BOND DISCLOSURE: What you dont do can hurt you
(from Maine Townsman, July 1998)
By Rick Ashburn and Bob Fernald, MBIA Municipal Investors Service Corporation
The watchdogs of Wall Street are taking a closer look at how the public sector discloses information on municipal financings. For public finance officials responsible for issuing municipal bonds, what you dont do CAN hurt you.
Public agencies that fail to provide materially accurate and complete financial disclosure information on municipal bond issues could face civil charges of securities fraud from the Securities and Exchange Commission. In addition, bondholders can file civil action against public entities for recovery of damages incurred due to a misleading disclosure report.
In recent years, the Securities and Exchange Commission has enacted regulations designed to protect municipal bond investors from fraudulent practices by underwriters and municipal issuers. Although the SEC is prohibited from regulating municipalities directly, it does require bond underwriters to contract with issuers to ensure that the issuer provides disclosure reports. This indirectly affects public entities because underwriters cannot buy bonds from an issuer who will not agree to provide annual disclosure. More importantly, the SEC has made it clear to issuers that compliance with the disclosure regulations also requires adherence to the SECs anti-fraud regulations.
There are two important SEC regulations that public finance officials must follow when issuing bonds. SEC Rule 15c2-12 requires that an issuer agree to disclose annually operating and financial information. SEC Rule lOb-5 (the general "antifraud" rule) requires that an issuer, in providing such annual list, (1) be accurate, and (2) not omit any material information. In other words, be accurate in whatever you say and dont leave anything out if it would change the nature of what has been said.
Public finance officials can protect themselves from liability by exercising a reasonable "standard of care" in preparing disclosure reports. This "standard of care" is best demonstrated by following an established process that ensures that nothing material is omitted.
Here are four steps to follow in preparing disclosure reports:
Gather the information by using due diligence standards. In addition to budgetary and financial information, also consider other factors such as local housing and office markets, land values, demographics and employment statistics.
Filter the information through the "materiality" lens of Rule 1 Ob-5. In defining what is material, the Supreme Court has said: "A statement or omission is material if there is a substantial likelihood that a reasonable investor would consider it important in making the decision to purchase or sell the securities." This is often necessary to distinguish between what is material versus what is merely interesting.
Prepare the information for distribution and get a sign-off from all parties. It is important to identify anything that is unusual, alarming or worrisome. Each person in the process should raise their hand when they see a "red flag."
Disseminate the resulting report in a manner designed to reach the municipal bond marketplace. Rule 15c2-12 requires that continuing disclosure documents be filed with the Nationally Recognized Municipal Securities Information Repositories. Many issuers go further by making the reports available to investors over the Internet or through other means.
A proactive approach to disclosure not only limits an issuers exposure to liability under Rule l0b-5, it also enhances the value of the bond issue in the marketplace. Bond investors need information to do their jobs and they prefer to buy bonds from issuers that provide complete disclosure information.
FINANCIAL STATEMENT REQUIRED FOR MUNICIPAL BORROWING (sidebar)
By Richard Flewelling, MMA Senior Staff Attorney
Since October 9, 1991, state law has required municipal treasurers to prepare a signed financial statement to accompany any question submitted to the "electors" for ratification of revenue bonds or general obligation securities. (See 30-A M.R.S.A. § 5404, sub-§ 1-A and § 5772, sub-§ 2-A, respectively.) This requirement does not apply to borrowing in anticipation of taxes, state or federal revenue-sharing or state or federal aid. However, lenders and others are construing it to apply to any certificate of indebtedness to which is pledged a municipalitys "full faith and credit" (i.e., taxing powers), including mere promissory notes evidencing short-term debt. (See 30-A M.R.S.A. § 2001, sub-§ 6.) In addition, the statutes reference to "electors" apparently contemplates a municipalitys legislative body, whether town meeting or town or city council. (See 30-A M.R.S.A. § 2001, sub-§ 9). Thus any question authorizing municipal borrowing (other than the exceptions noted above) should now be accompanied by this financial statement. (published as Legal Note in Townsman, December 1996).