Statement of the Commission Regarding Disclosure Obligations of Municipal Securities Issuers and Others

SUMMARY: The Securities and Exchange Commission (``Commission'') is

publishing its views with respect to the disclosure obligations of

participants in the municipal securities markets under the antifraud

provisions of the federal securities laws, both in connection with

primary offerings and on a continuing basis with respect to the

secondary market. This interpretive guidance is intended to assist

municipal securities issuers, brokers, dealers and municipal securities

dealers in meeting their obligations under the antifraud provisions.

The Commission is seeking comment on issues discussed in this release

and possible future agency action.

DATES: This Interpretation is effective March 9, 1994.

Comments should be received on or before July 15, 1994.

ADDRESSES: Comments should be submitted in triplicate to Jonathan G.

Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street,

NW., Stop 6-9, Washington, DC 20549. Comment letters should refer to

File No. S7-4-94. All comments received will be available for public

inspection and copying at the Commission's Public Reference Room, 450

Fifth Street, NW., Washington, DC 20549.

FOR FURTHER INFORMATION CONTACT: Ann D. Wallace ((202) 272-7282), Amy

Meltzer Starr ((202) 272-3654), Vincent W. Mathis ((202) 272-3968),

Division of Corporation Finance; Janet W. Russell-Hunter (with respect

to Sections III.C.6. and V.) ((202) 504-2418), Division of Market

Regulation, U.S. Securities and Exchange Commission, 450 Fifth Street,

NW., Washington, DC 20549.

SUPPLEMENTARY INFORMATION: In a companion release, the Commission is

proposing rule amendments that prohibit a broker, dealer or municipal

securities dealer from underwriting a municipal issue unless the issuer

agrees to disseminate information to the secondary market and from

recommending the purchase of a municipal security without reviewing

such information.

I. Executive Summary

The recent high volume of municipal securities offerings, as well

as the growing ownership of municipal securities by individual

investors, has highlighted the need for improved disclosure practices

in the municipal securities market, particularly in the secondary

market. To encourage and expedite the ongoing efforts by market

participants to improve disclosure practices, and to assist market

participants in meeting their obligations under the antifraud

provisions, the Commission is publishing its views with respect to

disclosures under the federal securities laws in the municipal market.

This interpretive release addresses the following:

(1) With respect to primary offering disclosure, despite the

significant improvement in disclosure practices in recent years as a

result of voluntary initiatives, increased attention needs to be

directed at

Disclosure of potential conflicts of interest and

material financial relationships among issuers, advisers and

underwriters, including those arising from political contributions;

Disclosure regarding the terms and risks of securities

being offered;

Disclosure of the issuer's or obligor's financial

condition, results of operations, and cash flows. This information

should include audited financial statements (or disclosure that the

financial statements were not subject to audit) and an explanation

of the accounting principles followed in the preparation of the

financial statements, unless the statements were prepared in

accordance with generally accepted accounting principles (``GAAP'')

or accompanied by a quantified explanation of any deviation from

GAAP;

Disclosure of the issuer's plans regarding the

provision of information to the secondary market; and

Timely delivery of preliminary official statements to

underwriters and potential investors.

(2) The Commission is renewing its recommendation for

legislation to repeal the exemption for corporate obligations

underlying certain conduit securities from the registration and

reporting requirements of the federal securities laws.

(3) Particularly because of their public nature, issuers in the

municipal market routinely make public statements and issue reports

that can affect the market for their securities; without a mechanism

for providing ongoing disclosures to investors, these disclosures

may cause the issuer to violate the antifraud provisions.

Basic mechanisms to address potential antifraud liability

include:

Publication of financial information, including audited

financial statements and other financial and operating information,

on at least an annual basis;

Timely reporting of material events reflecting upon the

creditworthiness of the issuer or the obligor and the terms of its

securities, including material defaults, draws on reserves, adverse

rating changes and receipt of an adverse tax opinion; and

Submission of such information to an information

repository.

(4) Underwriters and municipal securities dealers are key

players in maintaining the quality of disclosure in the municipal

securities markets. The underwriter has a duty to review the

issuer's disclosure documents before offering, selling or bidding

for the securities and to have a reasonable basis for its belief as

to the accuracy and completeness of the representations in the

documents. Municipal dealers must have a reasonable basis for

recommending the purchase of securities.

In a companion release,1 the Commission is proposing for

comment two related rule amendments, the first proposing to prohibit

a broker, dealer or municipal securities dealer from underwriting a

municipal issue unless the issuer makes a commitment to provide

annual and event-related secondary market information to a

designated repository; and the second proposing to prohibit a

broker, dealer, or municipal securities dealer from recommending

purchases of such issues in the secondary market if it does not

review such information.

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\1\Exchange Act Release No. 33742 (March 9, 1994) (``Companion

Release'').

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II. Introduction

A. The Municipal Securities Market

As detailed in the recent Staff Report on the Municipal Securities

Market, the market for municipal securities is characterized by great

diversity and high volume. Issuers, estimated to number approximately

50,000, include state governments, cities, towns, counties, and special

subdivisions, such as special purpose districts and public authorities.

It is estimated that there currently are 1.3 million municipal issues

outstanding, representing approximately $1.2 trillion in

securities.2 In 1993, a record level of over $335 billion in

municipal securities was sold, representing over 17,000 issues. This

record financing was heavily influenced by refundings. Nevertheless,

the level of long term new money financings, representing 49% of

financings for the year, reflected continued growth. In 1993, there

were $142 billion of new money long term financings, compared to $81

billion in 1988, a 75% increase.3

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\2\See Division of Market Regulation, Securities and Exchange

Commission, Staff Report on the Municipal Securities Market (``Staff

Report'') (Sept. 1993) at 1.

\3\``A Decade of Municipal Finance,'' The Bond Buyer (Jan. 6,

1994) at 24.

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In recent years, the forms of securities used to meet the financing

needs of these issuers have become increasingly diverse and complex.

For example, conduit bonds, certificates of participation, and a

variety of derivative products have joined traditional general

obligation and revenue bonds as prevalent forms of municipal

financing.4

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\4\Staff Report at 1-2.

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In addition, there has been a change in the investor profile in the

municipal securities market. By 1992, individual investors, including

those holding through mutual funds, held 75% of the municipal debt

outstanding, compared to 44% in 1983.5

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\5\The Bond Buyer 1993 Yearbook (``Bond Buyer 1993 Yearbook'')

at 61-63.

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Along with the changing investor profile, there has been a change

in investor strategy. Traditionally, municipal bondholders have been

buy and hold investors; however, this strategy has changed

significantly with the growth and development of municipal bond funds.

Many of these funds actively trade their portfolio securities to take

advantage of market conditions or to meet redemption needs.

B. SEC Oversight of the Municipal Securities Market

As the agency charged with administering the federal securities

laws and overseeing this nation's securities markets, the Commission

has an obligation to protect investors in the municipal markets from

fraud, including misleading disclosures. As the New York City report

stated nearly two decades ago:

By virtue of the large dollar volume of municipal securities

issued and outstanding each year, such securities are a major factor

in the Nation's economy and the national securities markets. In

light of the national scope of the municipal securities markets,

there is an overriding federal interest in assuring that there is

adequate disclosure of all material information by issuers of

municipal securities.

Although municipalities have certain unique attributes by virtue

of their political nature, insofar as they are issuers of

securities, they are subject to the proscription against false and

misleading disclosures.6

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\6\Staff Report on Transactions in Securities of the City of New

York (``NY City Report'') (Aug. 1977) Chapter III, at 1-2.

The burgeoning volume and complexity of municipal securities

offerings, as well as the retail nature of the market, heighten the

need for market participants to seek to prevent fraud through the

timely provision of material information concerning municipal issuers

and securities.

While Congress exempted offerings of municipal securities from the

registration requirements and civil liability provisions of the

Securities Act of 1933,7 and a mandated system of periodic

reporting under the Securities Exchange Act of 1934,8 it did not

exempt transactions in municipal securities from the coverage of the

antifraud provisions of section 17(a) of the Securities Act,9

section 10(b) of the Exchange Act, and Rule 10b-5 promulgated

thereunder.10 These antifraud provisions prohibit any person,

including municipal issuers and brokers, dealers and municipal

securities dealers, from making a false or misleading statement of

material fact, or omitting any material facts necessary to make

statements made by that person not misleading, in connection with the

offer, purchase or sale of any security. In addition, brokers, dealers

and municipal securities dealers are subject to regulations adopted by

the Commission, including those regulations adopted to define and

prevent fraud.11 Municipal securities dealers are also subject to

rules promulgated by the Municipal Securities Rulemaking Board

(``MSRB'').12

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\7\See section 3(a)(2) of the Securities Act (15 U.S.C.

77c(a)(2)).

\8\See section 3(a)(29) of the Exchange Act (15 U.S.C.

78c(a)(29)).

\9\15 U.S.C. 77q(a).

\1\015 U.S.C. 78j(b); 17 CFR 240.10b-5.

\1\1Sections 15(c) (1) and (2) of the Exchange Act (15 U.S.C.

78o(c) (1) and (2)).

\1\2See MSRB Manual (CCH).

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C. Disclosure Practices and Calls for Enhanced Disclosure

In the absence of a statutory scheme for municipal securities

registration and reporting, disclosure by municipal issuers has been

governed by the demands of market participants and antifraud

strictures. Spurred by the New York City fiscal crisis in 1975 and the

Washington Public Power Supply System defaults,13 participants in

the municipal securities market have developed extensive guidance to

improve the level and quality of disclosure in primary offerings of

municipal securities, and to a more limited extent, continuing

disclosure in the secondary market.

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\1\3See Securities and Exchange Commission, Report of the

Securities and Exchange Commission on Regulation of Municipal

Securities (1988); Securities and Exchange Commission, Staff Report

on the Investigation in the Matter of Transactions in the Washington

Public Power Supply System Securities (1988); Securities Act Release

No. 6021, Final Report in the Matter of Transactions in the

Securities of the City of New York (Feb. 5, 1979); NY City Report.

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In 1989, the Commission adopted Rule 15c2-12 under the Exchange

Act14 to enhance the quality and timeliness of disclosure to

investors in municipal securities.15 The rule requires that

underwriters (both bank and non-bank) of primary offerings of municipal

securities with an aggregate principal amount of $1,000,000 or more

obtain and distribute to their customers the issuers' official

statements for the offerings. This mechanism provides underwriters an

opportunity to review the issuer's disclosure documents before

commencing sales to investors.16

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\1\417 CFR 240.15c2-12; see Municipal Securities Disclosure,

Securities Exchange Act Release No. 26100 (Sept. 28, 1988), 53 FR

37778 (``Proposing Release''); Municipal Securities Disclosure,

Securities Exchange Act Release No. 26985 (July 10, 1989), 54 FR

28799 (``Adopting Release'').

\1\5Proposing Release, 53 FR at 37779-37782; Staff Report at 25.

\1\6Adopting Release, 54 FR at 28800.

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There is a consensus that, over the last two decades, these market

and regulatory efforts have improved significantly the quality of

primary offering disclosure in the municipal securities markets.17

Nonetheless, there continue to be concerns with the adequacy of

municipal offering disclosure, particularly with respect to offerings

of non-general obligation bonds and smaller issues.18

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\1\7National Federation of Municipal Analysts, Membership Survey

Results Fall 1992 Disclosure Survey (``NFMA Survey''); Public

Securities Association, Municipal Securities Disclosure Task Force,

Report: Initial Analysis of Current Disclosure Practices in the

Municipal Securities Market (June 1988) (``PSA Survey'') (content

and completeness of primary disclosure documents and sufficiency of

financial information rated satisfactory to excellent by 94% and 93%

of firms responding, respectively).

\1\8See Letter to Chairman Levitt from Charles Mires, Allstate

Insurance Company (Nov. 4, 1993, as updated Jan. 19, 1994)

(``Allstate Letter'') (primary market disclosure by conduits found

inadequate in 43.8% of rated issues reviewed); NFMA Survey (local

housing, special district, hospitals, long term healthcare and

industrial development issues were found to provide the least

disclosure); PSA Survey (small issue industrial development bonds

received a low rating; issues of $10 million or less received a low

rating).

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Secondary market disclosure practices present greater concerns.

Recent highly publicized defaults19 and refundings,20 as well

as the tremendous level of issuances during the past two years, have

heightened interest in municipal secondary market disclosure.21

The PSA has testified that today ``secondary market information is

difficult to come by even for professional municipal credit analysts,

to say nothing of retail investors.''22 Substantial issuer

information, in the form of official statements, state-required

reports, and other public documents, is available from the

approximately 20% of municipal issuers that come to market frequently,

accounting for 80% of the dollar volume of municipal securities

issued.23 However, the remaining issuers, representing 20% in

dollar volume but 80% in number, which come to the market much less

frequently, provide substantially less continuing information. Many of

these issues are health care issues, housing issues, industrial

development bonds, and other conduit financings,24 financing

sectors which have had the greatest incidence of defaults, both

monetary and technical.25 In addition, information often is

unavailable for smaller issues of securities of general purpose units

of government and the securities of special purpose districts and

authorities.26

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\1\9Examples include the defaults engendered by the failures of

Mutual Benefit Life, Executive Life and Tucson Electric Power, and

the bankruptcies arising out of the Colorado Special Districts. See,

e.g., Hinden, ``Mutual Benefit Life's Collapse Shows Fragility of

Bond Guarantees,'' The Washington Post (Jul. 22, 1991) at F 27;

Levinson, ``No Coverage Against Junk,'' Newsweek (Apr. 22, 1991) at

46; Stamas, ``Rep. Dingell Asks SEC to Investigate Defaults by

Special Assessment Districts in Colorado,'' The Bond Buyer (Jan. 25,

1991) at 1.

\2\0See Gasparino, ``Balancing Budgets Through Lease Deals May

Pose Credit Risks, Rating Agency Warns,'' The Bond Buyer (Jan. 25,

1993) at 1; Herman, ``Municipal-Bond Holders: Watch Out for `Call'

Shock,'' The Wall Street Journal (Aug. 29, 1992) at C1; Hume,

``Dealer Threatens Suit Over Proposed Call for Escrowed Bonds,'' The

Bond Buyer (Nov. 8, 1993) at 4; Hume, ``Issuer in Louisiana May Run

Afoul of Law if Escrowed Bonds Are Called Next Month,'' The Bond

Buyer (Apr. 22, 1993) at 1; Hume, ``Rise in Re-Refundings of

Escrowed Bonds Likely to Gain Attention at Treasury, SEC,'' The Bond

Buyer (May 12, 1992) Pat 1.

\2\1See generally, Testimony of Jeffrey S. Green, General

Counsel, Port Authority of New York and New Jersey on behalf of

Government Finance Officers Association, before the Subcommittee on

Telecommunications and Finance, House Committee on Energy and

Commerce, Oct. 7, 1993 (``GFOA Testimony'') at 7-9; Remarks by C.

Richard Lehmann, President, Bond Investors Association Before the

U.S. House of Representatives Subcommittee on Telecommunications and

Finance Concerning the Municipal Securities Market, Oct. 7, 1993

(``Lehmann Testimony'') at 4-5; Testimony of Andrew R. Kintzinger,

President-Elect, National Association of Bond Lawyers, Before the

Subcommittee on Telecommunications and Finance, House Committee on

Energy and Commerce, Oct. 7, 1993 (``NABL Testimony'') at 8-23;

Testimony of Harvey Eckert, Chairman of the Blue Ribbon Committee on

Secondary Market Disclosure on Behalf of the National Association of

State Auditors, Comptrollers and Treasurers Before the Subcommittee

on Telecommunications and Finance, House Committee on Energy and

Commerce, Oct. 7, 1993 (``NASACT Testimony'') at 3-6; Testimony

Relating to the Municipal Securities Market given by the National

Federation of Municipal Analysts, Katherine Bateman, Chairperson, to

the Subcommittee on Telecommunications and Finance, Oct. 7, 1993

(``NFMA Testimony'') at 1-7; Statement of Gerald McBride, Chairman,

Municipal Securities Division, Public Securities Association, Before

the House Committee on Energy and Commerce, Telecommunications and

Finance Subcommittee, Oct. 7, 1993 (``PSA Testimony'') at 5-7;

NASACT, State and Local Government Securities Markets and Secondary

Market Disclosure (Oct. 1993) at 5; Stamas, ``Issuers' Intentions on

Secondary Market Disclosure are Starting to Appear in Official

Statements,'' The Bond Buyer (Dec. 14, 1992) at 1; Standard &

Poor's, ``In Support of Secondary Market Disclosure,'' CreditWeek

Municipal (Mar. 16, 1992).

\2\2PSA Testimony at 5. See also Lehmann Testimony at 4; NASACT

Testimony at 3; Nemes, ``Investors' Service Steps in to Fill Void in

Hospital Data Disclosure,'' Modern Healthcare (Feb. 3, 1992) at 46;

Quint, ``Credit Markets; Aiming for More Data About Municipal

Bonds,'' The New York Times (June 28, 1993) at D5; Schifrin,

``Hello, Sucker,'' Forbes (Feb. 1, 1993) at 40.

\2\3NASACT, Report of the Blue Ribbon Committee on Secondary

Market Disclosure--Improving Secondary Market Disclosure (Aug. 1993)

(``NASACT Blue Ribbon Committee Report'') at 1-2.

\2\4See id. at 1. See also Allstate Letter.

\2\5See Bond Buyer 1993 Yearbook at 3-5; Municipal Bond

Defaults--The 1980's; a Decade in Review (J.J. Kenny Co., Inc.

1993)(``Kenny Default Report''); Public Securities Association, An

Examination of Non-Rated Municipal Defaults 1986-1991 (Jan. 8,

1993)(``PSA Default Report''); Staff Report, Appendix B.

\2\6See NASACT Blue Ribbon Committee Report at 1-2.

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In response to a request by Commission Chairman Arthur Levitt for a

recommended ``market-participant sponsored solution'' to the disclosure

issues in the municipal securities market, on December 20, 1993, 12

groups and associations representing a broad range of market

participants submitted to the Commission a Joint Statement on

Improvements in Municipal Securities Market Disclosure (the ``Joint

Statement'').27 The Joint Statement sets forth ``a framework for

improving the availability of information in the marketplace'' that

calls for both continued market initiatives to improve issuer

disclosure and ``support from the SEC and the Municipal Securities

Rulemaking Board (MSRB).''28 Among other things, its participants

recommend the adoption of a rule or interpretive guidance restricting

underwriting of municipal issues unless continuing information

covenants are provided by the issuer.

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\2\7Joint Statement on Improvements in Municipal Securities

Market Disclosure (``Joint Statement'') (Dec. 20, 1993) at 1. The

Joint Statement was submitted by the American Bankers Association's

Corporate Trust Committee, American Public Power Association,

Association of Local Housing Finance Agencies, Council of

Infrastructure Financing Authorities, Government Finance Officers

Association, National Association of Bond Lawyers, National

Association of Counties, National Association of State Auditors,

Comptrollers and Treasurers, National Association of State

Treasurers, National Council of State Housing Agencies, National

Federation of Municipal Analysts, and Public Securities Association.

\2\8Id.

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III. Primary Offering Disclosure

A. Application of the Antifraud Provisions

The antifraud provisions of the federal securities laws prohibit

fraudulent or deceptive practices in the offer and sale of municipal

securities.29 Disclosure documents used by municipal issuers, such

as official statements, are subject to the prohibition against false or

misleading statements of material facts, including the omission of

material facts necessary to make the statements made, in light of the

circumstances in which they are made, not misleading. The adequacy of

the disclosure provided in municipal security offering materials is

tested against an objective standard: an omitted fact is material if

there is a substantial likelihood that, under all the circumstances,

the omitted fact would have assumed actual significance in the

deliberations of the reasonable [investor]. Put another way, there must

be a substantial likelihood that the disclosure of the omitted fact

would have been viewed by the reasonable investor as having

significantly altered the ``total mix'' of information made

available.30

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\2\9See In re Washington Public Power Supply System Securities

Litigation, 623 F. Supp. 1466, 1478 (W.D. Wash. 1985). See also

Brown v. City of Covington, 805 F.2d 1266, 1270 (6th Cir. 1986).

\3\0TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449

(1976).

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B. Voluntary Guidelines

In the primary offering of municipal securities, the extensive

voluntary guidelines issued by the Government Finance Officers

Association (``GFOA'') have received widespread acceptance and, among a

number of larger issuers, have been viewed as ``in essence obligatory

rules.''31 Other groups, including the National Federation of

Municipal Analysts (``NFMA''), have published voluntary disclosure

guidelines covering industry specific sectors, including among others,

housing, student loans, transportation and health care.32 In

connection with the offering of municipal securities, the GFOA

Guidelines call for:33

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\3\1Letter from Harlan E. Boyles, Treasurer of North Carolina to

SEC Chairman Levitt, dated December 7, 1993. See Government Finance

Officers Association, Disclosure Guidelines for State and Local

Government Securities (Jan. 1991) (``GFOA Guidelines'').

\3\2See NFMA, Disclosure Handbook for Municipal Securities 1992

Update (Nov. 1992) (``NFMA Handbook''). See also Government

Accounting Standards Board, Codification of Government Accounting

and Financial Reporting Standards (2d ed. 1987); PSA,

Recommendations for a Consistent Presentation of Basic Bond

Provisions in Official Statements (Dec. 1989).

\3\3GFOA Guidelines at xv-xix (summary).

An introduction to serve as the guide to the official

statement;

A description of the securities being offered,

including complete information regarding the purposes of the

offering, the plan of financing, the security and sources of

repayment, and the priority of the securities, as well as structural

characteristics, such as call provisions, tender options, original

issue or deep discount, variable rates, and lease purchase

agreements;

Information regarding the nature and extent of any

credit enhancement and financial and business information about the

issuer of the enhancement;

A description of the government issuer or enterprise,

including information about the issuer's range or level of service,

capacity and demographic factors and, in the case of revenue

supported offerings, information on the enterprise's organization,

management, revenue structure, results of operations and operating

plan;

With respect to obligations of private profit making

and nonprofit conduit issuers, information regarding the business or

other activity, including the enterprise's form of organization and

management, rate-making or pricing policies, and historical

operations and plan of operation;

A description of the issuer's outstanding debt,

including the authority to incur debt, limitations on debt, and the

prospective debt burden and rate of its retirement;

A description of the basic documentation, such as

indentures, trust agreements and resolutions authorizing the

issuance and establishing the rights of the parties;

Financial information, including summary information

regarding the issuer's or obligor's financial practices and results

of operations, and financial statements, prepared in conformity with

generally accepted accounting principles and audited in accordance

with generally accepted auditing standards;

A discussion of legal matters, such as pending

judicial, administrative, or regulatory proceedings that may

significantly affect the securities offered, legal opinions, and tax

considerations; and

A discussion of miscellaneous matters, including

ratings and their description and meanings, underwriting

arrangements, arrangements with financial advisors, interests of

named experts, pending legislation, and the availability of

additional information and documentation.

The guidelines prepared by the GFOA and the NFMA provide a

generally comprehensive roadmap for disclosure in offering statements

for municipal securities offerings. There are, however, areas that need

further improvement in both the context of negotiated and competitively

bid underwritings. In addition, implementation of these guidelines

needs to be extended to the whole market. For example, while large

repeat general obligation issuers usually have comprehensive disclosure

documents, small issuers and conduit issuers, particularly in the

health care, housing and industrial development areas, do not always

provide the same quality of disclosure.34

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\3\4See NASACT Blue Ribbon Committee Report at 1-2; Staff Report

at 26. Industry participants generally agreed in testimony before

the House of Representatives Subcommittee on Telecommunications and

Finance on October 7, 1993, that both the greatest disclosure

problems and the greatest risk of default were with unrated

hospital, housing, special district and industrial development

revenue bonds.

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C. Areas Where Improvement Is Needed

1. Conflicts of Interest and Other Relationships or Practices

Information concerning financial and business relationships and

arrangements among the parties involved in the issuance of municipal

securities may be critical to an evaluation of an offering.35

Recent revelations about practices used in the municipal securities

offering process have highlighted the potential materiality of

information concerning financial and business relationships,

arrangements or practices, including political contributions, that

could influence municipal securities offerings. For example, such

information could indicate the existence of actual or potential

conflicts of interest, breaches of duty, or less than arm's-length

transactions. Similarly, these matters may reflect upon the

qualifications, level of diligence, and disinterestedness of financial

advisers, underwriters, experts and other participants in an offering.

Failure to disclose material information concerning such relationships,

arrangements or practices may render misleading statements made in

connection with the process, including statements in the official

statement about the use of proceeds, underwriters' compensation and

other expenses of the offering. In addition, investors reasonably

expect participants in municipal securities offerings to follow

standards and procedures established by such participants, or other

governing authorities, to safeguard the integrity of the offering

process; accordingly, material deviations from those procedures warrant

disclosure.

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\3\5See SEC v. Washington County Utility District, 676 F.2d 218,

222 (6th Cir. 1982) (``Flagrant violations'' of antifraud provisions

arising from failure to disclose use of proceeds to purchase options

on property held by issuer's manager and financial arrangements

between the manager and the underwriter).

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Existing rules and voluntary guidelines call for certain specific

disclosures by offering participants. GFOA guidelines call for offering

statement disclosure to investors of contingency fees to named experts,

including counsel, and any other interest or connection those parties

have with other transaction participants.36 MSRB rules call for

dealer disclosure to issuers and investors of any financial advisory

relationship between an issuer and a broker, dealer, or municipal

securities dealer, under certain circumstances.37 MSRB rules also

call for dealer disclosure to investors of, among other things, certain

fees and expenses in negotiated transactions.38

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\3\6Section XII.D. of the GFOA Guidelines.

\3\7MSRB rule G-23.

\3\8MSRB rule G-32. See Section 15B(c)(1) of the Exchange Act

(15 U.S.C. 78o-4(c)(1)) (requiring compliance with MSRB rules); MSRB

rule G-17.

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Beyond existing specific disclosure requirements and guidelines,

the range of financial and business relationships, arrangements and

practices that need to be disclosed depends on the particular facts and

circumstances of each case. If, for example, the issuer (or any person

acting on its behalf) selects an underwriter, syndicate or selling

group member, expert, counsel or other party who has a direct or

indirect (for example, through a consultant) financial or business

relationship or arrangement with persons connected with the offering

process, that relationship or arrangement may be material.39 Areas

of particular concern are undisclosed payments to obtain underwriting

assignments and undisclosed agreements or arrangements, including fee

splitting, between financial advisers and underwriters.40 If the

adviser is hired to assist the issuer, such relationships, financial or

otherwise, may divide loyalties. Similarly, affiliations between

sellers of property to be used in a financed project and conduit

borrowers raise questions regarding, among other things, the

determination of fair market value of the property and self-dealing.

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\3\9Gasparino, ``The Trouble with Consultants'', The Bond Buyer

(Nov. 16, 1993) at 1. In his testimony before the Subcommittee on

Telecommunications and Finance, Andrew Kintzinger, on behalf of the

National Association of Bond Lawyers (``NABL''), stated: ``[M]embers

of the municipal finance bar should work with issuers to develop

procurement procedures for state and local governments to ensure

that all material financial arrangements between underwriters within

the syndicate and between underwriters and financial advisors and

possible conflicts of interest between issuers and members of the

underwriting syndicate or other participants be accurately

documented and disclosed or, if appropriate, prohibited.'' NABL

Testimony at 28. See Joint Statement at 2.

\4\0Gasparino, ``Several Issuers Start to Scrutinize Ties

Between Advisers, Bankers,'' The Bond Buyer (Dec. 27, 1993) at 1.

See Section XII.C. of the GFOA Guidelines; rule G-23 of the MSRB.

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2. Terms and Risks of Securities

Evolution in the financial markets has led to increasingly complex

and sophisticated derivative and other municipal products. While these

new products offer investors a wide range of investment alternatives,

in choosing among the alternatives, investors need a clear

understanding of the terms and the particular risks arising from the

nature of the products.41

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\4\1As the NABL Testimony indicates: ``Derivatives are

sophisticated securities products designed for sophisticated

investors and should not be sold to retail investors generally and

certainly not without comprehensive disclosure. If issuers choose to

undertake the financial benefits of these sophisticated and

complicated transactions, they can assume the financial costs of

providing * * * information.'' NABL Testimony at 22.

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In particular, investors need to be informed about the nature and

effects of each significant term of the debt, including credit

enhancements and risk modifiers, such as inverse floaters and

detachable call rights. Investors in these securities should be aware

of their exposure to interest rate volatility, under all possible

scenarios. In addition, any legal risk concerning the issuer's

authority to issue securities with unconventional features needs to be

disclosed. The PSA recently has identified disclosure that should be

provided in connection with the offer of financial instruments that

include such features as auction and swap-based inverse floaters and

embedded cap bonds.42

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\4\2PSA, Recommendation on Dissemination of Product--Specific

Terms For Municipal Derivative Products (1993).

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Credit enhancements are used with increasing frequency in the

municipal market. According to published information, over 37% of the

dollar volume of new long term issues carry some form of credit

enhancement.43 The existence of bond insurance or other credit

enhancement creates the need for disclosure concerning the provider of

the credit enhancement and the terms of the enhancement44 to avoid

misleading investors concerning the value of the enhancements provided

and the party's ability to fund the enhancement. The GFOA recommends

that appropriate financial information about the assets, revenues,

reserves and results of operations of credit enhancers be provided in

the official statement. In determining the extent of disclosure,

consideration should be given to the amount of the enhancement relative

to the income and cash flows of the issuer or obligor, conditions

precedent to application of the enhancement, duration of the

enhancement, and other factors indicating a material relationship

between the enhancement and the investor's anticipated return.

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\4\3PSA, Municipal Market Developments (Aug. 1993) at 5.

\4\4See Revisions to Rules Regulating Money Market Funds,

Securities Act Rel. No. 7038, 58 FR 68585, 68588 (footnote omitted)

(``Money Market Fund Release''); Securities and Exchange Commission,

Report by the United States Securities and Exchange Commission on

the Financial Guarantee Market: The Use of the Exemption in Section

3(a)(2) of the Securities Act of 1933 for Securities Guaranteed by

Banks and the Use of Insurance Policies to Guarantee Debt Securities

(Aug. 28, 1987) (``SEC Financial Guarantee Report'') at 82; Adopting

Release, 54 FR at 28812.

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In a trend that has become increasingly common, municipal bond

insurers are including in indentures provisions that appear to delegate

to the bond insurer the ability to modify terms of the indenture, prior

to default, without the consent of, or even prior notification to,

bondholders.45 There should be clear disclosure of any such

provision that may have a material impact on the rights of bondholders

or the obligations of the issuer, including the specific material

rights of the bondholder that could be so altered.

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\4\5See Allstate Letter.

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3. Financial Information

a. Financial Accounting. Sound financial statements are critical to

the integrity of the primary and secondary markets for municipal

securities, just as they are for corporate securities.46 The key

to the reliability and relevancy of the information contained in the

financial statements of a municipal issuer is the use of a

comprehensive body of accounting principles consistently applied by the

issuer.47

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\4\6See NY City Report at Ch. II p. 92.

\4\7See GFOA Guidelines at 50.

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Although there continues to be some diversity in the financial

reporting practices used in preparing financial statements of

governmental issuers, practice in the municipal market is evolving

rapidly to reliance on generally accepted accounting principles

(``GAAP'') as determined by the Government Accounting Standards Board

(``GASB'').48 Only two years after GASB was founded in 1984,

financial statements prepared in accordance with GAAP, as promulgated

by GASB, were required by 75.2% of cities, 78.3% of counties and 69% of

school districts responding to a research survey.49 Forty-six

states currently require, or are in the process of establishing a

requirement, that state government financial statements be presented in

accordance with GAAP.50 In addition, local as well as state

governments that receive significant amounts of federal aid must

prepare financial statements in accordance with GAAP or provide

information concerning variance from GAAP.51

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\4\8The financial statements of corporate obligors backing

conduit securities should follow GAAP for such entities, as

established by the Financial Accounting Standards Board and other

bodies.

\4\9Ingram & Robbins, Financial Reporting Practices of Local

Governments, Government Accounting Standards Board (1987) at 12 (The

survey results were based on information received from 567

respondents to a survey questionnaire mailed to 1161 government

units).

\5\0State Comptrollers: Technical Activities and Functions (1992

Edition).

\5\1Where state and local governments programs that are subject

to the federal ``Single Audit Act of 1984,'' Public Law 98-502 et

seq. prepare financial statements on a basis other than GAAP, ``the

audit report should state the nature of the variances therefrom and

follow professional guidance for reporting on financial statements

which have not been prepared in accordance with GAAP.'' Office of

Management and Budget, ``Questions and Answers on the Single Audit

Process of OMB Circular A-128, `Single Audits of State and Local

Governments,' '' 52 FR at 43716 (Nov. 13, 1987), question 35.

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The GFOA Guidelines call for financial statements that are either

prepared in accordance with GAAP or accompanied by a quantified (if

practicable) explanation of the differences.52 To avoid

misunderstanding, investors need to be informed of the basis for

financial statement presentation. Accordingly, when a municipal issuer

neither uses GAAP nor provides a quantified explanation of material

deviations from GAAP, investors need a full explanation of the

accounting principles followed.

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\5\2GFOA Guidelines at 45.

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b. Audits. Investors in the public securities markets have a

reasonable expectation that annual financial statements contained in

offering documents or periodic reports are subject to audit.53 In

the case of municipal issuers, these financial statement audits are

typically conducted by either an independent certified public

accountant or a state auditor. Although the frequency and timeliness of

audits vary, every state requires some periodic audit verification of

government financial statements.54 A prudent investor needs to be

able to evaluate the extent to which he or she can rely on the second

look an auditor provides.

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\5\3See Gauthier, An Elected Official's Guide to Auditing (1992)

at vii and xi.

\5\4State Comptrollers: Technical Activities and Functions;

NASACT, Municipal Task Force Report (1990) (``NASACT 1990 Task Force

Report'') at 12.

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Accordingly, the offering statement should state whether the

financial statements it contains were audited in accordance with

generally accepted auditing standards (``GAAS''), as established by the

American Institute of Certified Public Accountants.

c. Other Financial and Operating Information. Financial information

beyond that contained in the financial statements--provided in tabular

and narrative format, footnotes, supplemental tables, schedules and

discussions of operations and financial position--is essential to the

fair presentation of an issuer's financial performance and position. As

reflected in industry guidelines,55 the type of information needed

(e.g., tax revenue base, budget, demographics, project revenues and

operations) varies depending on the type of issuer, the type of

security sold, and the sources for repayment of the bond obligations.

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\5\5See generally, GFOA Guidelines; NFMA Handbook. See also

infra n. 84.

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There are a number of areas in which greater care needs to be taken

to provide investors with adequate information. In a pooled financing

structure, such as that used by bond banks, in addition to providing

financial information concerning the issuing authority or program in

the aggregate, it may be necessary to provide information on

participating obligors. This will depend on diversification and risk

concentration factors, such as the significance of any single obligor

to the overall financing.

Conduit bond issuers need to provide operational information

concerning the activities of the private enterprise that will provide

the cash flows to service the debt--for example, financial reporting,

legal proceedings, changes in indebtedness, defaults and other

significant developments relating to the underlying corporate obligor.

Where the issuing authority in a conduit financing has no remaining

obligation for the repayment of the indebtedness, in providing

financial information about the issuing entity (as compared to the

obligor on the bonds), care must be taken to avoid misleading investors

regarding the sources of repayment.56

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\5\6See Letter of John Murphy, Executive Director of Association

of Local Housing Finance Agencies to Chairman Levitt (Dec. 20,

1993).

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Municipal issuers also must consider disclosure issues arising from

their activities as end users of derivative products. For example, the

use of non-exchange traded derivatives to alter interest rate risk

exposes the issuer to counterparty credit risk. Disclosure documents

need to discuss the market risks to which issuers are exposed, the

strategies used to alter such risks and the exposure to both market

risk and credit risk resulting from risk alteration strategies. The

NFMA has published sector specific secondary market disclosure

guidelines calling for a discussion of the issuer's use of derivative

products, especially interest rate swaps.57

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\5\7NFMA Handbook.

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Moreover, in addition to financial and operating data, the official

statement may need to include a narrative explanation to avoid

misunderstanding and assist the reader in understanding the financial

presentation. A numerical presentation alone may not be sufficient to

permit an investor to judge financial and operating condition of the

issuer or obligor.58 For example, it may be necessary to explain

the presentation of budget information and the relationship of the

budget figures to the financial statements.

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\5\8See Management's Discussion and Analysis of Financial

Condition and Results of Operations; Certain Investment Company

Disclosures, Securities Act Release No. 6835 (May 24, 1989), 54 FR

22427; Securities Act Release No. 6711 (April 24, 1987), 52 FR

13715.

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In addition, issuers must assess whether the future impact of

currently known facts mandate disclosure. The GFOA Guidelines call for

a description of known facts that would significantly affect the

financial information presented or future financial operation of the

issuer, as well as a discussion of its projected operations.59 For

example, in a hospital financing, a steadily declining population in

the surrounding community that, in the future, would not support the

size of facility to be built would be important to investors.

Disclosure of such currently known conditions and their future impact

is critical to informed decisionmaking.

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\5\9GFOA Guidelines at 55.

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d. Timeliness of Financial Statements. The timeliness of financial

information is a major factor in its usefulness. To avoid providing

investors with a stale, and therefore potentially misleading, picture

of financial condition and results of operations, issuers and obligors

need to release their annual financial statements as soon as practical.

After extensive discussion with market participants, it appears that,

for the most part, audited financial statements of municipal issuers

for the most recently completed fiscal year are available within six

months after fiscal year end. The six month time period is consistent

with the recommendations of NASACT's Blue Ribbon Committee

Report.60 Unaudited financial statements should be provided when

available prior to the completion of the audit.

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\6\0See NASACT Blue Ribbon Committee Report at 17. While due

dates for audited financial statements of government units differ, a

significant majority of states currently require audited financial

statements for government units to be filed within six months after

the fiscal year end. NASACT 1990 Task Force Report at 12-22.

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4. Availability of Continuing Information

An investor's ability to monitor future developments affecting the

issuer, as well as the likely liquidity of a security, are important to

an investor's evaluation of an offering. The official statement should

state clearly whether ongoing disclosure concerning the issuer or

obligor will be provided, including the type, timing, and method of

providing such information.61 In deciding whether to purchase the

securities or to continue to hold them, investors need to know whether

the issuer has committed to provide information on an ongoing

basis.62 The absence of such a commitment can adversely affect the

secondary market for the securities and increases the risks of the

investment.

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\6\1See Fall 1992 NFMA Survey. See also American Bankers

Association, Corporate Trust Committee, Four Point Public 1991

Disclosure Guidelines for Corporate Trustees (``ABA 1991

Guidelines'') at 2; Stamas, ``Issuers' Intentions on Secondary

Disclosure are Starting to Appear in Official Statements,'' The Bond

Buyer (Dec. 14, 1992) at 1.

\6\2See MSRB, Report of the Municipal Securities Rulemaking

Board on Regulation of the Municipal Securities Market (Sept. 1993)

at 6-7 (Board announced plan that would include requiring

underwriters to recommend to issuers that they provide continuing

disclosure to the market and requiring municipal securities dealers

to disclose to their customers the negative impact that the lack of

secondary market information may have on the value and liquidity of

the securities and whether the issuer has agreed to voluntarily

provide such disclosures).

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As discussed above, the Joint Statement recommends that the

Commission adopt a rule prohibiting a municipal securities dealer from

underwriting securities absent a commitment to provide ongoing

information. In the Companion Release, the Commission is proposing such

a rule for comment. In order to fully inform investors, an issuer needs

to include in the official statement a description of the scope of its

continuing disclosure commitment, the type of information that would be

provided, the repositories to which the information would be sent, when

annual and other periodic information would be available, and the

consequences of the issuer's failure to abide by the requirements of

the covenant.

5. Clarity and Conciseness

Like other disclosure documents, official statements need to be

clear and concise to avoid misleading investors through confusion and

obfuscation. The expanded level of disclosure in official statements

and increased sophistication of municipal securities instruments have,

in many cases, resulted in longer and more complex disclosure

documents, with the corresponding danger of overly detailed,

legalistic, and possibly obtuse disclosure.63

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\6\3See GFOA Testimony at 6. See also Allstate Letter.

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The location, emphasis, and context of the disclosure can affect

the ability of a reasonable investor to understand the relationship

between, and cumulative effect of, the disclosure.64 As the U.S.

Court of Appeals for the Second Circuit has stated:

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\6\4Isquith v. Middle South Utilities, 847 F.2d 186, 201 (5th

Cir.), cert. denied, 488 U.S. 926 (1988); Kas v. Financial General

Bankshares, Inc., et al., 796 F.2d 508, 516 (D.C. Cir. 1986);

Kennedy v. Tallant, 710 F.2d 711, 720 (11th Cir. 1983).

[D]isclosures in a prospectus must steer a middle course,

neither submerging a material fact in a flood of collateral data,

nor slighting its importance through seemingly cavalier treatment.

The import of the information conveyed must be neither oversubtle

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nor overplayed, its meaning accurate, yet accessible.65

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\6\5Isquith, 847 F.2d at 202.

Appropriate disclosure ``is measured not by literal truth, but by

the ability of the material to accurately inform rather than mislead''

investors.66 As the Commission has indicated in other contexts,

legalistic, overly complex presentations and inattention to

understandability can render the disclosure incomprehensible and

consequently misleading.67

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\6\6McMahan & Company, et. al. v. Wherehouse Entertainment,

Inc., 900 F.2d 576, 579 (2d Cir. 1990).

\6\7See, e.g., Limited Partnership Reorganizations and Public

Offerings of Limited Partnership Interests, Securities Act Release

No. 6900 (June 25, 1991) 56 FR 28979, 28980 (``Limited Partnership

Release'').

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6. Delivery of Official Statements

One of the concerns leading to the adoption of Rule 15c2-12 was

that underwriters were not receiving official statements within time

periods that would allow them to examine the accuracy of the

disclosure.68 The Commission noted in proposing the rule that a

thorough, professional review by underwriters of municipal offering

documents could encourage appropriate disclosure of foreseeable risks

and accurate descriptions of complex put and call features, as well as

novel financing structures now employed in many municipal offerings. In

addition, with the increase in novel or complex financings, there may

be greater value in having investors receive disclosure documents

describing fundamental aspects of their investment. Yet, underwriters

are unable to perform this function effectively when offering

statements are not provided to them on a timely basis.69

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\6\8Proposing Release, 53 FR at 37781.

\6\9Proposing Release, 53 FR at 37782.

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To address this concern, the rule requires any underwriter,

including lead underwriters, syndicate members, and selling group

members that receive in excess of the usual seller's commission, to

obtain and review an official statement that is deemed final as of its

date by the issuer, except for the omission of certain information,

before bidding for, purchasing, offering, or selling municipal

securities in a primary offering.

Since the adoption of Rule 15c2-12, however, there have been

continued problems with the timeliness of receipt by underwriters of

the ``near final'' official statement required by the Rule.70 In

addition to compromising the ability of an underwriter to make a

reasonable investigation of the issuer, this problem also may limit the

ability of potential customers to make informed investment decisions.

In a recent NFMA survey, 59% of those responding rated the delivery of

preliminary official statements in competitive sales as either not very

good or poor, and 50% rated the delivery of preliminary official

statements in negotiated sales as either not very good or poor.71

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\7\0As a practical matter, near final official statements

distributed to underwriters to satisfy Rule 15c2-12(b)(1) are often

the same document as the preliminary official statement distributed

to potential customers pursuant to Rule 15c2-12(b)(2). See Mudge

Rose Guthrie Alexander & Ferndon (April 4, 1990) (``Mudge Rose'')

(rejecting the argument that in a negotiated offering, the

identification of a credit enhancer and related information about

the credit enhancer may be omitted on the assumption that the

information depends on pricing). See also Fippinger & Pittman,

Disclosure Obligations of Underwriters of Municipal Securities, 47

Business Lawyer 127, 140 (Nov. 1991). In addition, underwriters are

required to deliver to potential customers, upon request, copies of

the final official statement for a specified time period. Rule 15c2-

12(b)(4).

\7\1NFMA Survey. See also Letter from Jeffrey M. Baker,

Chairperson, NFMA Industry Practices and Procedures Committee and

Richard A. Ciccarone, Past Chairperson, NFMA Industry Practices and

Procedures Committee to Arthur Levitt, Chairman, Securities and

Exchange Commission, Christopher A. Taylor, Executive Director, MSRB

and Joseph R. Hardiman, President and Chief Executive Officer,

National Association of Securities Dealers, Inc. (Oct. 19, 1993)

(regarding the timeliness of receipt of near final and preliminary

official statements).

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One cause of delay has been confusion as to the point at which the

underwriter must have obtained and reviewed the near final official

statement in a negotiated offering. The term ``offer'' traditionally

has been defined broadly under the federal securities laws and, for

purposes of Rule 15c2-12, encompasses the distribution of a preliminary

official statement by the underwriter, as well as oral solicitations of

indications of interest. Thus, prior to the time that the underwriter

distributes the preliminary official statement to potential investors,

or otherwise begins orally soliciting investors, the rule requires it

to have obtained and reviewed a near final official statement. If no

offers are made, the underwriter is required to obtain and review a

near final official statement by the earlier of the time the

underwriter agrees (whether in principle or by signing the bond

purchase agreement) to purchase the bonds, or the first sale of bonds

to investors.72

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\7\2See Mudge Rose.

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The Commission has acknowledged that the rule would require greater

planning and discipline by some issuers.73 The Commission

anticipated that, in order to allow underwriters to meet their

obligation to have a reasonable basis for recommending any municipal

securities, issuers would have to begin drafting disclosure documents

earlier, and perhaps with greater care than in the past.74 This

result enables underwriters to receive, and if necessary influence the

content of, the final official statement before committing themselves

to an offering.75 Moreover, placing an obligation on the issuer to

prepare the official statement at an earlier stage is appropriate,

because it is the issuer's obligation to ensure that there is timely

dissemination of disclosure documents in connection with the offer and

sale of the issuer's securities.76

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\7\3Adopting Release, 54 FR at 28804. The Commission also noted

that the requirements of Rule 15c2-12(b)(1) could be met through the

use of multiple documents. For example, a frequent issuer might be

able to supply a recent official statement, together with

supplementary information containing the terms of the current

offering, as well as any material changes from the previous offering

materials.

\7\4Proposing Release, 53 FR at 37790.

\7\5Id.

\7\6See Adopting Release, 54 FR at 28811 N. 84 (official

statement is issuer's document).

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D. Conduit Financings

When financing involves a third party as the source of repayment,

investors need information on that underlying borrower. The GFOA

Guidelines call for description of conduit obligors, which are defined

by the GFOA Guidelines to include both private profit-making and

nonprofit entities.77 The suggested information includes the

nature and development of the business or other activity to be

undertaken by the conduit obligor (including its form of organization

and management), location of principal facilities and service area,

ratemaking or pricing policies and historical operations and plan of

operations.

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\7\7GFOA Guidelines at 26. In a recent policy statement, the

GFOA referred to ``conduit bonds'' as ``municipal securities issued

by a state or local government for the benefit of a private

corporation or other entity that is ultimately obligated to pay such

bonds * * *.'' GFOA, Committee on Governmental Debt and Fiscal

Policy, Improvements in Municipal Securities' Market Disclosure

(Feb. 1, 1994) (``GFOA Disclosure Policy Statement'').

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To address disclosure issues involving conduit financings in a

comprehensive fashion, however, legislation addressing the exempt

status of conduit securities under the federal securities laws is

necessary. Bonds used to finance a project to be used in the trade or

business of a private corporation are, from an investment standpoint,

equivalent to corporate debt securities issued directly by the

underlying corporate obligor.78 Payments on these types of conduit

securities are derived solely from revenues received by the

governmental entity under the terms of a contractual agreement,

typically a lease or a note, from a private enterprise, rather than

from the general credit and taxing power of the governmental issuer.

The tax-exempt status of interest payments does not alter the

fundamental analysis that these are private obligations, in which the

investor looks, and can look, only to a private entity for repayment.

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\7\8See Money Market Fund Release, 58 FR at 68588 (proposal to

subject tax exempt money market fund investments in conduit

securities to restrictions similar to those applicable to securities

of comparable obligors offered to taxable funds).

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The private nature of many conduit enterprises distinguishes them

from traditional municipal financings. The incidence of bond default

appears to be inversely related to the degree a financed project

represents an essential public service.79 A study conducted by the

PSA on non-rated issues that defaulted found that 75% were issued by

local authorities in the areas of health care and industrial related

sectors such as energy, chemical, pollution control and industrial

development.80

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\7\9Kenny Default Report at 2.

\8\0PSA Default Report at 12.

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Given the essentially private nature of non-governmental industrial

development financings, investors need the same disclosure regarding

the underlying non-municipal corporate obligor as they would receive

regarding any corporate obligor, and the same regulatory and liability

scheme should apply. Accordingly, the Commission has consistently

supported legislative proposals to amend Section 3(a)(2) of the

Securities Act81 and Section 3(a)(29)82 of the Exchange Act

to remove the registration exemption for the corporate credit

underlying municipal conduit securities involving non-governmental

industrial development (private activity) financings.83 The

Commission today renews that legislative recommendation.

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\8\115 U.S.C. 77c(a)(2).

\8\215 U.S.C. 78c(a)(29).

\8\3See Remarks of David S. Ruder, Chairman, SEC, ``Disclosure

in the Municipal Securities Markets,'' Before the Public Securities

Association (Oct. 23, 1987) at 17-18; Letter from John S.R. Shad,

Chairman, SEC to Representative Timothy E. Wirth, Chairman, House

Subcommittee on Telecommunications, Consumer Protection, and Finance

(March 12, 1985); 124 Cong. Rec. 21, 639 (1978) (letter from SEC

Chairman Harold M. Williams to Senator Harrison A. Williams). There

were two bills introduced, one in 1975 and one in 1978, that would

have repealed the exemption from the registration requirements of

the Securities Act of 1933. The 1978 bill would have subjected

certain industrial development bonds to the registration

requirements of the Securities Act of 1933, the filing and

qualification provisions of the Trust Indenture Act and the periodic

reporting requirements of the Securities Exchange Act of 1934.

Neither bill was enacted. See also ``Municipal Securities Full

Disclosure Act of 1976,'' S. 2969, 94th Cong., 2d. Sess. (Feb. 17,

1976).

Governmental industrial development financings, which would have

retained their exempt status under prior proposals, include those

financings in which the bonds are repaid from the general revenues

of the governmental unit or the project or facility is a public

facility (or part of a public facility) and owned and operated by or

on behalf of the governmental unit. The prior proposals to register

conduit financings would not have affected the separate exemption

for securities issued by non-profit charitable organizations in

Section 3(a)(4) of the Securities Act (15 U.S.C. 77c(a)(4)).

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Pending amendment to the securities laws to eliminate the

registration exemption, the disclosure provided by such non-

governmental conduit borrowers should be substantially the same as if

such conduit borrower were subject to the information requirements of

the federal securities laws applicable to the particular conduit

borrower. For example, financial statements prepared in accordance with

generally accepted accounting principles prescribed by the Financial

Accounting Standards Board should be provided.

IV. Disclosure in the Secondary Market for Municipal Securities

While significant progress has been made in primary market

disclosure practices in recent years, the same development has not

taken place with respect to secondary market disclosure. The GFOA

issued separate secondary market disclosure guidelines in 1979, but

they have not yet achieved the broad acceptance accorded its primary

offering guidance. In the last five years, the NFMA, the National

Council of State Housing Agencies, and the Association of Local Housing

Authorities have published sector specific guidelines for secondary

market disclosure; the National Advisory Council of the National

Association of State Auditors, Comptrollers and Treasurers (``NASACT'')

is in the process of preparing such guidelines for adoption by the

states.84 The GFOA's longstanding Certificate of Achievement

program recognizes issuers that have prepared comprehensive annual

financial reports meeting its guidelines. The NFMA's Award of

Recognition Program likewise recognizes issuers that have committed to

provide continuous disclosure.

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\8\4See Association of Local Housing Finance Agencies,

Guidelines for Information Disclosure to the Secondary Market (1992)

(``Local Housing Guidelines''); National Council of State Housing

Agencies, Quarterly Reporting Format for State Housing Finance

Agency Single Family Housing Bonds (1989) and Multi-family

Disclosure Format (1991) collectively (``State Housing

Guidelines''); NFMA Handbook. See also Healthcare Financial

Management Association, Statement of Principles of Public Disclosure

of Financial and Operating Information by Healthcare Providers

(Exposure Draft dated Aug. 1, 1993) (``Healthcare Disclosure

Principles'').

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A. Application of Antifraud Provisions

Participants in the municipal securities market do not dispute the

need for ongoing disclosure following an offering of securities, but

municipal issuers reportedly resist developing a routine of ongoing

disclosure to the investing market because of concerns about the costs

of generating and disseminating that information and about potential

liability relating to such disclosure. These issuers and obligors are

at times advised by their professional advisors that there is no duty

under the federal securities laws to make disclosure following the

completion of the distribution.85 At least some municipal issuers

thus appear to believe that silence shields them from liability for

what may later be found to be false or misleading information. As a

practical matter, however, municipal issuers do not have the option of

remaining silent. Given the wide range of information routinely

released to the public, formally and informally, by these issuers in

their day-to-day operations, the stream of information on which the

market relies does not cease with the close of a municipal offering. In

light of the public nature of these issuers and their accountability

and governmental functions, a variety of information about issuers of

municipal securities is collected by state and local governmental

bodies, and routinely made publicly available.86 Municipal

officials also make frequent public statements and issue press releases

concerning the entity's fiscal affairs.

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\8\5See Stamas, ``Issuers' Intentions on Secondary Market

Disclosure Are Starting to Appear in Official Statements,'' The Bond

Buyer (Dec. 14, 1992) at 1; Stamas, ``Why the Issue of Secondary-

Market Disclosure Remains on the Back Burner: It Can Be Risky,'' The

Bond Buyer (Sept. 20, 1991) at 1; Stamas, ``Analysts Warn Issuers

About Some Lawyers' Disclosure Advice,'' The Bond Buyer (Jan. 15,

1991) at 1.

\8\6See NASACT Blue Ribbon Committee Report at 2, 24; NASACT

1990 Task Force Report at 21.

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A municipal issuer may not be subject to the mandated continuous

reporting requirements of the Exchange Act, but when it releases

information to the public that is reasonably expected to reach

investors and the trading markets, those disclosures are subject to the

antifraud provisions.87 The fact that they are not published for

purposes of informing the securities markets does not alter the mandate

that they not violate antifraud proscriptions.88 Those statements

are a principal source of significant, current information about the

issuer of the security, and thus reasonably can be expected to reach

investors and the trading market. As the U.S. Court of Appeals for the

Second Circuit has said: ``The securities markets are highly sensitive

to press releases and to information contained in all sorts of publicly

released . . . documents, and the investor is foolish who would ignore

such releases.''89 Since investors obtain information concerning

the fiscal health of a municipal issuer from its public statements

concerning financial and other matters, ``[t]he nature of these

statements and the assumptions upon which they are based must be

carefully and accurately communicated to the public, so that potential

investors may be fully informed of all material facts relevant to their

investment decision.''90

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\8\7See Public Statements by Corporate Representatives,

Securities Act Release No. 6504 (Jan. 20, 1984) 49 FR 2468, 2469; In

re Ames Dept. Stores Inc. Stock Litigation, 991 F.2d 953, 965-67 (2d

Cir. 1993) (with respect to corporate information).

\8\8See Fippinger, The Securities Law of Public Finance (2d ed.

1993) at 291 (``[P]ress releases, conversations with analysts,

information meetings, official comments on budget negotiations, and

even angry reactions by public officials to rating agency

downgrades'' are subject to antifraud provisions).

\8\9Ames, 991 F.2d at 963 (corporate information).

\9\0NY City Report at Ch. III at 2. The report found that public

statements by City officials were misleading, since they were

characterized by unwarranted reassurances as to the soundness and

attractiveness of the City's securities, including statements that

the City's budget problems, no matter how serious, had nothing to do

with the City's ability to pay its debts. Id. at 110-111.

Municipal issuers should also be sensitive to whether their

official statements contain forward-looking statements, such as

projections of revenues, that remain alive in the market and may

require updating in light of subsequent events. Guides for

Disclosure of Projections of Future Economic Performance, Exchange

Act Rel. No. 5992 (Nov. 7, 1978), 43 FR 53246. To the extent that

the official statement in many cases remains the principal (or

perhaps even the sole) source of information concerning an

outstanding security, the potential for an obligation to update is

of particular importance.

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The current process by which municipal issuers and their officials

release information to market participants does not address the risk of

misleading investors, because there is no mechanism for disseminating

information about the municipal issuer to the market as a whole. To the

contrary, in the municipal market, information released publicly

frequently is disseminated only to a narrow segment of the marketplace.

For example, market participants who request current information from

indenture trustees are often turned away on the grounds that they are

not current holders of the securities.91 As a result, investors

purchasing municipal securities in the secondary market risk doing so

on the basis of incomplete and outdated information.

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\9\1Under notice provisions of indentures, the issuer and

trustee generally are required to provide notice to existing

bondholders of events of default and other significant matters, such

as a draw on reserves, a failure to renew a letter of credit, or a

substitution of collateral. ABA 1991 Guidelines at 10. Indeed,

trustees often deny requests by market participants for information

out of concern for liability arising from exceeding the authority

set forth in the indenture. Fippinger at 325. This situation led the

American Bankers Association Corporate Trust Committee, in

cooperation with the National Association of Bond Lawyers, to

develop agreed upon guidelines for indenture provisions permitting

the trustee to provide public notice of specified events. See ABA

1991 Guidelines.

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Since access by market participants to current and reliable

information is uneven and inefficient, municipal issuers presently face

a risk of misleading investors through public statements that may not

be intended to be the basis of investment decisions, but nevertheless

may reasonably be expected to reach the securities markets. As market

participants have urged,92 in order to minimize the risk of

misleading investors, municipal issuers should establish practices and

procedures to identify and timely disclose, in a manner designed to

inform the trading market, material information reflecting on the

creditworthiness of the issuer and obligor and the terms of the

security.93

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\9\2See GFOA Guidelines at 91-97; Joint Statement.

\9\3National Association of Bond Lawyers and Section of Urban,

State and Local Government Law, American Bar Association, Disclosure

Roles of Counsel in State and Local Government Securities Offerings

at 135 (forthcoming 1994) (Pre-publication Draft) (``ABA Disclosure

Roles'') (noting that many municipal issuers have concluded that

post-issuance disclosure in accordance with GFOA guidelines can be

more efficient and expose them to less potential liability than ad

hoc disclosures).

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B. Secondary Market Disclosure

There is general recognition of the need for disseminating

comprehensive information on an annual basis and, on a more timely

basis, information about material events that reflect on the credit

quality of the security.94

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\9\4See GFOA Testimony; Mires, ``An Investor's Framework for

Examining Disclosure Issues and Possible Solutions,'' The Bond Buyer

(Feb. 7, 1994) at 24; NASACT Blue Ribbon Committee Report at 7. See

also PSA Testimony at 6, supporting annual financial statement

filing requirements and submission of information regarding any

material fact for issuers who borrow $1 million or more annually.

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1. Annual Information

Investors need updated comprehensive information sufficient to

enable them to evaluate the financial condition, results of operations

and cash flows of the issuer or underlying borrower. Although the

issuance of comprehensive annual information has not yet become

prevailing practice, it is recommended by industry disclosure

guidelines, including those published by the GFOA in connection with

its Comprehensive Annual Financial Reports (``CAFRs'') award program,

NFMA, and the other industry specific guidelines,95 and is an

effective means of providing the market updated information about the

issuer and the issue. The GFOA Guidelines for Continuing Disclosure

call for, either in an official statement or comprehensive annual

report, a description of:

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\9\5See ABA Disclosure Roles at 134-136; ABA 1991 Guidelines;

Association of Local Housing Guidelines; Healthcare Disclosure

Principles. The Disclosure Task Force of the National Council of

State Housing Agencies is developing standards for the issuance of

audited financial and annual reports.

The issuer and its structure, management, assets and

operations;

The issuer's debt structure (including changes in

indebtedness);

The issuer's finances (including financial condition and

results of operations and financial practices of the issuer or the

enterprise);

Legal matters affecting the issuer; including litigation

and legislation;

Ratings; and

Interests of certain persons.

The GFOA Guidelines also specify additional information to be

provided by conduit borrowers. The eligibility criteria for a

Certificate of Achievement from GFOA include audited financial

statements prepared in accordance with GAAP, reported upon by an

independent public auditor. The guidelines for CAFRs include both a

financial section and a statistical section.96

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\9\6See GFOA Certificate of Achievement for Excellence in

Financial Reporting Program; GFOA Guidelines at 64.

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For frequent issuers, current information can be disseminated in

official statements for new offerings, and thus is readily available

without the preparation of a separate annual financial report.

Regardless of the form of document relied upon to provide the

marketplace with information concerning the financial condition of the

issuer or obligor, to minimize risk of misleading investors, issuers or

obligors should provide, as discussed above with respect to primary

offerings:

Financial statements that are audited in accordance with

GAAS (or disclosure of the absence of such an audit) and that are

either prepared in accordance with GAAP, or accompanied by a

quantified explanation of material deviations from GAAP or a full

explanation of the accounting principles used;

Other pertinent financial and operating information

(depending on the type of issuer and security sold), as well as the

sources for repayment--of course, a variety of information may be

appropriate for an issuer with a range of outstanding securities

with differing characteristics, from general obligation to revenue

and conduit bonds; and

A narrative discussion that analyzes the issuer's or

obligor's financial condition, and results of operations, as well as

facts likely to have a material impact on the issuer or obligor.

Clarity and conciseness are equally relevant concerns with respect to

ongoing disclosures, as with official statements.

As discussed above with respect to offering statements, as a

general matter, the annual financial information may reasonably be

expected to be made available within six months of the issuer's fiscal

year end.\97\ For some conduit entities, annual information may not be

sufficient and investors may need more frequent periodic financial

information. Under guidelines developed by the National Council of

State Housing Agencies, for example, current information on loan

portfolio status is compiled and disseminated to information

repositories on a quarterly basis.\98\ Similar ongoing disclosure on a

periodic basis appears appropriate for analogous conduit municipal

financings such as structured student loan programs, housing and health

care financings.

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\97\See Section III.C.3.d. above.

\98\State Housing Guidelines.

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2. Event Disclosure

In addition to periodic information, to assure that participants in

the secondary market base their investment decisions on current

information, commentators have called for timely disclosure of events

that materially reflect on the creditworthiness of municipal securities

issuers and obligors and the terms of their securities. There is a

general consensus among participants in the municipal securities market

that investors need information about the following events, among

others, where material:\99\

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\99\In 1990, the American Bankers Association Corporate Trust

Committee drafted a proposal identifying 16 factors that it believed

were important for issuers to disclose to bondholders and the

marketplace. American Bankers Association Corporate Trust Committee,

Proposed Disclosure Guidelines for Corporate Trustees (ABA Draft for

Discussion Purposes) (June 12, 1990) (``ABA 1990 Guidelines''). As

published in final form in September of 1991 (``ABA 1991

Guidelines''), the Guidelines contained a nonexclusive list of five

types of events that could be disclosed by notice to a repository.

Numerous market participants have referenced the ABA draft proposal,

or variations of that proposal, as a starting point for identifying

straightforward, nonjudgmental, categories of events that call for

prompt disclosure. An addendum to the Joint Statement provided four

examples of ``significant information'' that the participants

considered appropriate for disclosure. The nonexclusive examples

were (1) nontechnical defaults, (2) draws from a debt service

reserve fund, (3) failure to make a regularly scheduled payment, and

(4) any draws on any credit enhancement. Joint Statement, Addendum.

The list set forth above is drawn from these proposals.

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a. Principal and interest payment delinquencies

b. Nonpayment-related defaults

c. Unscheduled draws on reserves

d. Unscheduled draws on credit enhancements

e. Substitution of credit or liquidity providers, or their failure to

perform

f. Adverse tax opinions or events affecting the tax-exempt status of

the security

g. Modifications to rights of security holders

h. Bond calls

i. Defeasances

j. Matters affecting collateral

k. Rating changes

3. Dissemination

As discussed above, the municipal market today lacks an effective

mechanism for dissemination of material information to investors and

the marketplace. To be effective in minimizing the issuer's risk under

the antifraud provisions, the annual financial information and event

disclosure should be disseminated in a manner reasonably designed to

inform the holders of the issuer's securities and the market for those

securities.

Trustees can serve as cost effective disseminators of information

to the market due to the capacity and duties of trustees under the

terms of the indentures, which positions them to have knowledge of the

events requiring disclosure, and the ability and authority to

communicate with bondholders.\100\ The Commission encourages the

inclusion of provisions in trust indentures that authorize trustees to

transmit information to the market, particularly in structured

financings where the issuer's obligations generally are delegated to

various participants. Trustees also may provide a service to other

small issuers, by enabling them to notify the market in a timely manner

and at a lower cost.

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\100\See ABA 1991 Guidelines at 3.

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The common denominator for current proposals to improve secondary

market disclosure for municipal securities is the establishment and

designation of one or more information repositories to serve as a

collection and access point for annual and current information.\101\

Such repositories would serve as predetermined sources for information

concerning a particular issuer, allowing participants to verify that

they have the latest available information concerning the issuer before

recommending, purchasing, or bidding for a security. The repositories

would supplement, not substitute for, the existing access bondholders

may have to issuers to obtain current information.\102\

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\101\Consistent with the recent recommendation of the Joint

Statement, the GFOA Guidelines call for lodging secondary market

disclosure with a repository, as did the ABA guidelines published in

1991. GFOA Guidelines, Procedural Statement No. 8; ABA 1991

Guidelines at 3.

\102\The American Bankers Association Corporate Trust Committee

and the National Association of Bond Lawyers, as well as the Joint

Statement, have expressed concern that securities depositories and

their participants do not retransmit notices they receive from

trustees and issuers to the beneficial owners of the issuer's

securities. The ABA Corporate Trust Committee sought to address the

problem by calling for simultaneous dissemination of the information

to the marketplace through an information repository. The National

Association of Bond Lawyers has suggested that the Commission

promulgate a rule mandating that all depositories and their direct

and indirect participants promptly retransmit notices received from

the issuer or indenture trustee. While the establishment of

information repositories may address the problem to some extent, the

Commission staff intends to work with the relevant organizations to

assure that steps are taken to provide for consistent retransmission

of the information.

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In the Companion Release, the Commission is proposing an amendment

to Rule 15c2-12 to prohibit, as suggested by the Joint Statement,

underwriting of a municipal securities issue unless the issuer of the

municipal security has covenanted to provide annual and ongoing

disclosure to a repository.

V. Interpretive Guidance With Respect to Obligations of Municipal

Securities Dealers

In the Proposing and Adopting Releases for Rule 15c2-12, the

Commission set forth its interpretation of the obligation of municipal

underwriters under the antifraud provisions of the federal securities

laws. The interpretation discussed the duty of underwriters to the

investing public to have a reasonable basis for recommending any

municipal securities, and their responsibility, in fulfilling that

obligation, to review in a professional manner the accuracy of

statements made in connection with the offering. The interpretation was

set out in the Proposing Release, and modified slightly in the Adopting

Release. The Commission reaffirms its Interpretation with respect to

underwriters' responsibilities under the antifraud provisions of the

federal securities laws.\103\

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\103\In light of the underwriter's obligation, as discussed in

the prior releases, to review the official statement and to have a

reasonable basis for its belief in the accuracy and completeness of

the official statement's key representations, disclaimers by

underwriters of responsibility for the information provided by the

issuer or other parties, without further clarification regarding the

underwriter's belief as to accuracy, and the basis therefor, are

misleading and should not be included in official statements.

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Furthermore, the Commission believes that it is also appropriate to

emphasize the responsibilities of brokers and dealers in trading

municipal securities in the secondary market. The Commission

historically has taken the position that a broker-dealer recommending

securities to investors implies by its recommendation that it has an

adequate basis for the recommendation.\104\ A dealer, unlike an

underwriter, ordinarily is not obligated to contact the issuer to

verify information. A dealer must, however, have a reasonable basis for

its recommendation.\105\ If, based on publicly available information, a

dealer discovers any factors that indicate the disclosure is inaccurate

or incomplete, or signal the need for further inquiry, a municipal

securities dealer may need to obtain additional information, or seek to

verify existing information.\106\

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\104\See Donald T. Sheldon, Securities Exchange Act Release No.

31475 (Nov. 18, 1992); Elizabeth Bamberg, Securities Exchange Act

Release No. 27672 (Feb. 5, 1990); Feeney v. SEC, 564 F.2d 260 (8th

Cir. 1977); Nassar & Co., Securities Exchange Act Release No. 15347

(Nov. 22, 1978). See also Proposing Release, 53 FR at 37787, n.72-

73.

\105\Richard J. Buck & Co., 43 SEC 998 (1968), aff'd sub nom.

Hanley v. SEC, 416 F.2d 589 (2d Cir. 1969). See also The Obligations

of Underwriters, Brokers and Dealers in Distributing and Trading

Securities, Particularly of New High Risk Ventures, Securities Act

Release No. 5275 (Aug. 9, 1972) 37 FR 16011, 16012-13; In Re

Blumenfeld. Securities Exchange Act Release No. 16437 (Dec. 19,

1979) (broker-dealer charged unfair mark-ups and recommended

transactions in municipal securities without a reasonable basis);

J.A. Winston & Co., Inc., 42 S.E.C. 62 (1964) (broker-dealer

recommended transactions without a reasonable basis, and made

representations that were false and misleading).

\106\See Merrill, Lynch, Pierce, Fenner & Smith, Securities

Exchange Act Release No. 14149 (Nov. 9, 1977) (``A recommendation by

a broker-dealer is perceived by a customer as (and in fact it should

be) the product of an objective analysis [which] can only be

achieved when the scope of an investigation is extended beyond the

company's management); John R. Brick, Securities Exchange Act

Release No. 11763 (Oct. 24, 1975) (``the professional...is not an

issuer. But he is under a duty to investigate and see that his

recommendations have a reasonable basis''); M.G. Davis & Co., 44 SEC

153, 157-58 (1970) (broker-dealer registration revoked because

``representations and predictions'' made and market letter relied on

by registrant ``were without reasonable basis,'' and ``registrant

could not reasonably accept all of the statements in the [market

letter] without further investigation''), aff'd sub nom. Levine v.

SEC, 436 F.2d 88 (2d Cir. 1971). See also Merrill, Lynch, Pierce,

Fenner & Smith, Securities Exchange Act Release No. 14149 (Nov. 9,

1977) (noting that if a broker-dealer lacks sufficient information

to make a recommendation, the lack of information is material and

should be disclosed).

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One of the rules proposed simultaneously with the issuance of this

release would require a broker, dealer or municipal securities dealer

to review current information provided by the issuer prior to

recommending a transaction in a municipal security. In the absence of

such current information, the dealer could not recommend a transaction

in the issuer's securities. That rule, which would be applicable to

municipal securities issued subsequent to the effective date of the

proposed rule, would reinforce the obligations of dealers under the

antifraud provisions of the federal securities laws to have a

reasonable basis for recommendations of outstanding municipal

securities.

The Joint Statement also called for a strengthening of the

suitability rules to require disclosure of ratings and whether the

issuer has committed to provide annual financial reports. Today, the

Commission is proposing amendments to its confirmation rules to require

disclosure of the absence of a rating in confirmations. The MSRB has

indicated it has under consideration a plan requiring municipal

securities dealers to disclose to their customers the importance of

secondary market information and whether the issuer has agreed to

voluntarily provide such disclosures.107 The Commission will defer

to the MSRB's reexamination of its suitability rules in implementing

those aspects of the Joint Statement.

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\1\07See supra n. 62.

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VI. Request for Comments

The Commission intends to continue to monitor developments in

municipal securities disclosure practices. Comment is requested

regarding the disclosure items discussed in this release, and in

particular, items warranting event disclosure. Comment also is

requested regarding additional action that should be taken with respect

to disclosure in the municipal securities market by the Commission, the

MSRB, or Congress.

List of Subjects in 17 CFR Parts 211, 231 and 241

Securities.

Amendment of the Code of Federal Regulations

For the reasons set out in the preamble, title 17 chapter II of the

Code of Federal Regulations is amended as set forth below:

PART 211--INTERPRETATIONS RELATING TO FINANCIAL REPORTING MATTERS

1. Part 211, Subpart A, is amended by adding Release No. FR-42 and

the release date of March 9, 1994, to the list of interpretive

releases.

PART 231--INTERPRETATIVE RELEASES RELATING TO THE SECURITIES ACT OF

1933 AND GENERAL RULES AND REGULATIONS THEREUNDER

2. Part 231 is amended by adding Release No. 33-7049 and the

release date of March 9, 1994, to the list of interpretive releases.

PART 241--INTERPRETATIVE RELEASES RELATING TO THE SECURITIES

EXCHANGE ACT OF 1934 AND GENERAL RULES AND REGULATIONS THEREUNDER

3. Part 241 is amended by adding Release No. 34-33741 and the

release date of March 9, 1994, to the list of interpretive releases.

By the Commission.

Dated: March 9, 1994.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 94-5922 Filed 3-16-94; 8:45 am]

BILLING CODE 8010-01-P