A Muni Bond Warning

Current law prohibits it, but the SEC chairman is talking about reasons to regulate the municipal bond market.
by | June 2007

The federal government may be backing into the business of regulating state and local finances. At least, that is the specter raised by a recent suggestion from the federal Securities and Exchange Commission Chairman Christopher Cox that his agency set disclosure rules for those issuing municipal bonds.

Among state and local finance officials, the response to that idea is obvious: No way. Having to meet new requirements, they say, would raise their costs for borrowing and add complexity to transactions. "As a matter of federalism, states should be allowed to regulate the issuance of their own municipal securities," says Dan DeSimone, of the National Association of State Treasurers.

That's long been the prevailing arrangement. The Depression-era legislation that set up the SEC and securities regulation specifically exempted municipal bonds. Such exemptions were reiterated in 1975, when Congress created a municipal securities rulemaking board. "As a result," says Paul Maco, former director of the SEC's Office of Municipal Securities, "the SEC does not have the authority to prescribe the forms and content of disclosure in the same way that it does for publicly traded companies."

What the SEC can do is step in to pursue enforcement actions after there has been clear wrongdoing. That is what brought the agency to San Diego, where it sanctioned the city last November for securities fraud and failure to disclose important information to bond buyers. The SEC also has been involved in Philadelphia's big pay-to-play scandal, which partially involves the city's bond business and has resulted in the former city treasurer, among others, going to jail.

Cox, as a U.S. congressman, represented a district that included Orange County, California, during that entity's 1994 bankruptcy. "Our enforcement program is focused on fraud in this area," Cox told The Bond Buyer in March, "because the protection of retail investors is so central to our mission."

Jeffrey Esser, executive director of the Government Finance Officers Association, says that the $2.3 trillion muni bond market remains a safe haven for investors both because the government default rate is microscopically low and because government, by its nature, is more transparent than corporations. "The SEC is looking at a couple of anecdotal stories about governments that have been a problem," he says, "and it's extrapolating from those problems the idea that all state and local governments are in need of federal regulation."

It's easy to find out a lot of information about a state such as California, notes Thomas Weyl, a municipal bond researcher in Boston. His concerns rest with non-governmental issuers of muni bonds, such as corporations doing pollution-control projects. "There is no direct regulator," Weyl says. "We do a pretty good job in the market, but we're not perfect."

Cox has yet to put a formal proposal before his own commission, let alone push for legislation on Capitol Hill. The congressional banking committees have so far shown little interest in taking on this fight, although one New York congressman has.

All that may change in the coming months, but in the meantime, it's possible that the chairman floated his idea simply as a warning to muni bond issuers: Fix your problem areas, or we're going to fix them for you.