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Muni Issuers Should Face Disclosure Penalties, MSRB Says

U.S. states and cities should face sanctions for failing to provide updated financial information after they sell bonds, the municipal market’s regulator said, challenging the lax disclosure that has unnerved investors.

The Municipal Securities Rulemaking Board, which writes regulations for the tax-exempt debt industry, made the comments in a letter to Securities and Exchange Commissioner Elisse Walter, who is leading an agency review into how to improve the municipal bond market.

Public borrowers aren’t penalized if they don’t provide annual financial reports and other disclosures on time after issuing debt. The failure by some borrowers to make timely disclosures has long rankled municipal-bond investors.

“There seem to be no significant regulatory repercussions for non-compliance,” the board wrote in the Aug. 8 letter, which was released today. The board said the SEC should take steps “necessary to impose consequences for non-compliance with continuing disclosure undertakings.”

The SEC doesn’t directly regulate disclosures made by municipalities after bonds are sold, as it does with corporations that sell securities to the public. Instead, the agency requires underwriters that sell the securities to be assured by the municipalities that they will provide to investors annual financial statements and other information that could affect the value of the bonds.

Market Enforcement

The SEC has stepped up its enforcement of standards for municipal securities by establishing a unit to police fraud and last year settled a case against New Jersey for masking the state of its pension plans as it raised money from investors.

While the agency has the authority to crack down on fraudulent disclosures, its direct power over public officials remains limited.

The Dodd-Frank regulatory overhaul enacted a year ago provided for a two-year study of municipal-finance disclosure, including whether to scrap the exemption that prevents the SEC from bringing corporate-style information rules to the market. Previous moves to change that law have been resisted by local officials.

The MSRB suggested ways the SEC could penalize municipalities including obliging them to disclose their history of failing to meet the requirements in initial bond offering documents, or craft ways that would allow investors to sue borrowers that breach them.

Any Solution

“Any solution proffered should balance the legitimate needs and real world concerns of issuers and obligated persons with the needs of the investors that require financial information so they can make informed investment decisions,” the MSRB wrote.

Walter has been holding hearings on the $2.9 trillion municipal bond market with the intention of recommending improvements. The SEC also is updating its 1994 guidance covering the disclosure obligations for the municipal industry, a review the MSRB was seeking to influence with its recommendations.

The SEC should require the disclosure of more information about the risks posed by some bonds, including those associated with bank credit agreements that guarantee the securities, the MSRB said. The board also said the commission should scrap an exemption that allows floating-rate securities known as variable-rate demand obligations to be sold without official offering statements.

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