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

Letter

Background

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.

Investors and Market Participants Cited Limitations of Continuing Disclosures

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.

Investors and Market Participants Most Commonly Cited Timeliness, Frequency, and Completeness as Disclosure Limitations

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.

Current Regulations Broadly Reflect Disclosure Principles but Some Limitations Exist

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.

Effect of Limitations of Disclosure Regulations on Individual Investors Largely Is Unknown

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.

Options for Improving Disclosure Involve Potential Benefits and Challenges

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.

Some Options Identified to Improve Disclosure Would Require Statutory Changes

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.

Other Options for Improving Continuing Disclosure Could Be Achieved within Existing Regulatory Framework

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.

MSRB and SEC Have Been Taking Steps to Address Some Options

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.

Agency Comments

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.

Appendix I: Objectives, Scope, and Methodology

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.

Appendix II: Key Federal Disclosure Requirements for Publicly Offered Municipal and Corporate Securities

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.

Appendix III: Principles of Effective Disclosure Compared with Current Disclosure Regulations for Municipal Securities

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.

Appendix IV: Pension Liability Reporting

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.

Appendix V: GAO Contact and Staff Acknowledgments

GAO Contact

Staff Acknowledgments

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.