Blame it on Orange County. Back in 1994, the huge California county filed for bankruptcy after losing billions of dollars on a risky investment in financial derivatives. Among other sins, it hadn't disclosed its high-wire investment strategy to the people and institutions who owned the county's bonds.

Not all of us remember those events, but Christopher Cox does. He was a congressman representing Orange County at the time. Now that he's chairman of the federal Securities and Exchange Commission, he's trying to make local governments that issue bonds answer to a higher authority: the SEC itself.

Cox wants the SEC to regulate the way issuers disclose information and do their accounting. His argument is essentially this: State and local governments have $2.4 trillion in outstanding debt, but they are subject to less stringent debt-disclosure rules than private businesses are. State and local issuers don't have to follow accounting rules as set out by the Government Accounting Standards Board -- even though private companies must adhere to the rules developed by GASB's corporate counterpart, the Financial Accounting Standards Board.

To bring the SEC presence into the muni market, Cox has asked Congress to rewrite the federal laws that currently preclude such a role. He wants the federal government to mandate issuer use of GASB accounting rules and to fund GASB so it can be independent of the state and local governments that it serves. And he's pushing to gain a voice for the SEC in naming the state or local representatives who sit on the board of the foundation that oversees GASB.

All of this is setting off alarms in the offices of state and local issuers. "The SEC doesn't have a role in setting financial and accounting standards," says Jeff Esser, executive director of the Government Finance Officers Association. "That is a sovereign right of the individual 50 states." Esser acknowledges that the SEC plays an important role in investigating and prosecuting fraud -- but he thinks that's what it should stick to doing.

The issuing community points out that the muni bond default rate is one-tenth of 1 percent, and that has been the case for the past 30 years. That was, of course, before the very recent destablizing dynamics of the municipal bond market kicked in. The downgrading of bond insurance companies, based on exposure to subprime debt they insured, is creating turmoil for several municipal bond issuers, such as Jefferson County, Alabama, that relied on their bond insurers' triple-A rating.

History Lessons

While these problems may have nothing to do with disclosure, there clearly are some difficulties when it comes to transparency. Without adequate and up-to-date information about a jurisdiction's fiscal health, bond investors can get hurt. Cox points to several examples of such harm in the muni market. Some of them date back to 1983 but one of the more recent instances is San Diego.

The city was sanctioned by the SEC in 2006 for misleading bond investors about its ability to meet pension and retiree health care liabilities. It was a first for both San Diego and the SEC. The commission had never before taken action against a local government for being deceptive about the condition of a public pension fund.

While local government issuers may not see a pressing need for disclosure reform, some in the investor community do. The National Federation of Municipal Analysts, which looks after investor interests, has been outspoken in claiming that there isn't nearly enough reporting of relevant data and that investors need fresh information disclosed more frequently than is currently the case. Right now, the rules require only annual filing of information.

The simplest way for the federal government to impose such changes would be for Congress to step in and give the SEC authority to regulate some aspects of the muni bond market. This would require the repeal of existing federal laws, such as the Tower Amendment, that currently prohibit the SEC and the Municipal Securities Rulemaking Board from directly or indirectly requiring issuers to file documents with them prior to issuance of municipal securities.

That isn't likely to happen soon. Congressman Barney Frank, chairman of the House Financial Services Committee, opposes any such legislation. He believes that general obligation debts backed by the full faith and credit of states and localities do not need added federal regulatory burdens -- the issuers can be counted on to meet their commitments. "They may lay off teachers, they may lay off cops," Frank said recently, "but they're going to pay the bondholders." Christopher Dodd of Connecticut, Frank's counterpart on the Senate side, has expressed similar sentiments.

Waiting for EMMA

But there's a back-door way the feds have been able to get into muni bond regulation, and that is by setting rules for the broker-dealers who underwrite the bonds. The SEC has the authority to prohibit underwriters from bringing to market bonds that do not meet specified disclosure requirements. Currently, that information is filed with a NRMSIR -- one of four Nationally Recognized Municipal Securities Information Repositories. These were created more than a decade ago and are where state and local issuers send reports on their financial well-being and the sources of revenue they will tap to repay the bonds. But the NRMSIR system is difficult to use and provides little up-to-date information of real value to investors.

So the SEC is proposing a new central storage facility. It would be based on a similar system, known as EDGAR, that is in place for corporate issuers. Here, the SEC is gaining ground. The agency is working on a pilot to develop a clone to EDGAR for governments -- called EMMA -- that will provide a better system for filing disclosure statements and making them available to investors. EMMA, which could be operational within a few months, will provide a free place for issuers to file and for investors to get information.

Going After GASB

But more efficient disclosure won't end the controversy over just what role the SEC should play in the whole muni bond arena. One of Cox's other strategies is for the feds to establish more of a presence on the accounting boards that set the rules. Three of the 16 trustees on the board of the Financial Accounting Foundation, which oversees both private and government issuing -- are government seats. They always have been occupied by state and local officials. This year, the SEC tried to muscle in on that process by asking to nominate a candidate for one of the three government slots. This attempt was not greeted warmly by the state and local officials involved in the process. "Given that states are recognized as sovereign units of government," wrote South Dakota Treasurer Vern L. Larson, "the SEC should not be in a position to directly, or indirectly, select the government trustees that oversee the operations of the GASB." So far, Larson's position has prevailed.

There is one other thing Congress could do: mandate that states and localities follow GASB rules. Adherence to GASB rules is currently voluntary, except that any jurisdiction that does not follow the generally accepted accounting practices as interpreted for governments by GASB finds itself downgraded by credit-market analysts. This year, however, Texas passed legislation permitting its localities to ignore GASB rules on reporting retiree health care liabilities, and Cox sees that as a direct threat to undermine GASB rules overall. "There is every reason," he has said, "to worry about this erosion in current standards."

Still, for all the turmoil right now over the question of federal interference in muni bond regulation, major changes don't seem to be on the immediate horizon. Christopher Cox may still harbor an aggressive agenda for regulating the muni market, but that subject is unlikely to remain near the top of the SEC agenda at a time when the mortgage mess and its devastating effects on other financial markets are keeping both his agency and the U.S. Congress quite busy.