Financial Regulatory Forum

ANALYSIS-New Jersey case puts U.S. muni issuers on alert

By Reuters Staff
August 20, 2010

By Lisa Lambert and Joan Gralla

WASHINGTON/NEW YORK, Aug 19 (Reuters) – Municipal bond issuers are on high alert after the Securities and Exchange Commission charged the state of New Jersey with fraud for failing to disclose to bond buyers it had underfunded the state’s pensions.

The SEC move on Wednesday was groundbreaking for several reasons. It was the first time the SEC charged a state for violating federal securities laws. New Jersey agreed to settle the case.

It also highlighted the increasing attention the federal government is paying to those who sell municipal bonds, the tax-exempt debt that pay for roads, bridges, schools and hospitals.

“Issuers of municipal bonds must be held accountable when they seek to borrow the public’s money using offering documents containing false and misleading information,” said Elaine Greenberg, Chief of the SEC’s Municipal Securities and Public Pensions Unit, in announcing the charges.

A 1975 securities law known as the Tower Amendment has long been considered a shield for muni issuers against federal intervention because it bars the U.S. government from requiring issuers to file municipal securities documents with the SEC before the securities are sold.

A self-regulatory organization, the Municipal Securities Rulemaking Board, drafts the rules governing broker and dealer operations that the SEC enforces. Since Tower was passed, muni issuers have used the spirit of the amendment to oppose any further regulation.

“Our view … is that this is sort of the beginning,” said Jon Teall of New York’s Teall & Associates, a financial communications firm.

“The SEC can’t require issuers to produce documents” said Teall, who has worked at The Bond Market Association, Standard & Poor’s and Lipper Analytical Securities. Broker-dealers “have to get a promise from issuers that they will disclose.”

“It seems like New Jersey did something unusual here, to say the least, and what our guys will do and other issuers will do is be very careful,” he said. “But we can’t compel. All we can do is get the promise.

The SEC, under Chairman Mary Schapiro, has begun investigating ways to work around the Tower Amendment. One member, Elisse Walter, has called outright for its repeal.

The commission has increased the number of staff dedicated to investigating possible fraud to meet Schapiro’s aim of increasing investor protections and demanding better disclosure in the municipal bond market.

“New Jersey only feeds into that,” said Mike Nicholas, chief executive officer of the Regional Bond Dealers Association in Washington, about how the charges support the SEC’s argument on the need for better disclosure.

The senior vice president of government relations for the group, William Daly, said the New Jersey case “is an outlier but it is an indication” of how much more interested the federal government has become in municipal bonds.

This past winter, the National Association of State Treasurers discussed compromises and ways to work with the MSRB and SEC in changing federal regulation of munis.

The financial regulatory overhaul recently signed into law has drawn issuers more into the process of setting rules for the market by requiring they have heavier representation at the MSRB. It also calls for a study of the Tower Amendment.

Since 2007, the MSRB and SEC have rallied to increase disclosure in the municipal bond market, emphasizing timeliness and accuracy in documents.

Recently, the SEC has begun requiring broker-dealers to disclose more about how they define “retail order periods,” a fairly flexible time when individual investors can buy new bonds before they are sold to institutional investors.

“This is going to be an increased area of focus,” said bond lawyer Teri Guarnaccia of Ballard Spahr, LLP, on Wednesday after learning about the New Jersey charges.

“They’ve been very public about increased scrutiny of the municipal market and wanting to be clear about what states are doing in the marketplace.” ((Reporting by Lisa Lambert and Joan Gralla; Editing by Gary Crosse)) ((lisa.lambert@thomsonreuters.com; +1-202-898-8328; Reuters Messaging: lisa.lambert.reuters.com@reuters.net))

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