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Report on the Municipal Securities Market

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Report on the Municipal Securities Market Report on the Municipal Securities Market ____________________________________________________ U.S. Securities and Exchange Commission July 31, 2012 _______________________________________ EXECUTIVE SUMMARY Background on Report on the Municipal Securities Market The mission of the SEC is to protect investors – including investors in municipal securities – maintain fair, orderly, and efficient markets, and facilitate capital formation. In furtherance of that mission, Chairman Mary L. Schapiro announced in May 2010 that Commissioner Elisse B. Walter, along with staff from across the agency, would lead an effort to examine the municipal securities market. In 2010 and 2011, Commissioner Walter and the Commission staff (“Staff”) held public field hearings in San Francisco, California; Washington, DC; and Birmingham, Alabama. At each of the hearings, the Staff invited individuals representing many different perspectives to participate in panels on specific topics, including disclosure, accounting, pre-trade price transparency, and other investor and municipal issuer concerns. In addition to the field hearings, the Staff held meetings and conference calls with market participants and public comment was invited by email, by mail, through the Commission’s web-based comment submission form, or through a dedicated telephone line. The development of this Report on the Municipal Securities Market (“Report”) included consideration of the transcripts of the field hearings, the comment letters received, academic studies, other publicly available materials, Staff-generated statistics based on certain data sources, and the input received during meetings and conference calls with market participants. This Report commences with an overview of the municipal securities market, the regulatory structure and the roles of key market participants. Next, the Report focuses on two key areas of concern in the municipal securities market: disclosure and market structure. Finally, the Commission provides a number of recommendations for potential further consideration, including legislative changes, Commission rulemaking, Municipal Securities Rulemaking Board (“MSRB”) rulemaking and enhancement of industry “best practices.” These recommendations are designed to address the various concerns raised by market participants and others and to provide avenues to improve the municipal securities market, including transparency for municipal securities investors. While we believe, based on our review of the market as described in this Report, that these recommendations could help improve the municipal securities market, we recognize that further action on specific recommendations will involve further study of relevant additional information, including information as applicable related to the costs and benefits of the recommendations and the consideration as applicable of public comment. Overview of the Municipal Securities Market The municipal securities market is critical to building and maintaining the infrastructure of our nation. State and local governmental entities issue municipal securities to finance a wide variety of public projects, to provide for cash flow and other governmental needs, and to finance non-governmental private projects (through the use of “conduit” financings). As of December 31, 2011, there were over one million different municipal bonds outstanding, in the total aggregate principal amount of more than $3.7 trillion. i Depending on the type of financing, payments of the principal and interest on an issue of municipal securities may come from general revenues of the municipal issuer, specific tax receipts, revenues generated from a public project, or payments from private entities or from a combination of sources. In addition to being issued for many different purposes, municipal securities are also issued in many different forms, such as fixed rate, zero coupon or variable rate bonds. The interest paid on municipal securities is typically exempt from federal income taxation and may be exempt from state income and other taxes as well. Municipal bonds also may be accompanied by a form of credit enhancement, such as a letter of credit issued by a bank, a governmental guarantee, or an insurance policy issued by a bond insurance company. Credit enhancements were common during 2000-2007, with more than half of the municipal principal issued supported by at least one type of credit enhancement during that period. However, private sector credit enhancement in the form of bond insurance in particular has decreased since 2008 due to the effect of the financial crisis on banks and municipal bond insurers. This decline has impacted the market for municipal securities and renewed investor focus on the disclosure practices and underlying credit quality of municipal securities, municipal issuers, and conduit borrowers. Historically, municipal securities have had significantly lower rates of default than corporate and foreign government bonds. Studies indicate that the risk of ultimate non-payment for municipal debt historically has been low, both when compared to total municipal debt outstanding and total municipal debt in default. Nevertheless, municipal bonds can and do default, and these defaults can negatively impact investors in ways other than non-payment, including delayed payments and pricing disruptions. Reports indicate that a majority of defaults in the municipal securities market are in conduit revenue bonds issued for non-governmental purposes, such as multi-family housing, healthcare (hospitals and nursing homes), and industrial development bonds (for economic development and manufacturing purposes). Overview of the Federal Regulatory Structure for the Municipal Securities Market Despite its size and importance, the municipal securities market has not been subject to the same level of regulation as other sectors of the U.S. capital markets. The Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”) were both enacted with broad exemptions for municipal securities from all their provisions, except for the antifraud provisions of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 promulgated thereunder. Congress, as part of the Securities Acts Amendments of 1975 (“1975 Amendments”), created a limited regulatory scheme for the municipal securities market at the federal level in response to the growth of the market, market abuses, and the increasing participation of retail investors. The 1975 Amendments required firms transacting business in municipal securities to register with the Commission as broker-dealers, required banks dealing in municipal securities to register as municipal securities dealers, and gave the Commission broad rulemaking and enforcement authority over such broker-dealers and municipal securities dealers. In addition, the 1975 Amendments created the MSRB and granted it authority to promulgate rules governing the sale of municipal securities by broker-dealers and municipal securities dealers. ii The 1975 Amendments did not create a regulatory regime for, or impose any new requirements on, municipal issuers. Pursuant to provisions commonly known as the “Tower Amendment,” the 1975 Amendments expressly limited the Commission’s and the MSRB’s authority to require municipal securities issuers, either directly or indirectly, to file any application, report, or document with the Commission or the MSRB prior to any sale of municipal securities by the municipal issuer. The 1975 Amendments do not, by their terms, preclude the Commission from promulgating disclosure standards in municipal offerings, but there is no express statutory authority contained in the Exchange Act over disclosure by municipal issuers. The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) did not change these provisions, but required a study and review by the U.S. Comptroller General of municipal securities disclosure, possible recommendations for municipal issuer disclosure requirements and the advisability of the repeal or retention of the Tower Amendment. In addition, the Dodd-Frank Act contained other provisions that affected the municipal securities market. Among other things, it amended Section 15B of the Exchange Act to require the registration of municipal advisors with the Commission and provide for their regulation by the MSRB. Additionally, the Dodd-Frank Act expanded the MSRB’s authority by explicitly requiring it to protect municipal entities and obligated persons. In the absence of a statutory scheme for municipal securities registration and reporting, the Commission’s investor protection efforts in the municipal securities market have been accomplished primarily through regulation of broker-dealers and municipal securities dealers, including through Exchange Act Rule 15c2-12, Commission interpretations, enforcement of the antifraud provisions of the federal securities laws, and Commission oversight of the MSRB. The existing regulatory scheme for broker-dealers and municipal securities dealers can significantly impact municipal entities’ and obligated persons’ business practices and the availability of information about them in the marketplace. Overview of Disclosure Practices in the Municipal Securities Market Disclosure practices in municipal securities offerings and on an ongoing basis have developed as a result of the antifraud provisions of federal and state securities laws, Exchange Act Rule 15c2-12, Commission interpretive guidance,
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