Municipalities and Their Continuing Disclosure Obligations
October 15, 2018
In light of recent SEC Rule changes, and aggressive enforcement, municipalities entering the bond market in 2018 and beyond should expect to see a heightened level of attention placed on continuing disclosure compliance. McNees recently hired a Continuing Disclosure Specialist to assist municipalities in meeting their obligations.
On December 20, 2017, Congress passed the Tax Cuts and Jobs Act (TCJA), the first major overhaul of the federal income tax code in other thirty years. The legislation was signed by President Trump on December 22, 2017, and many key provisions of the law went into effect on January 1, 2018.
One such provision was the reduction in the federal corporate income tax rate from 35% to 21%. The reduction in the tax rate, combined with multiple increases by the Federal Reserve in the federal funds rate, has caused tax-exempt rates of interest available to municipalities to rise substantially in 2018. The conventional wisdom indicates that these factors, during a time of economic expansion, has caused some banks to cut back on direct lending to municipalities.
For municipalities that have traditionally relied on such loans to finance their capital needs, the pool of available banks for such loans may shrink, with the remaining choices offering less attractive financial terms. Therefore, some of your municipal clients may want to consider a public offering of bonds as an alternative to a bank loan.
While the basics of a municipal bond transaction have not changed, if you have not participated in a public bond offering for a few years, you should expect to see some differences in how the transaction unfolds. For instance, you should anticipate seeing a heightened emphasis by the underwriter on confirming that your client has met its continuing disclosure undertaking responsibilities and is able to continue to meet those responsibilities in the future.
Continuing disclosure is not a new requirement in the municipal bond underwriting process. Under SEC Rule 15c2-12, an underwriter of municipal bonds may not market the bonds unless it obtains a written commitment from the municipal issuer to make periodic disclosure filings. Those filings generally consist of the municipality’s financial statements and certain operating data (updated on an annual basis), as well as disclosures of significant events specified by the Rule (such as rating changes or defaults on the bonds).
Municipal issuers that have not undertaken a public offering of bonds in recent years may be familiar with these “basics” of continuing disclosure, but may not be aware of the heightened interest the SEC has shown lately on this issue and ensuring that municipal issuers comply with their continuing disclosure obligations. Many in the industry trace this heightened interest to 2014, with the announcement by the SEC of its Municipalities Continuing Disclosure Cooperation (MCDC) Initiative.
Under MCDC, municipal issuers and underwriters were afforded the opportunity to self-report if they were involved in bond issues in the last five years in which the offering documents for the bonds did not accurately report the issuer’s historic compliance with Rule 15c2-12. For example, a municipal issuer might have chosen to self-report under MCDC if it had failed to disclose in an offering document that it had failed to file annual financial information for a prior bond issue.
The MCDC Initiative ended on September 10, 2014, and the SEC subsequently brought enforcement actions against a number of municipal issuers located throughout the country that had self-reported a variety of violations. Municipalities caught up in the enforcement initiative did not face monetary penalties in accordance with the settlement guidelines established by the SEC. Instead, the settlements generally focused on ensuring future compliance with the rule, by requiring issuers to establish appropriate policies and procedures and training regarding continuing disclosure obligations. The SEC has continued its aggressive enforcement of this issue since the MCDC Initiative ended, bringing actions against issuers and individual officials of issuers, alleging inadequate disclosure in offering documents. A municipal issuer entering the bond market in 2018 and beyond should expect to see during the underwriting process a heightened level of attention placed on continuing disclosure compliance.
Solicitors should also be aware that on August 20, 2018 the SEC approved amendments to Rule 15c2-12 which expand the types of disclosures that municipalities must make in connection with their public bond offerings. Previously, municipalities were not required to include in their written continuing disclosure commitment an agreement to disclose to investors the incurrence of bank loans and other financial obligations. With the passage of these amendments, however, municipalities must now disclose such obligations.
The amendments go into effect on February 27, 2019. A municipality that sells bonds after that date must include the new disclosure requirements in its written continuing disclosure commitment, and determine how the changes will affect their ongoing disclosure obligations with respect to those bonds. Municipalities also should revisit their existing policies and procedures on continuing disclosure to determine whether changes are warranted to address the new regulatory requirements.
If you need assistance with addressing your municipal clients’ continuing disclosure obligations, the attorneys and specialists at McNees can help.
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