On March 1, 2017, the Securities and Exchange Commission (SEC) issued Release No. 34-80130 (the Release) proposing several amendments to its Rule 15c2-12 (the Rule) that would add two new events to the list of events that must be included in the continuing disclosure undertakings of municipal issuers or obligors (Borrowers) of municipal bonds. These 2 new events are:
The SEC has yet to respond to the comments received on the proposed changes to the Rule and has a variety of alternatives from taking no action on the rule change, implementing the rule as proposed, or adopting the rule with various modifications. Given the increasing call for greater transparency in the municipal securities industry, but without firm guidance on the “materiality question” discussed below, the best action during this waiting period is simply to prepare for change. Following are some strategies for participants in the municipal market to address the challenges posed by the proposed amendments.
Scope of “financial obligations” that must be disclosed. The clear focus of the Release and the proposed amendments to the Rule is provision of continuing disclosure relating to direct placements of debt obligations, but the scope of the proposed financial obligations that would have to be disclosed is significantly broader than that. The term “financial obligation” is defined in the Release to include a “(i) debt obligation, (ii) lease, (iii) guarantee, (iv) derivative instrument, or (v) monetary obligation resulting from a judicial, administrative, or arbitration proceeding.” These terms are interpreted broadly in the Release.
For example, the Release provides that the term “lease” is intended to include an operating lease or a capital lease, while a “guarantee” is intended to capture a contingent financial obligation of the issuer or obligor to secure the obligations of a third party or of the issuer or obligor itself. Thus, an extremely wide range of obligations, if material, would need to be disclosed on the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access (EMMA) website by Borrowers if the amendments are adopted, as proposed.
Impact of “materiality” qualifier. A second area of concern is the use of materiality to qualify those events that must be disclosed. This qualification ideally would limit the amount of disclosure that must be provided only to events where there is a substantial likelihood that a reasonable investor would consider such information important in making an investment decision, based on the Basic v. Levinson standard of materiality. However, as was evidenced by the SEC’s recent Municipal Securities Disclosure Cooperation (MCDC) initiative, there is a lack of clear guidance regarding what is material to an investor in the municipal market, leading to a conservative view of materiality and what one market participant has termed “hyper disclosure.”
Determining which events are “material” to a reasonable investor could be difficult and, if the SEC does not later concur with the Borrower’s analysis, the consequences can be severe. Use of the materiality standard (without further guidance) to qualify the events that must be disclosed gives rise to the concern that Borrowers will be required to provide detailed summaries of their direct placements, leases, swaps, for example, or to post in full redacted copies of the underlying documentation, in order to comply with the amended Rule.
As described above, the amendments to the Rule as they are currently proposed could have a significant impact on the municipal market, especially upon Borrowers, but also on broker-dealers. Below are several actions that Borrowers and broker-dealers may wish to consider undertaking in response to the Release and Rule.
The SEC’s proposed amendments to the Rule are substantial and could have wide-ranging implications for Borrowers’ disclosure practices. We recommend that Borrowers examine their current disclosure practices and procedures to ensure that they are ready and able to comply with the Rule if and when it is amended. Additional information on the Release and the Rule, is available in the March 2017 client alert and the May 2017 webinar recording. Or contact Heidi Jeffery or David Bannard directly.
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