SEC Urges Muni Issuers to Improve Forward-Looking Disclosures

Steven Lofchie Commentary by Steven Lofchie

SEC Chair Jay Clayton and the Director of the Office of Municipal Securities, Rebecca Olsen, urged municipal securities issuers to provide improved forward-looking disclosures to investors during the COVID-19 pandemic.

In a joint statement, Mr. Clayton and Ms. Olsen encouraged municipal issuers to disclose to investors information on (i) current operational and financial statuses (e.g., a decrease in, or delay in, the collection of revenue), (ii) un-budgeted costs due to an issuer's COVID-19 response and (iii) potential changes in financial conditions. Mr. Clayton and Ms. Olsen referenced a recent SEC statement as to forward-looking disclosures by corporate issuers and acknowledged differences between the municipal and corporate markets. They stated that the importance of "high quality disclosure" for each, however, is the same.

Mr. Clayton and Ms. Olsen advised municipal issuers to keep investors up to date on their respective financial and operational conditions to the fullest extent possible. They cautioned that, due to the impact of the COVID-19 on the markets, historical financial information (e.g., annual information filings) may not be sufficient. Mr. Clayton and Ms. Olsen also recognized the potential liability associated with additional voluntary disclosures, but argued that "there are various factors that generally weigh in favor of making these disclosures." These include:

  • aiding in the ability to refinance existing obligations and raise new capital;
  • when accompanied by additional cautionary language, reduction in legal risks;
  • ensuring consistency and helping to maintain confidentiality, and when disclosed, disclosed broadly; and
  • demonstrating "good faith," which would lessen the likelihood that the SEC would "second guess" the disclosure.

The regulators also stated that while certain safe harbors for forward-looking statements are not available to municipal securities issuers, "we believe that a municipal issuer’s approach to forward-looking disclosures should be informed by the judicially developed 'bespeaks caution' doctrine."

Commentary

The regulators are in a tough position. Not only is the pandemic news bad for many municipal issuers, the prognosis may be worse. Further, as SEC Chair Clayton and Director Olsen observe, the "municipal securities market is dominated by retail investors," largely because of the tax benefits provided to taxable holders of municipal securities (i.e., many investors in the municipal securities markets are not sophisticated and are the types of investors most in need of protections).

How much pressure should the SEC bring to bear on municipal issuers to provide negative information where (i) the provision of such information may impact an issuer's ability to provide services and (ii) the failure to provide such information is to the detriment of individual, unsophisticated retail investors? Judging by the regulators statement, the SEC answer, provided in a low-key manner, is to remind broker-dealers and investment advisers that they should "discuss the importance of issuer-specific and security-specific disclosures with the Main Street investors they serve and [] consider the extent of such disclosures when providing recommendations and investment advice to Main Street investors."

Against this backdrop, it is notable that the SEC pointed out that broker-dealers must be concerned with their suitability obligations and investment advisers with their fiduciary obligations. The adoption of Regulation Best Interest and similar, but in some cases more burdensome, state law obligations could discourage broker-dealers from making recommendations other than for very "generic" investments, such as broad-based funds. See, e.g., Choose One - Best Interest or Full Service. Will the risk of liability associated with investment recommendations discourage broker-dealers from selling municipal securities to their customers, or even from allowing customers to "roll over" existing investments? The SEC's statement as to disclosure is quite relevant to broker-dealers in this regard. See, e.g., the "Care Obligation" of Regulation Best Interest, which requires a broker-dealer to "exercise reasonable diligence, care, and skill" in the making of any recommendation and, among other things, to "understand the potential risks, rewards and costs associated with the recommendation." If a broker-dealer or investment adviser is concerned with the quality of a municipal issuer's disclosure, then prudence would urge the broker-dealer or adviser to steer its retail customers away from the issuer's securities.

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