Municipal Securities: Options for Improving Continuing Disclosure
Published: 2012-07-19T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Municipal securities are debt instruments that state and local governments issue to finance diverse public projects. As of March 31, 2012, individual investors held up to 75 percent of the total value of municipal securities outstanding. These securities are exempt from certain federal disclosure requirements applicable to other securities sold publicly. Disclosure provided in the primary market, where these securities are issued, generally consists of official statements. Continuing disclosure is information provided in the secondary market, where these securities are bought and sold after issuance. The Dodd-Frank Wall Street Reform and Consumer Protection Act required GAO to review the information issuers of municipal securities must disclose for the benefit of investors.
This report addresses (1) the extent to which information currently provided on municipal securities is useful for investors and the extent to which existing regulations reflect principles for effective disclosure, and (2) options for improving the information issuers disclose to investors of municipal securities. To conduct this work, GAO reviewed disclosure rules and compared them with principles for effective disclosure cited by SEC and the International Organization of Securities Commissions, surveyed selected experts and market participants, and interviewed issuers.
GAO provided a draft of this report to SEC, MSRB, and the Financial Industry Regulatory Authority (FINRA). SEC and MSRB provided technical comments, which GAO incorporated, as appropriate. FINRA did not provide comments.
section_title: What GAO Found
paragraphs: Market participants indicated that primary market disclosure for municipal securitiesofficial statementsgenerally provides useful information, but investors and market participants cited a number of limitations to continuing disclosures. The most frequently cited limitations were timeliness, frequency, and completeness. For example, investors and other market participants said that issuers do not always provide all the financial information, event notices, or other information they pledged to provide for the lifetime of a security. While GAO's analysis of current regulatory requirements for municipal securities disclosure found that they largely reflected the seven principles of effective disclosure, regulators and market participants said that there are some limitations on the enforceability and efficiency of the regulations. However, the effect of these limitations on individual investors largely is unknown because limited information exists about the extent to which individual investors use disclosures to make investment decisions. Nevertheless, regulators remain concerned about this market, in part due to its size and the participation of individual investors. As discussed below, the Securities and Exchange Commission (SEC) and Municipal Securities Rulemaking Board (MSRB) have been taking or plan to take actions to improve disclosure.
Experts and market participant groups GAO surveyed suggested options for improving disclosure, some of which would require statutory changes while others could be achieved within the existing regulatory framework. One suggested statutory change was the repeal of the Tower Amendment, which some experts believed would allow federal regulators to directly require issuers to make disclosures, but SEC and MSRB staff did not agree. The Tower Amendment prohibits SEC and MSRB from requiring issuers of municipal securities to file certain materials with them. While MSRB and SEC staff said that repealing the Tower Amendment would remove the prohibitions on requiring issuers to file certain materials with them, they noted that it would have no real effect on what they can require issuers to disclose because municipal issuers are exempt from SEC registration and MSRB does not otherwise have affirmative authority to regulate municipal issuers. Other suggestions from experts and market participant groups requiring statutory changes included mandating accounting standards and requiring the submission of financial information at intervals more frequent than annually. Experts and market participant groups suggested other options to improve disclosure that could be achieved within the existing regulatory framework, including further improving and promoting MSRB's Electronic Municipal Market Access (EMMA) system, which since July 2009 has served as the official central repository for disclosures about municipal securities. While experts and market participants said that EMMA had greatly improved their access to information on municipal securities, many suggested that further enhancements to EMMA would increase the usefulness of the system to investors and issuers. MSRB issued a plan in January 2012 to improve EMMA and recently has taken steps to enhance EMMA's functionality. Further, SEC staff indicated their plan to release a staff report in 2012 to include recommendations on measures to improve primary and secondary market disclosure practices, market practices, and associated regulation.

section_title: Letter
paragraphs: Municipal securities are debt instruments that state and local  governments issue to finance transportation, housing, hospitals,  education, and other diverse public projects. The value of municipal  securities outstanding was an estimated $3.7 trillion as of March 31,  2012, with individuals (also known as retail investors) holding 50 percent  of the total outstanding directly, such as through purchases from broker- dealers, and up to another 25 percent indirectly through investment  funds. There are approximately 51,000 state and local government  issuers of municipal securities and the number of separate outstanding  municipal securities is estimated to be more than 1.3 million, according to  information cited by the Securities and Exchange Commission (SEC).
State and local governments account for 80 percent of the total  outstanding. Of the remaining 20 percent, corporate conduit borrowers  (public and privately held companies) account for approximately 13  percent and nonprofit conduit borrowers (such as schools, health care  providers, and nonprofit housing developers) account for approximately 7  percent.
Concerns have been raised about whether investors—particularly retail  investors—have access to enough information about municipal securities  to make informed investment decisions. Some professional analysts also  believe investors may be at heightened risk as states, municipalities, and  other entities that issue debt struggle with the aftermath of the recent  financial crisis and growing pension obligations. While the federal  securities laws generally require certain disclosure in connection with the  issuance of securities, Congress exempted municipal securities from the  registration and periodic reporting provisions of the federal securities  laws, but not the antifraud provisions. Furthermore, SEC and the  Municipal Securities Rulemaking Board (MSRB) are not authorized to  require issuers of municipal securities to file certain materials. The  specific prohibitions differ for each regulator, pursuant to provisions of the  Securities Acts Amendments of 1975, generally known as the Tower  Amendment.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd- Frank Act) directs us to conduct a study and review of the disclosure  required to be made by issuers of municipal securities. This report  addresses (1) the extent to which information currently provided on  municipal securities is useful and the extent to which existing regulation  reflects principles for effective disclosure, and (2) options for improving  the information issuers disclose to investors of municipal securities, and  the related benefits and challenges of these options.
To describe the extent to which information is useful for investors and the  extent to which existing regulations reflect principles for effective  disclosure, we reviewed SEC and MSRB rules, SEC and MSRB staff  reports for improving disclosures, and comment letters submitted to SEC  regarding its study of the municipal securities market. We reviewed  disclosure information in the Electronic Municipal Market Access (EMMA)  system, the official central repository for disclosures about municipal  securities. We compared disclosure regulations with principles for  effective disclosure from the International Organization of Securities  Commissions (Principles for Ongoing Disclosure and Material  Development Reporting by Listed Entities) and SEC’s Plain English  Handbook. We reviewed independent and academic studies on the  usefulness of disclosure information, and data on municipal securities  defaults from independent research firms and rating agencies to  understand the risks to investors of municipal securities. We worked  through the American Association of Individual Investors to identify and  interview 12 retail investors with diverse investment experience with  municipal securities. For more perspectives of individual investors, we  reviewed transcripts of SEC hearings on the state of the municipal  securities market held in 2010 and 2011 and reviewed a study conducted  for SEC on the usefulness of SEC-mandated disclosure documents. We  also conducted a case study of 14 issuances and made observations  about EMMA and the usefulness of the disclosures from the individual  investors’ points of view. We also interviewed institutional investors  (including representatives of eight investment companies), professional  analysts, an independent research firm, and groups representing market  participants, including broker-dealers, bond lawyers, and municipal  advisors. We interviewed staff of federal and state regulators, self- regulatory organizations (SRO), and associations, including SEC, MSRB,  the Financial Industry Regulatory Authority (FINRA), and the North  American Securities Administrators Association.
To identify options for improving the information issuers disclose to  investors, we reviewed securities laws, regulations, and guidance. We  also reviewed SEC and FINRA examination manuals for SEC Rule 15c2- 12, which establishes requirements for the underwriters of municipal  securities, and reviewed data on examinations that found violations of the  rule. issuers and other market participants, such as municipal advisors, broker- dealers, and professional analysts. We used a nonprobability sampling  method to identify and select experts by obtaining referrals from other  market participants, experts, and regulators. Although our results are not  generalizable, our survey covered a diverse group of experts and market  participant groups with broad and differing perspectives. We administered  the survey to 26 experts and 29 market participant groups and received  responses from 21 experts and 21 groups. To identify the benefits and  challenges of these options, we interviewed issuers in three groups  representing (1) large and frequent issuers, (2) small and infrequent  issuers, and (3) conduit issuers. To provide information about options for  improving disclosure information and related benefits and challenges, we  also drew on the interviews we conducted with investors, regulators, and  market participants.
Furthermore, we surveyed experts and groups representing  We conducted this performance audit from June 2011 to July 2012 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives. Appendix I provides a more  detailed description of our scope and methodology.
For the text of SEC Rule 15c2-12, see 17 C.F.R. § 240.15c2-12.
subsections: section_title: Background
paragraphs: SEC and MSRB are the primary entities that have authority at the federal  level with respect to disclosure to investors in municipal securities. In the  context of municipal securities, SEC interprets and enforces the federal  securities laws, including by adopting rules and enforcing antifraud  provisions; maintaining regimes for the registration, compliance,  inspection, and education of broker-dealers, investment advisers, and  municipal advisors; and providing general educational materials for  investors about investing in municipal securities. SEC also oversees  MSRB and FINRA. MSRB maintains an online repository of information  (that is, EMMA) to promote market transparency, for example, by  providing access to primary market and continuing disclosures and  information about trade pricing. MSRB also provides educational  materials to investors and issuers of municipal securities. MSRB  regulates brokers, dealers, municipal securities dealers, and municipal  advisors in the municipal securities market by adopting rules governing  their conduct, which are subject to SEC approval. However, MSRB does  not have authority to enforce these rules or examine entities for  compliance with these rules. Rather, SEC, FINRA, and bank regulators  enforce MSRB rules and conduct compliance examinations.
The Tower Amendment prohibits SEC and MSRB from directly requiring  state and local governments to submit information to them prior to sale.  Specifically, SEC and MSRB cannot require issuers to file any information  with them prior to any sale, and MSRB also cannot require issuers to  provide them or investors with any information either pre- or postsale.  Furthermore, the Securities Act of 1933 exempts the securities that state  and local governments issue from registration with SEC. Securities of  state and local governments also are exempt from the periodic disclosure  requirements of the Exchange Act of 1934. According to a 1975 Senate  report, congressional reasons for the decision to continue to limit direct  regulation of issuers when the 1975 amendments to the securities acts  were enacted included respect for the rights of state governments to  access the capital markets, concerns about the costs of regulation for  state and local government issuers, and the perceived lack of abuses in  the municipal market that would justify such an incursion on the states’  prerogatives.
While federal regulators are prohibited from directly requiring issuers to  file presale information on municipal securities, SEC has adopted rules— applicable to broker-dealers acting as underwriters—that relate to primary   More specifically, using its authority  market and continuing disclosures. over broker-dealers and its broad authority to prevent fraud in connection  with the offer, purchase, or sale of securities, SEC adopted Rule 15c2-12  in 1989. The rule established disclosure requirements related to municipal  securities in response to the need SEC found for increased  transparency.underwriters of municipal securities to obtain and review issuers’ official  statements (typically prepared by issuers or their advisors) and provide   This rule and accompanying guidance obligates  them to investors.underwriters to reasonably determine that issuers have entered into a  written continuing disclosure agreement for the benefit of municipal  securities holders to provide (1) annual financial information and  operating data of the type included in the official statement and when and  if available, audited financial statements, and (2) notices of certain  material events. Beginning in 2009, issuers have been obligated by the  agreement to provide the continuing disclosure information and data to  EMMA (either directly or by engaging a third-party dissemination agent to  submit such information and data on their behalf). For a comparison of  key federal disclosure requirements for publicly offered municipal and  corporate securities, see appendix II.
EMMA may be accessed at http://emma.msrb.org. insolvency, receivership and similar events.voluntarily submit to EMMA on a continuing basis any other types of  financial, operating, or event-based information, including (but not limited  to) information about bank loans, quarterly or monthly financial  information, consultant reports, and capital or other financing plans.  According to MSRB, users may conduct searches of issuances on EMMA  using one or more of the following parameters: Committee on Uniform  Security Identification Procedures (CUSIP) number, issuer name, issue  description, obligated person name, state, maturity date, date of  issuance, interest rate, and ratings. EMMA provides additional  parameters to search for continuing disclosure documents and other  information available through EMMA, including trade information.
section_title: Investors and Market Participants Cited Limitations of Continuing Disclosures
paragraphs: Many market participants told us that primary market disclosure for  municipal securities investors is generally useful. However, investors and  market participants with whom we spoke frequently cited limitations to  continuing disclosure, including the timeliness of annual financial  information, the frequency with which information is provided, and  incomplete information. Our analysis found that current regulatory  requirements for municipal securities disclosure broadly reflect the seven  principles of effective disclosure that were developed by the International  Organization of Securities Commissions and certain plain English  principles developed by SEC. However, regulators and market  participants indicated that, in practice, limitations exist in the current  regulatory scheme. Further, the effect on individual investors of limitations  to disclosure is largely unknown.
subsections: section_title: Investors and Market Participants Most Commonly Cited Timeliness, Frequency, and Completeness as Disclosure Limitations
paragraphs: Many market participants told us primary market disclosure is generally  useful for investors and EMMA has improved investor and market  participants’ ability to access disclosure documents, but investors and  market participants have identified limitations to disclosure. According to  MSRB officials, participants in the municipal securities market generally  acknowledge that primary market disclosure—official statements— contains the material facts an investor needs to know about an issuer and  a security. Investors and market participants such as groups  representing investment companies, bond lawyers, and broker-dealers  also have indicated that the information provided at the time of issuance  is comprehensive. Additionally, most market participant groups with  whom we spoke said that MSRB’s EMMA website has greatly improved  public access to disclosure compared with the prior system for obtaining  disclosure documents.central repository for disclosure documents has made finding information  easier and more efficient. In addition, one market participant noted that  EMMA increased access to information by allowing investors to receive  disclosures for free.
Several market participants said that having a  However, investors and other market participants cited limitations to the  information provided in continuing disclosures. The most frequently cited  limitations to the usefulness of this information were: the timeliness of  annual financial information, the frequency with which issuers and other  obligated persons provided information, and the completeness of the  information provided in accordance with the continuing disclosure  agreement. Individual investors also frequently cited the readability of  disclosures as a limitation.
Timeliness—According to investors and other market participants,  issuers release annual financial information too long after the end of  their fiscal years for the information to be useful in making investment  decisions. A Governmental Accounting Standards Board (GASB)  study of audited annual financial reports prepared in accordance with  generally accepted accounting principles (GAAP) for state and local  governments provided for fiscal years ending in 2006, 2007, and 2008  found that the average time frame for issuing the reports varied by  type and size of government. For example, issuance time frames  averaged from 126 days after the end of the fiscal year for large  special districts to 244 days for small counties. Similarly, according  to National Association of State Comptrollers data, in fiscal year 2010  states took an average of 198 days to complete their comprehensive  annual financial reports. Also, in our case study of disclosures for 14  securities in EMMA that were issued in 2009, our analysis found that  the number of days after the end of the fiscal year in which issuers or  obligated persons provided annual financial information to EMMA  varied. Annual financial information for a nonprofit hospital system  was provided 55 days after the end of a fiscal year, while annual  financial information for a general obligation security issued by a  school district was provided 257 days after the end of a fiscal year.  Several investors and market participants said that filings provided  well after the end of the fiscal year limit the information’s usefulness.  The GASB study found similar sentiments: less than 9 percent of  survey respondents—who represented a range of users of financial  information—considered information received 6 months after the end  of the fiscal year to be very useful. Three market participants further  indicated that untimely information was particularly worrisome for  investors at a time when state and local governments have been  facing credit stress. Moreover, evidence indicates that issuers have  not always met the time frames by which they agreed to provide  annual information. For example, a study by the California Debt and  Investment Advisory Commission of certain securities issued in  California from 2005 to 2009 found 11 percent filed more than 30 days  after the agreed-upon date.
Frequency—Investors and other market participants also said that  receiving financial information annually was not sufficient to monitor  the financial condition of an issuer. An individual investor with whom  we spoke and a professional analyst both noted that because  disclosures generally are provided annually, investors often must  learn important information about the current financial condition of an  issuer from external sources such as newspaper articles. For  instance, the individual investor told us that he may read in the  newspaper that a town that issued securities was having budget  problems; however, this information would not be disclosed to  investors until the financial statements for the fiscal year were  released at some point during the following year. A few market  participants indicated that obtaining information more frequently was  especially important for investors during times of economic stress.  Information that investors and other market participants indicated  would be useful to receive between annual financial statements  included unaudited quarterly financial reports, cash-flow reports, year- to-date budget updates, and tax revenue information. This type of  information is not routinely submitted to EMMA on a voluntary basis.  According to MSRB data, in 2011 EMMA received 8,290 submissions  categorized as quarterly or monthly financial information (which  represents 6 percent of all continuing disclosure documents  submitted) and 358 submissions categorized as interim, additional  financial information, or operating data. Similarly, quarterly or monthly  financial information was available in EMMA for 5 of the 14 securities  in our case study.
Completeness—Investors and other market participants said that  issuers do not always provide all of the financial information, event  notices, or other information they agreed to provide in a continuing  disclosure agreement for the lifetime of a security. For example, three  market participants told us that issuers and obligated persons did not  always file the annual financial information that they agreed to  provide. Our case study of disclosures for 14 securities in EMMA  identified similar issues in a few cases. In particular, our analysis  found that 2 securities—a 2009 general obligation security for a small  issuer and a 2009 conduit offering with a publicly traded corporation  as the obligated person—had no financial or other continuing  disclosures as of May 2012. In addition, a few market participants  indicated that filings of event notices can be delayed significantly or  that event notices may never be filed. For instance, one market  participant said that he had noted cases in which issuers failed to  report unscheduled draws on debt service or adverse tax opinions.  Such lapses in reporting may also go undetected. As one market  participant and a FINRA official noted, an investor or regulator may  not be able to ascertain if a reportable event had occurred unless an  event notice was filed with EMMA. Finally, a few market participants  told us that issuers may provide all of the information they agreed to  provide for the first few years after a security was issued, but  afterwards fail to provide some of the information—for instance, tax  data or operating information.
Readability—Individual investors commonly cited concerns about the  readability of disclosure documents. Four of the 12 individual  investors with whom we spoke said that disclosure documents were  not easy to read or understand. Furthermore, most individual  investors with whom we spoke said that they generally had limited  time to decide whether to buy a security, leaving them little time to  research a security. Several individual investors and market  participants said that disclosures were difficult to understand because  they contained extensive legal or technical terminology and complex  information. In addition, two of the individual investors with whom we  spoke noted that the information for which they looked was “buried” in  the disclosure documents and not easy to find.
To a lesser extent, investors and other market participants identified  additional limitations—including the lack of standardization and limitations  of EMMA—to the usefulness of disclosure. Several market participants  said that the lack of standardization of disclosure across different issuers  impeded their ability to compare issuances. MSRB also stated in a  comment letter to SEC in 2011 that many investors have told MSRB that  the lack of standardization in disclosure is a problem. MSRB indicated  that elements that market participants would like to see standardized  included the use of bond proceeds and some basic information, such as  the manner of reporting the name of the issuer or other obligated person  and information on the source of repayment. Two market participants also  told us standardization of accounting methods and the format of  disclosures would make disclosures more useful. Also, investors and  other market participants described several aspects of EMMA that limited  its usefulness. Several market participants noted that the ability to search  for issuances was limited, especially if users did not have the CUSIP  number for the issuance in which they were interested. Two market  participants noted that continuing disclosures sometimes were  categorized incorrectly by the issuer at submission to EMMA and one  said that issuers may not submit disclosures for all issuances to which  they applied.
section_title: Current Regulations Broadly Reflect Disclosure Principles but Some Limitations Exist
paragraphs: We compared requirements for continuing disclosure in SEC Rule 15c2- 12 and SEC’s antifraud authorities with principles for effective disclosure  that were developed by an international organization of securities  commissions, which included SEC, and certain plain English principles  developed by SEC. These principles include allocation of accountability,  continuing disclosure obligation, disclosure criteria, dissemination of  information, equal treatment of disclosure, timeliness, and use of plain  English in official statements (see app. III for the comparison of the  principles and municipal securities disclosure requirements).  We found  that current regulations broadly reflect the seven principles of effective  disclosure. However, regulators and market participants have indicated  that, in practice, limitations exist in the current regulatory scheme,  including the areas of enforceability, content, and efficiency. In particular,  they noted the following:
Allocation of accountability—Although security holders may enforce  continuing disclosure agreements by bringing suit against the issuer  or obligated person, SEC staff told us that they were not aware of any  public statements about any such lawsuits having occurred. Also, two  market participants noted that market participants other than investors  directly holding a security have no remediation should an issuer or  obligated person not provide disclosure. SEC and MSRB cannot  enforce continuing disclosure agreements. In a comment letter to SEC  in 2011, MSRB stated that because Rule 15c2-12 does not impose  penalties for noncompliance with continuing disclosure agreements,  there is limited accountability for those issuers or obligated persons  that do not provide the information. In addition, various regulatory  incentives that could encourage issuers to comply with their  agreements have limitations, according to regulators and market  participants. For example, regulatory requirements to disclose at  issuance failure to comply with prior continuing disclosure agreements  only may work as an incentive to encourage issuers to make required  disclosures if they anticipate issuing a new security in the future.  Moreover, SEC staff and two market participants indicated that even if  issuers anticipated issuing a future security they might not be  sufficiently incentivized to keep up with their disclosure obligations  between issuances, as some issuers may only go to market with a  new issuance from every 3 to 5 years. There are other reasons why  issuers may not keep up with continuing disclosure responsibilities  between issuances. A few market participants who work with issuers  to help prepare disclosures told us that some issuers face challenges  in complying with their continuing disclosure agreements because of a  lack of awareness or understanding of their disclosure responsibilities,  which members of one market participant group said can be due to  staff turnover and competing priorities in times of budgetary  challenges. Two small issuers with whom we spoke said that they do  not have staff dedicated to issuing and monitoring debt, which  presents a challenge in preparing disclosures.
Continuing disclosure obligation—As a condition of an underwriting,  an underwriter must reasonably determine that issuers or obligated  persons have agreed to provide certain information on a continuing  basis. However, this requirement is placed on the underwriter, not  directly on the issuer of the security. Regulators and market  participants have noted that this requirement on the underwriter is  inefficient for several reasons. For example, representatives of two  market participant groups told us that an underwriter often does not  have an opportunity to influence the content of a continuing disclosure  agreement before an issuance, although it is the underwriter’s  responsibility to ensure the agreement specifies that all required  information will be provided. Also, FINRA staff noted that should an  issuer or obligated person not provide continuing disclosure  information after a security is issued, the underwriter has no means to  compel them to do so. Furthermore, representatives of two market  participant groups and a former regulator have indicated that a  disproportionate amount of the regulatory burden for municipal  disclosure falls on underwriters. In addition, Rule 15c2-12 does not  expressly require underwriters to document how they comply with  requirements to reasonably determine that the issuer or obligated  person agreed to provide continuing disclosures and that they are  likely to comply with their continuing disclosure agreement. SEC staff  said that without this documentation, it may be difficult for an  underwriter to demonstrate that it met its obligations.
Timeliness—Although Rule 15c2-12 requires, as a condition of an  underwriting, that an underwriter must reasonably determine that  issuers or obligated persons have specified a date by which they  agreed to provide the annual financial report, it does not specify what  that date should be. Therefore, issuers and obligated persons may  provide annual financial information months after the close of the  fiscal year.
Use of plain English—Regulations do not require the use of plain  English in municipal securities’ official statements or other disclosure  documents.
SEC recognizes some of these limitations and has taken recent actions to  improve the timeliness and completeness of continuing disclosures.  Specifically, in June 2010, SEC amended Rule 15c2-12 and issued  interpretive guidance to  specify that event notices be submitted to EMMA in a timely manner  not in excess of 10 business days of the occurrence of the underlying  event, rather than merely “in a timely manner” as was previously  required;  remove the general materiality condition for determining whether  notice of an event is to be submitted to EMMA—thereby, requiring  that notification be provided for certain events when they occur  regardless of whether they are determined to be material (including  principal and interest payment delinquencies, and unscheduled draws  on debt service reserves reflecting financial difficulties, among  others), while adding separately a materiality condition to select  events (including nonpayment-related defaults and bond calls);  increase the number of events for which notice must be provided;  remove an exemption from reporting disclosure information for certain  variable-rate securities; and  reaffirm its previous interpretation that underwriters must form a  reasonable belief in the accuracy and completeness of  representations made by issuers or other obligated persons in  disclosures as a basis for recommending the securities, including  making a reasonable determination that the issuer will likely provide  the continuing disclosure information it agreed to provide.
section_title: Effect of Limitations of Disclosure Regulations on Individual Investors Largely Is Unknown
paragraphs: The risk posed to investors by the limitations of disclosure regulations  cited by market participants is largely unknown because (1) there is  limited information about the extent to which investors use disclosures to  make investment decisions, (2) there is limited information about the  extent to which disclosure limitations about which investors were  concerned actually have occurred, and (3) there is a low incidence of  defaults and other characteristics of the municipal market that mitigate  investor risk. Nevertheless, SEC and MSRB have continuing concerns  about disclosure in the municipal market.
There is limited information about the extent to which individual investors  in municipal securities use disclosures to make investment decisions.  Regulators and market participants with whom we spoke did not have  overall information on the extent to which individual investors in municipal  securities rely on disclosures in making their investment decisions.  However, anecdotal evidence suggests that individual investors’ reliance  on disclosures could be limited. For example, 5 of the 12 individual  investors with whom we spoke said that they relied solely on their broker- dealers’ advice when making an investment decision, while the others  said that they conducted their own research into securities. Of the 5  investors who said they relied solely on their broker-dealers’ advice, 2  indicated that they did not rely on disclosures because of the difficulty of  understanding them. Similarly, a 2008 SEC study of investor usage of  disclosure documents for stocks, bonds, and mutual funds found that only  2 percent of investors surveyed cited SEC-mandated disclosure  documents—prospectuses and annual reports—as the most important  source of investment information. Rather, surveyed investors most  frequently cited financial advisors or brokers as the most important source  of investment information. Although the SEC study did not focus on  municipal securities, some of the investors surveyed also may have  invested in these types of securities. More importantly, the study provides  a general indication of investors’ usage of disclosure documents and  other sources of information. Many individual investors with whom we  spoke also said that a security’s credit rating has been a main factor in  making investment decisions. However, several of these investors told us  that they have less faith in credit ratings than they did before the financial  crisis, potentially making disclosure information a more important factor in  their future investment decisions.
There is also limited information on the extent to which events relating to  limitations to disclosure cited by investors—such as issuers and other  obligated persons failing to submit information or submitting information  late—have occurred. MSRB has limited ability to track issuances with  missing or late disclosure for several reasons. For example, MSRB  reported that in 2011 it received 1,879 required notices of failure to  provide annual financial information; however, MSRB staff told us that  they could not reliably determine the universe of issuances in EMMA for  which annual financial information was required. This is because EMMA  did not have the capability to easily or systematically differentiate  between securities that should have disclosure submissions and those  that are exempt from SEC Rule 15c2-12, according to MSRB staff. In  addition, it is difficult for MSRB or others to develop reliable information  about issuer compliance with their continuing disclosure agreements for  the universe of outstanding issuances because the structure of continuing  disclosure obligations can vary by issuance, making compliance with  continuing disclosure agreements difficult to systematically identify and  track. As a result, there is limited information on the extent of the  problems.
The low levels of defaults on municipal securities and other  characteristics of the municipal securities market also make it difficult to  determine the importance of disclosure documents as a means of  investor protection. Long-term default rates associated with rated  municipal securities have been less than 1 percent, which is significantly  lower than long-term default rates for rated corporate debt securities (see  table 1). In addition, municipal bankruptcy filings historically have been  rare compared with bankruptcy filings by businesses. For 1991 through  2009, 177 municipalities filed for bankruptcy. In contrast, more than  49,000 businesses filed for bankruptcy in the 12-month period ending  March 31, 2009.
In addition, state and local government issuers have a strong incentive to  meet their payment obligations because issuances of municipal securities  constitute an important tool to finance critical projects, and defaults may  hinder their ability to issue future securities and may adversely affect  other issuers of municipal securities in the surrounding area. Defaulted  municipal securities also have a relatively high recovery rate for investors  compared to corporate securities, according to two rating agencies—with  one reporting a recovery rate of 67 percent for municipal securities  compared with 40 percent for corporate securities. Some states also  have mechanisms intended to address financial crises, allowing for state  intervention into a local government’s finances. Finally, 30 states have  laws that give holders of general-obligation and certain other securities  issued by municipalities within their states first rights to repayment from  certain revenue streams, even during bankruptcy.
Nevertheless, SEC and MSRB have expressed continuing concerns  about municipal securities disclosure due to individual investors  constituting a significant portion of the market, the size of the market,  default risk, and incomplete disclosure. SEC staff told us that disclosure  by municipal issuers should be improved in general as it relates to the  primary market and continuing disclosure. In rulemakings, SEC staff  have noted concern about the size of the municipal securities market and  that, while defaults of municipal securities are rare, they do occur.  Furthermore, the significant pressure on state and local government  budgets and the diminishment of bond insurance since the recent  financial crisis have increased focus on disclosure issues, according to  SEC and MSRB staff.  MSRB staff noted in 2010 that although the  municipal securities market largely weathered the 2008 financial crisis,  economic conditions and financial liabilities continued to stress municipal  bond issuers. SEC staff also told us that recent SEC enforcement actions  highlight risks posed by pension funding obligations. Furthermore, SEC  and MSRB leadership have publicly voiced concerns about various  aspects of the municipal securities market. Examples of their concerns  include the following:
An SEC Commissioner remarked that investors may have trouble  understanding the risks associated with increasingly complex  structures used by large and small municipalities.
A former SEC Chairman stated that the opacity of the municipal  market was unrivaled and presented a significant threat to the U.S.  economy.
An SEC Commissioner was concerned that investors might not have  access to the information they needed to accurately calculate their  risks when making investment decisions. She stated at an SEC field  hearing on the municipal market in 2010 that municipal market  investors were afforded second-class treatment compared with that  afforded to investors in other securities because they could not count  on receiving accurate and timely financial and other material  information about their investments.
MSRB stated in a comment letter to SEC in 2011 that MSRB received  complaints about some issuers’ disregard for their continuing  disclosure agreements and failure to provide information on time or at  all.
section_title: Options for Improving Disclosure Involve Potential Benefits and Challenges
paragraphs: Experts and market participant groups we surveyed suggested a number  of options for improving municipal securities disclosure. Some of the  options would require statutory changes while others could be achieved  within existing statutory authority. Each of the suggested options involves  trade-offs, and market participants and the regulators’ views on the  efficacy of the options varied. Our discussion of potential benefits  provided to investors and potential costs of implementing these options is  limited to the views of survey and interview participants.
subsections: section_title: Some Options Identified to Improve Disclosure Would Require Statutory Changes
paragraphs: Experts and market participant groups we surveyed suggested some  options to improve disclosure that would require statutory changes. While  many suggested repealing the Tower Amendment, regulators said it  would have no effect on what they could require issuers to disclose. SEC  staff said the Securities Act exempts municipal issuers from SEC  registration requirements. MSRB does not otherwise have affirmative  authority to regulate issuers. They said additional statutory changes  would be needed for regulators to implement other options we identified  for improving disclosure that included prescribing accounting standards,  requiring time frames for annual reporting or more frequent disclosure,  and requiring certain conduit borrowers to comply with corporate  disclosure requirements.
Seven of 21 experts we surveyed suggested that Congress repeal the  Tower Amendment—provisions that prohibit SEC and MSRB from  requiring issuers to file any information with them prior to any sale, and  MSRB from requiring issuers to provide them or investors with any  information pre- or postsale. Some experts believe that repealing these  provisions would allow federal regulators to directly require issuers to  provide continuing disclosures, and thereby address concerns about  incomplete submissions or failures to meet obligations under continuing  disclosure agreements, but SEC and MSRB staff did not agree and said  additional changes would be needed for them to directly regulate issuers.
As noted previously, the Tower Amendment prohibits SEC and MSRB  from requiring state and local governments to file presale information with  them in connection with the issuance, sale, or distribution of municipal  securities. MSRB is further limited by a prohibition against requiring any  issuer to furnish it or any purchaser or prospective purchaser with any  document or report about the issuer, except for documents and  information that generally are available from a source other than the  issuer. Some industry participants believe the Tower Amendment  prohibits any regulation of municipal issuers, while others believe its  scope is narrower and addresses only prefiling requirements. SEC staff  noted that repealing the Tower Amendment would have no real effect on  disclosure because of exemptions under the Securities Act. SEC and  MSRB staff agreed that repealing the Tower Amendment would remove a  prohibition on requiring issuers to file presale information. However, they  said such repeal would have no effect on their ability to establish  disclosure requirements for issuers with respect to primary or continuing  disclosures. SEC staff told us that the Securities Act provision that  broadly exempts municipal securities from SEC’s registration  requirements means that the registration requirements applicable to  corporate issuers do not apply to municipal securities offerings. In  addition, the periodic reporting requirements of the Exchange Act do not  apply to issuers of such municipal securities. MSRB does not otherwise  have affirmative authority to regulate municipal issuers. As a result, SEC  and MSRB staff told us that Congress may need to provide SEC or  MSRB with affirmative authority or amend exemptions under federal  securities laws to establish disclosure requirements directly on municipal  securities issuers.
Four market participant groups we surveyed and others (including  issuers) with whom we spoke discussed potential challenges to issuers of  expanding regulator authority. They expressed concern over the costs of  federal regulation as well as the potential infringement on state and local  government rights. According to a market participant group with whom we  spoke, an increase in the costs of accessing the market could prohibit  some issuers from raising capital in the public market and lead some  issuers to pursue other options for raising capital, such as through private  bank loans. In addition, a market participant group representing issuers  said the basic tenets of federalism and the importance of federal-state  comity behind the Tower Amendment were important considerations in  weighing potential options for improving municipal disclosure.
While neither SEC nor MSRB had indicated to us they were seeking  additional authority to regulate issuers, SEC staff indicated that additional  authority would be helpful to improve disclosure by municipal issuers.  Staff of each regulator had similar views on how to most appropriately  use any additional authority that could be granted to regulate disclosure  by municipal issuers.
First, staff generally agreed that the securities registration regime for  public companies would be inappropriate for the municipal securities  market. With approximately 50,000 issuers and 1.3 million separate  outstanding securities, SEC staff said the additional resources  potentially needed to review and declare effective registration  statements would be extensive, and an MSRB official said regulating  municipal issuers would be beyond MSRB’s current resource  capabilities.
Second, SEC and MSRB staff recognize that potential continuing  disclosure requirements could have costs for issuers, such as small or  infrequent issuers, although limited information exists on the universe  of issuers, and issuers that might be affected.
Third, SEC and MSRB staff told us broad-based or marketwide  standardized disclosure would not be favorable for the municipal  market. Rather, SEC staff told us disclosure requirements could be  principles-based. Principles-based disclosure is an approach that  would involve establishing key objectives of good reporting and  providing guidance and examples to explain each objective. MSRB  staff agreed that disclosure requirements should be tailored, noting  that the market is highly diverse in terms of the structure of financings  and the issuing community. Staff from both regulators said any  disclosure requirements for municipal securities issuers would need to  reflect the diversity of issuers as well as the federal interest in investor  protection.
Fourth, SEC and MSRB staff stated that regulation of municipal  securities must balance investor protection and intergovernmental  comity. For example, SEC staff told us any federal regulation of  municipal securities disclosure should be flexible and adaptable, so  that regulators could account for issues of comity and other political  realities present in the municipal market.
In addition to repealing the Tower Amendment, many of the experts and  market participants we surveyed identified additional options that would  require statutory changes. These include prescribing accounting  standards and requiring time frames for annual reporting, requiring more  frequent disclosure, or requiring certain conduit borrowers to comply with  corporate disclosure provisions. According to SEC and MSRB staff,  Congress would need to provide SEC or MSRB with authority to  implement any of these options.
Five of 21 experts we surveyed and a market participant group with whom  we spoke suggested federal regulators should prescribe accounting  standards for the financial information issuers disclose in EMMA. These  suggestions included that SEC should be provided authority to prescribe  accounting standards or regulators should require issuers to comply with  GAAP for state and local governments.participant groups suggested regulators should have authority to simplify  GAAP standards to more efficiently meet investor needs and reduce  compliance costs for issuers. According to MSRB staff, Congress could  provide MSRB authority to regulate issuers and authorize accounting  standards without needing to repeal the Tower Amendment. According to  MSRB staff, without statutory changes, MSRB could use existing  authority to prohibit broker-dealers from underwriting new securities  without an issuer of such securities committing to follow GAAP or other  accounting standards. However, an MSRB official also told us that  approach would be less effective than directly regulating issuers, an  unreasonable burden on broker-dealers, be difficult to comply with and  enforce, and could be viewed as an indirect obligation for issuers.
According to an expert, a market participant group, and SEC staff with  whom we spoke, standardized accounting requirements could benefit  investors by facilitating comparability of financial information across  different issuers and securities, and make annual financial information  easier to understand, particularly for individual investors. We previously  reported that many industry participants think GAAP-basis financial  statements provide a fuller, more transparent picture of a government’s  financial position than those prepared in accordance with other bases of  accounting.  Reporting of pension liability is one of the areas that market  participants and experts we surveyed said should be improved. Appendix  IV provides information on several industry-driven efforts to improve  pension liability reporting in municipal securities disclosure documents.
See GAO, Dodd-Frank Wall Street Reform Act: Role of Governmental Accounting  Standards Board in the Municipal Securities Markets and Its Past Funding, GAO-11-267R  (Washington, D.C.: Jan. 18, 2011). requirement to follow GAAP would be an unfunded mandate, particularly  for small or infrequent borrowers because they would be required to  invest in the staff time and expertise to prepare financial statements they  would not otherwise prepare. Some issuers also questioned the  potential benefits to investors of mandated GAAP compliance, saying that  statements that comply with GAAP provide too much irrelevant  information to investors.
SEC has statutory authority to establish financial accounting and reporting standards for  publicly held companies, but has looked to private-sector standard-setting bodies to  develop these accounting principles and standards. For example, SEC had recognized the  Accounting Principles Board as the authoritative source for GAAP until 1973. Since the  formation of the Financial Accounting Standards Board (FASB) in 1973, SEC has  designated FASB as the private-sector standard-setter whose accounting principles are  recognized as “generally accepted” for purposes of federal laws for public companies. The  Sarbanes-Oxley Act of 2002 established criteria that must be satisfied for the work product  of an accounting standard-setting body to be recognized as “generally accepted.”  Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, § 108, 116 Stat. 745 (2002). In 2003,  SEC reaffirmed FASB as the private-sector standard setter. Commission Statement of  Policy: Reaffirming the Status of the FASB as a Designated Private-Sector Standard  Setter, Securities Act Release No. 8221, Exchange Act Release No. 47,743 (Apr. 25,  2003). setting body, such as GASB, as “generally accepted.” In a 2010 speech  at a securities regulation seminar, the Commissioner identified options for  improving municipal securities disclosure that SEC would examine in an  ongoing review of the municipal securities market.mandating the use of uniform accounting standards, such as GAAP  standards.
Four of 21 experts and 4 of 21 market participant groups we surveyed,  and 2 market participant groups we interviewed, suggested that federal  regulators should require issuers to submit annual financial statements  and operating information on a timely basis. Suggestions included that  state and local government issuers should meet a standard of 120 or 180  days, or adhere to the same standard as corporate issuers. Improving  timeliness could benefit the market by helping build investor confidence in  a particular security or issuer and thereby increase investor demand for  municipal securities, according to 3 of the market participant groups and 1  of the experts. In turn, increased demand theoretically could improve  pricing and increase liquidity, but to what extent this would be the case is  unknown. While SEC requires in Rule 15c2-12, as a condition of an  underwriting, that an underwriter must reasonably determine that the  issuer or obligated person has agreed in a continuing disclosure  agreement to specify the date on which annual financial information will  be provided, SEC does not have authority to enforce this aspect of the  agreement.
Issuers discussed potential challenges of meeting shorter annual  reporting time frames. Large issuers (including states, cities, and a  county) told us a dependence on other entities—including component  units of government—for information could prohibit entities that satisfy  their annual reporting obligation by submitting audited financial  statements from completing audited financial statements in shorter time  frames. A state conduit issuer said some issuers might rely on a state to  reconcile Medicare payments after the close of the fiscal year before they  could report GAAP-compliant financial statements. In addition, some  issuers said a limited availability of auditors of governmental entities could  impede issuers from complying with a mandated annual reporting time  frame.auditors, in which case the local government might have little to no control  over the timing of the audit. Other states use private-sector auditors, and  several issuers told us that there is a shortage of these auditors. For  example, an issuer from Wisconsin noted that major accounting firms  have reduced staff resources supporting public-sector audits, and smaller  auditing firms also have moved away from government audits.
Some states require their local governments to use state  MSRB staff discussed with us their perspectives on possibly requiring  issuers to provide annual financial information on a timelier basis. They  said the diversity of the issuer community and significant impediments to  implementing such an option would need to be evaluated before putting in  place such a requirement. In response to market participant concerns that  information needed to make informed investment decisions is stale in  many cases, MSRB recently developed features in EMMA that allow  issuers, obligated persons, and parties providing disclosure upon their  behalf, to voluntarily specify a time frame of 120 or 150 days for  submitting annual financial information.
Three market participant groups we interviewed and 1 of 21 market  participant groups we surveyed told us federal regulators should require  issuers to disclose unaudited financial information on a quarterly basis in  EMMA, similar to requirements for corporate issuers. According to 3  market participant groups, more frequent reporting could help provide  investors with more timely, relevant information.
Four of seven large issuers and three of six small issuers told us they  posted interim financial information to their websites, including unaudited  quarterly financial statements and budget reports. Three other small  issuers that produced interim financial reports told us they did not post  such information on their websites, but could provide it to investors or  others on request. Issuers that already produce interim financial  information could face minimal cost to submit it to EMMA. Additionally,  members of a market participant group representing issuers said  unaudited interim financial information might be easier for issuers to  prepare than annual audited financial reports (for issuers that fulfill their  annual reporting obligation as agreed in their continuing disclosure  agreement by providing audited annual financial statements) and provide  investors with more current and relevant information. One market  participant group representing issuers told us smaller issuers could have  a greater incentive to disclose interim financial information for the benefit  of investors out of competitive pressure as more issuers adopted the  practice.
However, issuers and a market participant group indicated that a  requirement for issuers to provide quarterly information to EMMA could  be costly, would involve liability concerns, and could result in a limited  presentation of financial information that excludes information on accrued  assets and liabilities. Some large, small, and conduit issuers with whom  we spoke said preparing interim financial information for EMMA would  require additional staff resources and, with governments’ limited  resources, likely would result in issuers reallocating staff resources from  other areas. For example, several large issuers and conduit issuers told  us they and others would need to hire additional accounting staff if  required to provide standardized quarterly financial reports. Large and  small issuers also cited concerns about their liability under SEC’s  antifraud authority of posting unaudited financial information to EMMA,  and a market participant group suggested that issuers would be more  willing to disclose interim information if they could disclaim liability from  the antifraud provisions of the federal securities laws. SEC staff told us  that issuers and others cannot disclaim liability or responsibility for their  disclosures under the antifraud provisions. Finally, several large and  small issuers with whom we spoke and 1 of 21 market participant groups  we surveyed said significant adjustments that some government entities  make only at year-end to meet GAAP requirements would make it  infeasible to determine an issuer’s financial condition from interim  financial reports, as interim information would provide an incomplete  picture of an issuer’s financial condition.
In a 2010 speech to the Investment Company Institute, the SEC  Chairman stated that requiring periodic disclosure of financial  information—such as tax revenues, expenditures, tax base changes, or  pension obligations—could help improve municipal securities  disclosure. Further, MSRB staff told us quarterly disclosure could  enable investors to better compare different types of securities, as more  information would be available for comparative analyses. In addition, they  said more frequent disclosure in theory could increase liquidity and  improve pricing, but it would be difficult to determine to what extent, and  whether, more frequent disclosure would increase liquidity and improve  pricing. MSRB staff told us variation among the issuer community also  constitutes a significant barrier to mandating more frequent disclosures.  They said a tailored approach would be more effective than a one-size- fits-all requirement for issuers to provide more frequent disclosure  information.
Four of 21 experts and 1 of 21 market participant groups we surveyed  and several issuers we interviewed said SEC should require corporate  borrowers that issue debt in the municipal market to comply with  disclosure requirements for corporate issuers because this sector has  been responsible for most payment defaults.the municipal market with corporate borrower participation provide  disclosure beyond that required by Rule 15c2-12, not all do. According to  SEC staff with whom we spoke, requiring corporate disclosure of conduit  borrowers would require certain statutory action to repeal Securities Act  exemptions for certain types of securities; however, the Tower  Amendment could remain in place. While the Tower Amendment restricts   Although a few sectors of  SEC from requiring prefiling information from municipal securities issuers,  the restriction does not apply to conduit borrowers, as they are not  municipal securities issuers. Whether a corporate conduit borrower is  subject to registration and reporting requirements for public companies  would depend on whether the corporate conduit borrower qualified for a  specific exemption under the Securities Act.
Two market participant groups and an expert with whom we spoke  suggested that applying corporate disclosure requirements to conduit  borrowers would provide a risk-based approach to improving disclosure.  They said focusing changes of disclosure rules on the highest-risk sectors  of the market would improve investor protection in the areas of greatest  need. One expert we surveyed said conduit borrowers should be required  to provide investors with more information because conduit borrowers  benefit financially from reduced interest rates on tax-exempt municipal  bonds. The expert said eliminating exemptions for corporate borrowers  could provide clarity to investors on what entities issue debt in the  municipal market, and could provide investors with access to the same  registration and disclosure information that otherwise would be available  on the same entities if issuing securities in the corporate market. While  eliminating exemptions for conduit borrowers could improve transparency,  one small issuer told us there could be some costs to government  issuers, as some local governments may be required to assume  development costs. Conduit issuers agreed that eliminating exemptions  could increase costs to conduit borrowers and cause some to leave the  market—in theory, leading to lost economic development opportunities.
SEC staff have recommended that the exemption provided by Section  3(a)(2) of the Securities Act be eliminated for corporate conduit  borrowers. In 1994, SEC supported this option, but the current  commission has not taken a position on this issue. SEC staff have been  examining this issue as part of their ongoing study of the municipal  securities market. MSRB staff said market participants reported that  municipal securities with conduit borrowers in some sectors have been  less compliant with continuing disclosure agreements than other types of  municipal securities. They said planned improvements to EMMA could  help users identify and track conduit issuances, which could aid conduit  borrowers in managing their continuing disclosure obligations or help  regulators and investors track securities with conduit borrowers.
section_title: Other Options for Improving Continuing Disclosure Could Be Achieved within Existing Regulatory Framework
paragraphs: Experts and market participant groups we surveyed and others with  whom we spoke suggested other options for improving disclosure that  could be implemented within the existing regulatory framework. These  included further improving the functionality of EMMA and strengthening  efforts to promote EMMA to issuers and investors. Other options included  expanding SEC enforcement activities and improving the readability and  usefulness of disclosure information by providing guidance or requiring  use of plain English in disclosures.
Six market participant groups with whom we spoke and 4 of 21 experts  and 3 of 21 market participant groups we surveyed told us EMMA was a  significant improvement from the former system for distributing disclosure,  and 2 market participant groups said its usefulness had improved since it  was first implemented. Members of a group representing issuers said the  system provided issuers greater certainty about their compliance with  continuing disclosure agreements, as EMMA allows issuers to verify what  information they submitted to the system and where it was posted online.  When using the former system, issuers mailed in paper documents and  lacked the ability to see whether information was filed or if it had been  categorized correctly. They said EMMA had made it easier to more  accurately file disclosure information, as it was easier to associate  disclosure information with appropriate identifiers (CUSIP numbers).
Nevertheless, 6 market participant groups we interviewed and 3 of 21  market participant groups and 2 of 21 experts we surveyed suggested  further improvements to EMMA could benefit disclosure. Suggestions  for improving EMMA included making it easier for investors to find specific  securities, making it easier for investors to determine whether financial  information had been submitted, and ensuring that information was  properly coded to appropriate categories and securities. According to one  market participant group with whom we spoke, further improving EMMA’s  functionality would reduce the time and level of effort required of EMMA  users to understand the significance of the information provided. Two  market participant groups representing issuers told us that while EMMA  has made it easier for them to manage their investor disclosures and  determine whether disclosures are publicly available, additional  improvements would further increase the functionality and usefulness of  the system. MSRB staff agreed that further improving EMMA would  encourage greater issuer discipline in complying with continuing  disclosure agreements, because functionality improvements to EMMA  could provide investors better access to disclosure information and, in  turn, increase investor demand for disclosure in EMMA.
Four of 21 market participant groups we surveyed and 3 others with  whom we spoke said regulators could strengthen efforts to educate  issuers on their disclosure responsibilities. For instance, three market  participant groups we interviewed told us some issuers have not yet  submitted information to EMMA because they might not be aware of their  disclosure obligations under their continuing disclosure agreements.  Regulators discussed with us their efforts to educate issuers about  EMMA. MSRB’s primary education focus for the first year after launching  EMMA was to inform and train issuers on their new obligations to file  disclosure information to EMMA. According to MSRB staff, these efforts  included providing industry conference presentations, developing  webinars, creating a call center to provide support to issuers submitting  information to EMMA, and posting a list of frequently asked questions on  the MSRB website. While these efforts have continued, MSRB has  updated its issuer education focus from introducing EMMA to how to  leverage EMMA to communicate directly with investors. In November  2011, MSRB launched a toolkit for state and local government issuers on  its website, which included information on making continuing disclosure  submissions to EMMA and how issuers can better use the information  available on EMMA. While MSRB staff view MSRB’s initial issuer  education efforts as successful because frequent issuers are aware of  EMMA and MSRB received positive feedback from the issuer community,  they said additional work was needed to educate infrequent, small  issuers.
Four of 21 market participant groups and 1 of 21 experts we surveyed  also suggested that regulators could strengthen efforts to improve  investor awareness of EMMA, as the extent to which individual investors  use EMMA is difficult to ascertain. More specifically, 7 of the 12 individual  investors with whom we spoke did not use EMMA to obtain disclosure  information because a few said they were not aware of EMMA and  several said they relied on advisors for investment advice and information  instead of conducting their own research.
Regulators said they expected investor awareness of EMMA to improve  over time, and described the extent of their efforts to make investors  aware of EMMA. In 2009, MSRB initiated an education and outreach  effort to raise awareness of EMMA among investors and others who act  on their behalf, and to promote use of the site by market participants.  MSRB has used websites, social media, search engines, print and  broadcast media, and public speaking engagements, among other things,  to communicate to investors, issuers, and the broker-dealer community  about EMMA. MSRB also requires that trade confirmations or other  documentation associated with primary market transactions provide  notice that primary offering disclosure information (official statements) is  available through EMMA. Further, MSRB developed an online education  center and in May 2012 launched an investor toolkit on its website. MSRB  staff told us they plan to develop focus groups of investors to explore  ways to improve EMMA, which could include how to improve investor  education efforts. Additionally, SEC, FINRA, and others have promoted  EMMA on various websites relevant to investors interested in purchasing  municipal securities.
Three of 21 market participant groups and 1 of 21 experts we surveyed,  and 3 market participant groups with whom we spoke suggested SEC  could expand its enforcement activities using its existing antifraud  authorities as leverage to improve issuers’ adherence with continuing  disclosure agreements. As discussed previously, SEC does not have the  authority to directly require issuers to submit continuing disclosure  information to EMMA. SEC enforcement actions using its antifraud  authority could encourage issuers to comply with their continuing  disclosure obligations. For example, one issuer we interviewed said he  was careful to comply with the continuing disclosure agreement, as he did  not want to risk the city becoming the subject of an SEC enforcement  action.
An expert and a market participant group we surveyed, and two market  participant groups we interviewed discussed the potential benefits of  increased enforcement activity. They said a few high-profile enforcement  actions could improve disclosure compliance. For example,  representatives of a national group that advises issuers on their  disclosures said enforcement actions and interpretive releases were their  main sources of guidance for preparing or advising issuers about  disclosure information.
To be held liable under the antifraud provisions, issuers must make a  material misstatement or omission in their disclosures or public  statements (such as to EMMA or in a speech). SEC has initiated  enforcement actions against state and local governments for materially  false and misleading disclosures they provided to investors in connection  with publicly offered municipal securities. For example, SEC found that  the State of New Jersey and the City of San Diego violated antifraud  provisions by misstating or omitting material information about the annual  funding of their pension obligations, which SEC alleged to be material  information on which investors would rely. To strengthen enforcement  efforts in the municipal securities market, SEC created a municipal  securities and public pensions unit in its Division of Enforcement in  January 2010. Initial efforts by the division include identifying market  activities that pose the greatest risk to investors and identifying potential  violations.
Six of 21 experts and 8 of 21 market participant groups we surveyed  suggested efforts by regulators to standardize disclosure information  could benefit investors by improving the content and readability of  disclosure. Their suggestions included that SEC establish disclosure  guidance on ways to standardize the organization of information or  highlight what information could be important according to the type of  security or credit sector. Additionally, an investor suggested regulators  develop a one-page template issuers could use to provide information  most pertinent to investors, in an easily understood format.
Three of 21 market participant groups we surveyed and a market  participant group and an investor with whom we spoke said additional  guidance or templates could improve the readability and comparability of  information disclosed in EMMA, improving investors’ understanding of the  information. Additionally, an expert said such guidance, outlining broad  categories of basic information all issuers should provide, would be  particularly helpful to small or infrequent issuers that lack the resources  needed to maintain an awareness of industry changes in disclosure  standards. However, many large, small, and conduit issuers with whom  we spoke identified potential challenges to providing standardized  information. They said standardized formats could require different  information from what is collected and maintained now, requiring changes  that could impose additional costs on issuers through increased staff  time, hiring additional expertise, and associated opportunity costs. Also, 1  of 21 market participant groups we surveyed was concerned that direct  regulation of disclosure content and format by SEC or MSRB could have  an adverse effect on the quality of disclosure information. That is,  standardized information might provide investors with information that  was too general to be useful.
SEC staff said they have been exploring different ideas to assist  municipal issuers in improving disclosure as part of the staff’s ongoing  review of the municipal securities market. For example, SEC staff told us  SEC could consider having a role in helping issuers determine what types  of information would be useful for investors’ decision making. While  MSRB had not specifically discussed developing templates for disclosure  in its long-range plan for EMMA, staff told us MSRB could consider  possible options to help standardize disclosure using its authority over  how information gets submitted to EMMA. MSRB staff told us examples  could include creating a template for baseline disclosure such as an  online form for submitting information to EMMA, or providing guidance or  best practices to show patterns of good disclosure and highlight good  disclosure practices. Staff also suggested MSRB could consider  developing an online library of links to websites with guidance and best  practices developed by industry groups and regulators.
Three of 21 market participant groups and 1 of 21 experts we surveyed  suggested federal regulators should require issuers to use plain English  when preparing information for submission to EMMA. For example, they  suggested issuers use plain language to describe financial information or  the implications of event notices.
To some extent, issuers already have been following these practices.  Municipal issuers that satisfy their annual reporting obligation (agreed on  in their continuing disclosure agreement) by submitting an annual  financial report prepared in accordance with GASB rules provide a  management discussion and analysis. Additionally, four of seven large  issuers and three of seven conduit issuers with whom we spoke had  made efforts to incorporate plain language into their annual financial  reports and other financial information they posted to their websites. For  example, three of seven large issuers said using plain language was a  long-time goal. However, large, small, and conduit issuers with whom we  spoke said cost factors, including potential liability under SEC antifraud  authority, lack of internal expertise, and complex accounting standards,  have made it challenging to summarize or interpret the disclosure  information they provide in plain language. Because of these factors, one  large issuer told us investors should seek assistance from brokers or  financial advisors on interpreting financial disclosure information, rather  than relying on issuers to provide plain language or summary information.
MSRB staff told us it would be difficult to enforce a requirement that  information provided to EMMA use plain English, given the number and  diversity of municipal issuers. They said it would be easier to mandate  use of plain English if SEC had direct authority over municipal issuers.
section_title: MSRB and SEC Have Been Taking Steps to Address Some Options
paragraphs: MSRB has taken recent actions to improve the timeliness of disclosure of  financial information, the frequency of disclosure, and the completeness  of disclosure filings through improvements to EMMA with a focus on the  system’s functionality. Examples of recent improvements include the  following:
Filing date information—MSRB expanded the information underwriters  report at the time of an offering to include the date by which issuers  agree to provide annual financial information. This information is  displayed in EMMA, making lapses in annual disclosure more  transparent to users.
Voluntary information—MSRB also developed features in EMMA that  allow issuers to submit different types of information on a voluntary  basis, including monthly budget updates. Additional changes, which  became effective May 2011, permit issuers, obligated persons, and  parties providing disclosure on their behalf, to provide to EMMA  additional categories of information including specifying a timeframe  of 120 or 150 days for submitting annual financial information,  indicating use of GAAP as established by GASB or Financial  Accounting Standards Board (FASB), or providing a web address   An issuer’s  (URL) where additional financial information is available. agreement to participate in any of these voluntary undertakings would  be prominently displayed in EMMA.
Rating information—MSRB implemented a direct feed to EMMA of  ratings information from two of the rating agencies that currently  provide ratings on municipal securities. According to MSRB, the rating agencies voluntarily provide ratings information to EMMA,  which is updated automatically. Consequently, EMMA users who  previously might not have been aware of rating changes affecting their  securities could obtain timely and accurate information.
Issuers can indicate voluntary plans to submit to EMMA annual financial information  within 120 calendar days after the end of their fiscal year, or as a transitional alternative  through 2013, within 150 calendar days after the end of the applicable fiscal year.
See MSRB, Long-Range Plan for Market Transparency Products (Jan. 27, 2012),  available at http://www.msrb.org/About-MSRB/Programs/Long-Range-Plan-for-Market- Transparency-Products.aspx. feedback through the EMMA website. MSRB’s long-range plan includes  improving search capabilities to make it easier for investors to find  securities. Planned changes would allow users to find specific securities  information using information other than CUSIP numbers, such as  keywords, map-based information, or hierarchy-based searches (for  example, securities within a given state), and would allow users to  conduct advanced searches within disclosure documents. The plan also  includes ongoing work with the issuer community to develop additional  tools and utilities to help issuers manage their debt portfolios and to  promote more comprehensive and timely disclosure. For example, MSRB  plans to develop more flexibility for issuers to manage disclosure  submissions and their appearance in EMMA. These new EMMA  capabilities could enable issuers to compare the disclosure and  performance of their securities with their peers’ securities. MSRB also  plans to continue promoting awareness of EMMA and provide additional  online education information for investors, including how to work with  advisors, access pricing information, and use EMMA.
SEC’s ongoing study of the state of the municipal securities market has  focused on a range of issues such as primary and secondary market  disclosure practices, financial reporting and accounting, investor  protection and education, and market structure (including pretrade price  transparency). SEC staff told us one purpose of the study is to identify  risks in the market and what types of changes, if any, might be needed,  including changes in the quality and timeliness of disclosure information  provided to the market. SEC staff expect to release their staff report in  2012, and include legislative, regulatory, and industry best practices and  recommendations to SEC Commissioners for measures to improve  primary and secondary market disclosure practices, measures to improve  market practices, and associated regulation. In addition, the Dodd-Frank  Act required SEC to create an Office of Municipal Securities to administer  SEC rules for municipal securities brokers and dealers, advisors,  investors, and issuers, and to coordinate with MSRB on rulemaking and  enforcement actions. SEC has been in the process of hiring an Office of  Municipal Securities director and staff. SEC’s fiscal year 2012 budget  provides for five full-time staff; however, as of April 2012, the office had  three employees.
section_title: Agency Comments
paragraphs: We provided a draft of this report to SEC, MSRB, and FINRA for  comment. SEC and MSRB provided technical comments, which we  incorporated, as appropriate. FINRA did not provide comments on the  draft report.
We are sending copies of this report to the Senate Committee on  Banking, Housing, and Urban Affairs and the House Committee on  Financial Services. In addition, the report is available at no charge on the  GAO website at http://www.gao.gov.
If you or your staff have any questions about this report, please contact  me at (202) 512-8678 or clowersa@gao.gov. Contact points for our  Offices of Public Affairs and Congressional Relations may be found on  the last page of this report. GAO staff who made key contributions to this  report are listed in appendix V.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: The objectives of this report were to (1) examine the extent to which  information currently provided on municipal securities is useful and the  extent to which existing regulation reflects principles for effective  disclosure; and (2) identify options for improving the information issuers  disclose to investors of municipal securities, and the related benefits and  challenges of these options for investors and issuers.
To describe the extent to which information is useful for investors, we  reviewed documents from the Securities and Exchange Commission  (SEC) and the Municipal Securities Rulemaking Board (MSRB), including  rulemakings, studies, statistical reports, staff reports, and a plan that  described various issues concerning municipal securities disclosure. We  reviewed the transcripts of SEC hearings on the state of the municipal  securities market held in San Francisco, California; Washington, D.C.;  and Birmingham, Alabama, on various dates in 2010 and 2011. We also  reviewed 45 comment letters submitted to SEC as of January 25, 2012,  regarding its study of the municipal securities market. We conducted a  case study of disclosure information that we obtained from MSRB’s  Electronic Municipal Market Access (EMMA) system and made  observations about EMMA’s ease of use, the completeness of the  disclosed information, and the ease with which certain information could  be found in the disclosures. As EMMA became the central repository for  primary market and continuing disclosures in July 2009, we reviewed 14  issuances that were offered between July and December 2009. The  issuances reviewed included 2 issued by small governmental entities (a  school district and a fire district), 2 issued by medium-sized governmental  entities (a utility district and a city), and 2 issued by large governmental  entities (a state and a city education board) for general-obligation debt  issuances. One issuance was a general-obligation bond issued for a  public hospital. The remaining 7 consisted of conduit issuances for a  variety of projects, including an airport, solid waste facility, multifamily  housing complex, stand-alone hospital, hospital system, continuing care  retirement community, and nursing home. We also reviewed independent  and academic studies on the usefulness of disclosure information and  default studies from the three largest rating agencies as well as data on  municipal securities defaults from an independent research firm to  understand the risks to investors of municipal securities. We used data  from Standard & Poor’s and Moody’s Investors Service to compare  default rates for U.S. municipal issuers and global corporate issuers rated  by each rating agency. We assessed the reliability of these data and  found it to be reliable for this purpose. In addition, we worked through the  American Association of Individual Investors to identify and interview 12  retail investors with diverse investment experience with municipal  securities. We also interviewed institutional investors (including  representatives for eight investment companies), professional analysts, a  rating agency, an independent research firm, and groups representing  market participants, including broker-dealers, bond lawyers, and  municipal advisors. Finally, we interviewed staff of federal and state  regulators, including SEC, MSRB, the Financial Industry Regulatory  Authority (FINRA), and the North American Securities Administrators  Association.
To describe the extent to which the information that issuers must provide  reflects principles for effective disclosure, we reviewed federal laws and  rules, agency regulations, and interpretive guidance that set forth  disclosure requirements related to municipal securities. We reviewed  SEC Rule 15c2-12, the primary SEC rule relating to underwriters of  municipal securities. We reviewed information on SEC regulations for  insider trading and that establish fair disclosure requirements for  corporate securities to determine their applicability to municipal securities.  We also reviewed SEC’s antifraud authorities in the Securities Act of  1933 and the Securities Exchange Act of 1934, as well as provisions of  these acts that exempt municipal securities from SEC registration and  periodic reporting requirements. In addition, we reviewed MSRB’s facility  filing on EMMA, which establishes requirements for submitting disclosure  information to the system. We compared these requirements with  principles for effective disclosure and had two analysts review and come  to independent judgments to determine the extent to which disclosure  regulations reflected the principles. We used two sources for criteria.  First, we used Principles for Ongoing Disclosure and Material  Development Reporting by Listed Entities from the International  Organization of Securities Commissions. We believed these principles to  be appropriate criteria for use in this context because our data collection  indicated that continuing disclosure was a key issue for municipal  securities disclosure. Although trading of municipal securities in the  secondary market is infrequent, trading volume is substantial, indicating  the importance of continuing disclosure. We did not use one of the  principles—simultaneous and identical disclosure—in our analysis  because the principle referred to making disclosures across borders,  which is not important for municipal securities because the market is  largely domestic and the securities do not trade on exchanges. Second,  we used SEC’s A Plain English Handbook: How to Create Clear SEC  Disclosure Documents, which sets forth principles for preparing  disclosure documents in easy-to-understand language. We believed  these principles to be appropriate criteria for municipal securities  disclosure because our data collection indicated that readability was an  issue for investors and a national organization representing state and  local governments had suggested the principles to its members for  producing municipal securities disclosure documents.
To identify options for improving the information issuers disclose to  investors, we reviewed compliance and enforcement information from  SEC and FINRA, including examination manuals for Rule 15c2-12 and  MSRB Rule G-32, which set forth broker-dealer requirements for  disclosures in connection with primary offerings. We reviewed data on  examinations that found violations of the rule, and in certain cases,  reviewed examination reports. Furthermore, we surveyed experts and  groups representing issuers and other market participants, such as  municipal advisors, broker-dealers, and professional analysts. The  questions we asked experts focused on the regulation of municipal  securities disclosure, whereas the questions we asked market participant  groups focused on disclosure practices. This is because our initial  interviews with market participant groups illuminated conflicts of interest  that made it challenging to discuss options for regulating municipal  securities disclosure. We recruited experts with career expertise in the  municipal securities market and without obvious conflicts of interest,  which we defined as the potential to benefit personally or professionally  from the outcomes of our study or with a constituent they might feel the  need to satisfy. Surveys for both groups asked for options to improve  disclosure. We used a nonprobability sampling method to identify and  select experts by obtaining referrals from other market participants,  experts, and regulators. Although our results are not generalizable, our  survey covered a diverse group of experts and market participant groups  with broad and differing perspectives. We administered the survey to 26  experts and 29 market participant groups and received responses from  21 experts and 21 groups. We analyzed options according to what was  mentioned most frequently and excluded suggestions that were not based  on a correct understanding of the existing disclosure regime or were  beyond the scope of our review. To control for small variations across the  suggestions, three analysts reviewed and came to independent  judgments to assign suggestions into various categories. To identify the  types of benefits and challenges related to suggested options, we  interviewed 20 issuers in three groups representing (1) large and frequent  issuers, (2) small and infrequent issuers, and (3) conduit issuers. The  group consisting of large and frequent issuers included representatives of  three states, three large cities, and a county. The group of small and  infrequent issuers included representatives of five cities and a county with  populations of 500,000 or fewer. The group of conduit issuers included  representatives of three state housing finance agencies, three state  health and educational facilities agencies, and a state bond bank. The  issuers were geographically diverse, and represented entities from:  California, Colorado, Florida, Georgia, Kansas, Maine, Maryland,  Minnesota, New York, Oregon, Pennsylvania, Rhode Island, South  Carolina, Tennessee, Texas, Washington, and Wisconsin. We also drew  on information obtained from our survey and other interviews we  conducted with investors, regulators, and market participants.
We conducted this performance audit from June 2011 to July 2012 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
section_title: Appendix II: Key Federal Disclosure Requirements for Publicly Offered Municipal and Corporate Securities
paragraphs: Table 2 compares key federal disclosure requirements for municipal and  corporate securities. The information in the table is organized according  to whether requirements apply to primary or secondary market disclosure,  with requirements that apply to both presented first.
section_title: Appendix III: Principles of Effective Disclosure Compared with Current Disclosure Regulations for Municipal Securities
paragraphs: We compared requirements for continuing disclosure in the Securities  and Exchange Commission’s (SEC) Rule 15c2-12 and SEC’s antifraud  authorities with principles for effective disclosure that were developed by  an international organization of securities commissions, which included  SEC, and certain plain English principles developed by SEC. We found  that the current municipal securities disclosure requirements broadly  reflect the seven principles for effective disclosure.
section_title: Appendix IV: Pension Liability Reporting
paragraphs: Investors, a market participant group, and an expert told us that the  reporting of pension liability in municipal securities disclosure documents  could be improved with changes to accounting standards and financial  reporting requirements. For example, several investors told us that  Governmental Accounting Standards Board (GASB) standards, to the  extent issuers adopted them, did not provide for reporting enough  information, such as financial projections, that could help users determine  whether an entity will have sufficient resources to cover future financial  obligations. Consequently, there are concerns that future pension costs  could crowd out an entity’s ability to meet scheduled principal and interest  payments on its municipal securities.
GASB and the National Association of Bond Lawyers have undertaken  various efforts that could increase the amount of information reported on  pension and other long-term liabilities, but the viability of certain  proposals already has been questioned, and it is too early to determine  how issuers will react to recent guidance produced by an industry  coalition.
In November 2011, GASB issued suggestions for broadening the  information governmental entities report in annual financial reports to  include projections of cash flow and long-term financial obligations  (that is, bonds, pensions, other postemployment benefits, and long- term contracts) for a minimum of 5 years beyond the reporting  period. GASB issued these suggestions for public comment and  anticipated that respondents could be sharply divided on the issue.  Two of the seven board members did not agree with the suggestions.  They said forward-looking financial information would be subjective,  and they questioned the potential costs and benefits to governmental  entities of preparing the information. They had concerns that the  proposed suggestions could affect the timeliness of audited financial  statements and some entities’ willingness to report statements  compliant with generally accepted accounting principles, or GAAP (for  those entities that can choose whether to comply with GAAP).
National Association of Bond Lawyers, Considerations in Preparing Disclosure in Official  Statements Regarding an Issuer’s Pension Funding Obligations, (May 15, 2012).  Available at  http://www.nabl.org/uploads/cms/documents/pension_funding_obligations_document_5- 18-12_b.pdf, as of May 18, 2012.
The revised standards, approved as Statements 67 and 68, replaced previous pension  plan reporting standards (Statements 25, 27, and 50). Specifically, Statement 67 revised  guidance for the financial reports of most pension plans, effective for periods beginning  after June 15, 2013, and Statement 68 established new financial reporting requirements  for most governments that provide their employees with pension benefits, effective for  fiscal years beginning after June 15, 2014. appropriate way to measure and accrue cost for these obligations)  had become widely divergent.
section_title: Appendix V: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Karen Tremba, Assistant  Director; Heather Chartier; William R. Chatlos; Rachel DeMarcus; Melissa  Kornblau; Courtney LaFountain; G. Michael Mikota; Patricia Moye; Alise  Nacson; Barbara Roesmann; and Kathryn Supinski made key  contributions to this report.