On May 26, 2010, the SEC approved amendments to its Rule 15c2-12. The amendments will become effective on December 1, 2010 for bonds that are issued, or for existing variable rate demand bonds that are converted from an “exempted mode” to a mode not so exempted, on and after that date. The amendments are limited to the continuing disclosure requirements of Rule 15c2-12, and were adopted in essentially the form proposed by the SEC on July 17, 2009.
The amendments will not require that existing continuing disclosure agreements be amended. The amendments apply to bonds issued on and after December 1, 2010, and thus new continuing disclosure agreements that become effective on that date. To the extent that an issuer or borrower (referred to in Rule 15c2-12 as an obligated person) has in place a “voluntary” continuing disclosure agreement with respect to variable rate demand bonds currently exempted from Rule 15c2-12, those agreements will most likely need to be amended if a conversion of those bonds occurs on or after December 1, 2010 to a “non-exempt” mode.
This is the first significant overhaul of Rule 15c2-12 since the base Rule, adopted in 1989, was amended in 1994 to include continuing disclosure requirements. These amendments will have significant implications for municipal securities issuers and borrowers of the proceeds of municipal bonds. The effects of these amendments are outlined below.
Rule 15c2-12 provides the basic framework for secondary market disclosure by issuers and borrowers in the municipal bond market. The SEC lacks statutory jurisdiction over municipal securities issuers, other than limited, but significant, jurisdiction and oversight that derives from anti-fraud laws, including the SEC’s Rule 10b-5. As a consequence, the SEC’s approach to regulating secondary market disclosure by municipal securities issuers and the borrowers of the proceeds of municipal bonds is to impose mandates on broker-dealers, in their various roles as underwriters, placement agents, and remarketing agents, to conduct their business and discharge their general securities law obligations in a manner consistent with Rule 15c2-12.
Rule 15c2-12 has two basic requirements. First, it obligates underwriters to obtain and review offering documents for municipal bonds (if available) and file them with the Municipal Securities Rulemaking Board (MSRB).1 Second, it obligates underwriters and remarketing agents to ensure that issuers and borrowers have in place contractual obligations for the benefit of bondholders to prepare and file annual reports and financial information, and notices of the occurrence of certain described events (referred to as “listed events”) with the MSRB, through its Electronic Municipal Market Access (EMMA) System. A few categories of issuers and types of bonds are currently exempted from the application of Rule 15c2-12.
The Amendments to Rule 15c2-12
The amendments affect the obligation to disclose the occurrence of the “listed events”and, subject to a narrow grandfathering provision, remove an exemption from continuing disclosure that currently exists for variable rate demand obligations.
Timing of Listed Event Notices
Currently, notice of the occurrence of a listed event must be filed “in a timely manner.” The amendments will require that the notice be filed within 10 business days of the occurrence of the event.
Existing Listed Events: Materiality No Longer Relevant
Rule 15c2-12 currently requires that notice be given of the occurrence of any of the listed events, provided that notice be made only if the event is “material.”2 Rule 15c2-12 removes the materiality determination for the following events:
Modification of Existing Listed Event: Tax Matters
Currently, notice of an adverse tax opinion or occurrence of an event affecting the tax-exempt status of the bonds must be given in a timely matter. The amendment would expand the sort of event that would trigger a notice to include “adverse tax opinions, the issuance by the Internal Revenue Service of proposed or final determinations of taxability, Notices of Proposed Issue (IRS Form 5701-TEB), or other material notices or determinations with respect to the tax status of the bonds, or other events affecting the tax status of the security.” Materiality determinations continue to be permitted for certain tax events such as the inception or progress of an IRS audit.
Existing Listed Events: Materiality Determination Permitted
Notice is currently required of the occurrence of the following events, if material. The materiality parameter remains in place.
New Listed Events: Materiality Not Relevant
Rule 15c2-12 adds four events, disclosure of two of which would be required regardless of materiality:
New Listed Events: Materiality Determination Permitted
Two new events will require a notice be filed, if the event is considered material:
No Exemption for Variable Rate Demand Bonds (VRDBs)
Currently, bonds with authorized denominations of $100,000 or more that may be tendered at the option of the holder at least as frequently as every nine months are exempted from Rule 15c2-12. The amendments to Rule 15c2-12 eliminate the exemption from the continued disclosure requirements of Rule 15c2-12 for bonds issued or, in some cases, converted and remarketed, after December 1, 2010, as more fully described below.
The changes made by the amendment of Rule 15c2-12 have practical consequences, including the following.
The amendments would apply to bonds issued after December 1, 2010. However, conversions of existing bonds that are currently exempt from Rule 15c2-12 (such as VRDBs) will cause those existing bonds to become subject to the continuing disclosure requirements of the amended Rule if the conversion constitutes a “primary offering,” as currently defined in Rule 15c2-12. This will require the issuer or borrower to enter into a new continuing disclosure agreement or amend an existing continuing disclosure agreement, effective on the date of conversion, to provide notices of the listed events, as and when required by the amendments to Rule 15c2-12. In addition, the loss of the exemption will effectively require that the issuer or borrower update annually any primary offering disclosure document used in conjunction with the conversion.
Additional Notice Covenants
The 10-business day time frame to provide notice commences on the day the listed event occurs, not the day on which the issuer or borrower received notice or became aware of the occurrence of the event. Issuers and borrowers do not necessarily control the flow of information necessary to support the obligation to provide notice of all listed events within the 10-business day time frame. Examples include the failure of a liquidity facility provider to perform if the borrower has assigned to the tender agent or the trustee the right to draw on that facility directly to fund tenders, the change in the identity or name of the trustee, or rating changes, particularly if those rating changes are predicated on a downgrade of the ratings of the credit or liquidity facility provider, rather than on the issuer’s or borrower’s own rating. Issuers and borrowers will need to consider adding notice covenants to their bond documents to provide for formal notice to the issuer or borrower immediately following the occurrence of an event that triggers the disclosure obligation, and will need to work carefully with their investment bankers or financial advisors to stay informed about rating changes. Other approaches include subscribing to rating agency services or contracting with such rating agencies (in the initial request for rating) for such notices.
In certain industries such as not-for-profit health care, expansion, contraction, mergers, consolidations, acquisitions, and asset sales are expected to continue. For the health care industry, these trends can be expected to intensify as the recently enacted health care reform act takes hold. Issuers and borrowers will be required to provide continuing disclosure notice of a definitive agreement to engage in these transactions, if material. As a result, borrowers and issuers should develop a thoughtful and comprehensive understanding of the concepts of materiality.
Interpretive Guidance: An Underwriter’s Duty to Form Reasonable Basis
In announcing the amendments to Rule 15c2-12 , the SEC also published its “Interpretive Guidance” addressed to underwriters. In that Guidance, the SEC reminded underwriters that they have an obligation to form a “reasonable basis” for recommending an investment, and toward that end,are obligated to review the issuer’s or borrower’s disclosure document, among other facts and circumstances. The disclosure document is required to disclose instances within the preceding five years in which the issuer or borrower failed to satisfy its continuing disclosure obligation. In addition, the underwriter is obligated to assure itself that the issuer or borrower is obligated to provide the continuing disclosure required by Rule 15c2-12 . In the Guidance, the SEC noted:
… it is doubtful that an underwriter could form a reasonable basis for relying on the accuracy or completeness of the issuer’s or obligated person’s ongoing disclosure representations, if such issuer or obligated person has a history of persistent and material breaches or has not remedied such past failures by the time the offering commences.
The SEC also noted that mitigating factors can be taken into consideration, including the existence and adherence by the issuer or borrower to its policies and procedures to ensure compliance with its continuing disclosure obligations. Issuers and borrowers should thus consider adoption and implementation of such internal procedures.
The Amendments Considered in the Context of Additional Disclosure Events
The timing of the amendments is notable. The consideration of the proposed amendments and the adoption of the final amendments occurred substantially during the same period when the SEC and MSRB have pending other regulatory actions that are intended to enhance the quality of disclosure, and legislators and regulatory agency leaders are increasingly critical of the lack of jurisdiction over disclosure by municipal securities issuers.
The announcement of the amendments also follows closely in time the recent implementation by the MSRB of its EMMA system. Public comments by organizations such as the National Federation of Municipal Analysts, the Investment Company Institute, the Government Finance Officers Association, the Securities Industry and Financial Markets Association, the Regional Bond Dealers Association,and the National Association of Bond Lawyers are increasing their focus on and, in some cases, criticisms of, the quality of existing disclosure requirements and practices. Some of these organizations as well as numerous politicians have been focusing on the validity and utility of continuing the exemptions from registration of municipal securities and their issuers. Moreover, SEC Commissioner Mary Schapiro has recommended legislative action toward removing or modifying the exemption.3
In addition, the SEC recently announced changes in its enforcement division, which changes include the creation of a national enforcement unit specializing in municipal bonds and public pensions.4
All of these developments should be considered in the context of the recent global financial crisis affecting the financial institutions and the economic recession, both of which have predictably resulted in the current political environment. This environment has led to intensified discussion surrounding the transparency and adequacy of disclosure in the municipal market place, which may lead to more substantial regulatory and statutory protection for investors and consumers beyond the changes to Rule 15c2-12 described in this alert.
While the amendments to Rule 15c2-12clarify and increase disclosure obligations, the likely demand of investors for more frequent and improved quantity and quality of disclosure, together with the increasing level of public debate on the subject, will impose more pressure upon issuers and borrowers to enhance their current secondary and primary market disclosure practices.
Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and colleagues. If you have any questions about this alert or would like to discuss this topic further, please contact your Foley attorney or any of the following individuals:
David Y. Bannard
|Chauncey W. Lever, Jr. |
Jeffrey C. Thrope
New York, New York
Robert J. Zimmerman