, the Commission is revising the amendment to paragraph (b)(5)(i)(C)(6) from that proposed to clarify its original intention that the event item pertains to “other

material

events affecting the tax status of the security” (emphasis added). The Commission agrees with the commenter that it would be appropriate to clarify this phrase so that notices of events not specified in the Rule that affect the tax status of a security are required only if these events are material to investors.

248

See

SIFMA Letter at 3.

249

Id.

Finally, in February 2009, Congress enacted the American Recovery and Reinvestment Act of 2009 (“ARRA”),

250

which authorized the issuance of Build America Bonds and other taxable municipal bonds with associated tax credits or direct federal payments to the issuer (collectively, “ARRA Bonds”).

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Because ARRA Bonds are municipal securities, Participating Underwriters would need to comply with the Rule's provisions, including paragraph (b)(5)(i)(C), when these bonds are the subject of a primary offering. Thus, a Participating Underwriter will be required to reasonably determine that an issuer or an obligated person has entered into a continuing disclosure agreement to submit continuing disclosure documents to the MSRB. ARRA Bonds are required to comply with many of the same provisions of the Internal Revenue Code as are tax-exempt bonds, such as restrictions on arbitrage.

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The benefits granted to ARRA Bonds (

e.g.,

tax credits and related federal payments to issuers) are only authorized for bonds that comply with the provisions of the Internal Revenue Code that grant these benefits.

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Furthermore, like tax-exempt municipal bonds, adverse tax opinions, proposed or final determinations of taxability, Notices of Proposed Issue, or other material notices or determinations by the IRS with respect to the tax status of the securities, or other material events affecting the tax status of the security, may be applicable to ARRA Bonds. To clarify the applicability of paragraph (b)(5)(i)(C)(6) of the Rule, as amended, to ARRA Bonds, the Commission is adopting, for purposes of this paragraph, the phrase “tax status,” rather than “tax-exempt status,” of the security. The Commission believes that this limited change will clarify that Participating Underwriters

of ARRA Bonds are required to reasonably determine that issuers or obligated persons of such bonds have entered into a continuing disclosure agreement to submit to the MSRB, among other things, the tax-related disclosure events included in paragraph (b)(5)(i)(C)(6) of the Rule. For investors who hold ARRA Bonds with associated tax credits, the consequence of an issuer's failure to comply with the applicable requirements of the Internal Revenue Code is the loss of the benefit of a tax credit.

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For investors who hold tax-exempt municipal securities, the consequence of an issuer's failure to comply with federal tax provisions is the loss of the benefit of tax-exempt interest income. In the Commission's view, the consequences to investors who hold either ARRA bonds or tax-exempt municipal securities are comparable. Therefore, the Commission believes that this minor revision to this disclosure event will allow investors in ARRA Bonds, like investors in tax-exempt bonds, to have timely access to important information concerning risks that may affect the tax status of their securities.

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Public Law 111-5, 123 Stat. 115 (2009).

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The American Recovery and Reinvestment Act of 2009 introduced three new categories of tax-advantaged

taxable

bonds—Build America Bonds (I.R.C. § 54AA), Qualified School Construction Bonds (I.R.C. § 54F), and Recovery Zone Economic Development Bonds (I.R.C. §§ 1400U-2). In addition, the ARRA expanded the authority to issue

taxable

New Clean Renewable Energy Bonds (I.R.C. § 54C), Qualified Energy Conservation Bonds (I.R.C. § 54D) and Qualified Zone Academy Bonds (I.R.C. § 54E). This followed the introduction of taxable Qualified Forestry Conservation Bonds (I.R.C. § 54B) in the Heartland, Habitat, Harvest, and Horticulture Act of 2008. Taxpayers who hold such bonds on a “credit allowance date” generally are allowed a specified credit against their federal income tax liability (with the notable exceptions being Build America Bonds for which the issuer has elected to receive payments from the U.S. Treasury under I.R.C. § 54AA(g)(1), referred to herein as “Direct-Pay BABs,” and Recovery Zone Economic Development Bonds). In addition, the tax credits may be “stripped” from the underlying taxable bonds (

see

I.R.C. §§ 54A(i), 54AA(f)(2)), either by the issuer or by a holder in the secondary market, and sold to different investors pursuant to Treasury Department regulations to be issued.

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See, e.g.,

Section 54AA of ARRA (Build America Bonds); I.R.C. § 1400U-2(b) (Recovery Zone Economic Development Bonds); I.R.C. §§ 54A and 54C (New Clean Renewable Energy Bonds); IRC sections 54A and 54C (Qualified Energy Conservation Bonds); I.R.C. §§ 54A and 54E (Qualified Zone Academy Bonds); I.R.C. §§ 54A and 54F (Qualified School Construction Bonds).