The Demand for Disclosure
Municipal bond market investors want to know more about issuers -- and they want to know it on a quarterly, semi-annual and annual basis.
For a while now, municipal bond market investors have been clamoring to know more about the bonds and the issuers they're investing in. The complaints are constant: There isn't enough disclosure. It isn't on par with corporate disclosure. Investors aren't being kept up-to-date on changes in the well-being of issuers. The lack of information makes the secondary market, where bonds are sold and resold, a perilous place.
Despite major improvements in the disclosure system -- namely the Municipal Securities Rulemaking Board's Electronic Municipal Market Access (EMMA) system -- the chorus of complaints continues. And this year, it's louder. After the Financial Industry Regulatory Authority came up with a disclosure checklist for secondary market bond dealers that keeps investors informed, the Bond Dealers of America (BDA) unveiled their own guidelines in an effort to keep disclosure a matter of self-regulation. Why should state or local officials care about how well information about their fiscal condition is distributed? Michael Nicholas, CEO of the BDA, has a simple answer: money.
"There's a clear difference," Nicholas says, "in the spread and liquidity in bonds where issuers provide timely and full disclosure vs. those that do not."
At this year's Government Finance Officers Association annual meeting, Frank Hoadley, Wisconsin's capital finance director, warned his fellow finance officers that they should voluntarily disclose performance or federal regulators may mandate it. "We're being hammered from all sides -- the SEC, the bond investor community and the political side -- about the quality and frequency of our disclosure," he said.
In an opinion piece in the summer issue of the Journal of Government Financial Management, Bob Attmore, the chairman of the Governmental Accounting Standards Board, advised issuers to release audited financial statements within three to six months of the end of their fiscal years. "There is no question that it can be done," Attmore wrote. "The only question is whether state and local government policymakers will consider the benefits sufficient to warrant making timely financial reporting a priority."
I talked to Lynnette Hotchkiss, executive director of the Municipal Securities Rulemaking Board (MSRB) about her views on disclosure, what she thinks public officials ought to understand about it and how EMMA might help. Here are highlights from our conversation.
Why is disclosure such a big problem now?
I don't consider it a big problem but the issue has gotten more prominence lately. One of the reasons is that since 2008 there have clearly been significant pressures on state and local government budgets.
There is room for improvement. Clearly as a regulator, we want to make sure the vast number of retail [or individual] investors is protected. Part of that means making sure that person has the information necessary to make good decisions when he buys or sells a bond. Disclosure is part of that. Another thing that has come to the forefront in the past few years is an incredibly active SEC [Securities and Exchange Commission]. The SEC has created a separate unit within its enforcement division to focus on municipal bonds and state and local government pension plans. They have been very aggressive in bringing action against municipal market participants for either inadequate disclosure -- material omission or misstatement in documents -- or other abuses that happen in the market.
What role does EMMA play in providing opportunities for states and localities to improve disclosure?
With the launch of the MSRB's EMMA system, it is the first time ever that you are able to see in one place all the disclosure an issuer is providing to its investors and constituents. The vast majority of frequent issuers have comprehensive, strong disclosure practices. Generally, it's smaller, less frequent issuers who don't appreciate ongoing disclosure responsibilities. But EMMA provides the tools to do it. At the closing of a bond deal, issuers sign a continuing disclosure agreement and that sets forth ongoing disclosure obligations. That can mean annual operating data and annual financial information. EMMA also allows issuers to post other disclosures and information that they think might be of value to investors and constituents. EMMA is very simple to use. I tested it on my 10-year-old nephew and he could upload documents easily. Small issuers have the capability, and they clearly produce these documents anyway. The trick is to educate them about ongoing obligations and help them understand the value of communicating directly with their investors.
What is that value?
If a bond issue is coming to market, an issuer with good disclosure practices will likely gather a broader interest from the investor community, which can result in lower cost of capital. Issuers with good disclosure generally find more liquidity for their bonds in the secondary market, which can also result in better pricing of those trades. Good disclosure creates greater familiarity with an issuer and its obligations so that there's greater receptivity when a bond comes to market -- and that can result in lower costs. Finally, it's not quantifiable but there is an advantage in being an open and transparent government.
Even with EMMA and good disclosure practices, investors complain that municipal disclosure is not as good as corporate disclosure. How deeply do they differ?
We can look to the corporate model but it doesn't really translate into the municipal market. Corporate issuers must register with the SEC, and they are required to provide quarterly, semi-annual and annual filings on prescribed forms. It's a highly regulated and highly structured disclosure regime. The municipal bond market standard is: You have to disclose all material facts. It's up to each issuer with the advice of counsel and advisers to determine what is and what is not material. In my experience, the overwhelming majority of issuers want to do the right thing, they want to disclose and communicate with investors and abide by all best practices in the industry. There are a handful of examples where there was willful intent to mislead, but in most cases, where disclosure is insufficient or not timely, it is more an education issue than ill will or ill motive.
How can issuers go above and beyond minimum requirements?
We heard loud and clear from the issuer community that they wanted to post presale documents: notices of sale and preliminary official statements for presale marketing. So, we spent time to make changes to the EMMA system to allow issuers on a voluntary basis to post these presale documents.
Muni issuers can own their real estate on EMMA. There is an unlimited opportunity to communicate directly with investors. Many issuers have taken advantage of this functionality and have posted significant amounts of voluntary disclosure. It's very important that elected officials and others senior members of government understand the importance of disclosure. Not only does good disclosure have the potential to reduce borrowing costs but it enhances confidence when you have an open, transparent government.