New Provisions for Disclosure Required by the Municipal Securities Rulemaking Bureau

March 2019 | Article

On February 27, 2019, the Securities and Exchange Commission (SEC) announced two rule changes that may increase required disclosure by states and local governments that incur debt of any sort with total outstanding debt balances (for the entire government) above $1,000,000. The two new rules issued were:

  • Financial Obligation – Incurrence or Agreement
  • Financial Obligation – Event Reflecting Financial Difficulties

The required disclosure is made on the Electronic Municipal Market Access (EMMA) website, which is managed by the Municipal Securities Rulemaking Bureau (MSRB). Debt issuers are required to provide certain information to EMMA to increase the transparency of the municipal security market. EMMA provides free public access to municipal securities information, bond pricing, annual financial reports and compliance information for investors.

Rule Changes
The amendment changes the Securities Exchange Act of 1934, Title 17 Code of Federal Regulations (CFR) part 240.15(c)(2)(12) commonly known as “Rule 15c2-12.” The amendment changes the list of events for which notice is required on the EMMA website. Additional required disclosures now include:

  • Incurrence of a financial obligation, if material, or agreement to covenants, events of default, remedies, priority rights or similar—any of which affect security holders (debtholders) if material.
  • Default, event of acceleration (speeding up of payments due to a lender), termination event, modification of terms or similar event—any of which reflect financial difficulties.

These two new elements are additions to the original 14 events that require filings by issuers on EMMA under Rule 15c2-12. The other 14 triggering events in existence prior to the rule change are as follows:

  • Principal and interest payment delinquencies
  • Material non-payment related defaults
  • Unscheduled draws on debt service reserve funds (sign of financial difficulties)
  • Unscheduled draws on lines of credit or credit enhancements (also a sign of difficulty)
  • Adverse tax notices or events causing the debt to be taxable
  • Modifications of the rights of security holders
  • Bond calls or tenders
  • Defeasances (refunding transactions or cash defeasances)
  • Release, substitution or sale of property that secures the debt
  • Ratings changes
  • Bankruptcy, insolvency, receivership or oversight by another government
  • Merger, acquisition, or sale of assets
  • Appointment of a successor trustee
  • Substitution of credit or liquidity providers, or if they fail to perform

Any of these events require filing on EMMA within 10 days.

The SEC has clarified the term “financial obligation” to mean:

  • Debt obligations (of any sort)
  • Derivative instruments in connection with, or security of an existing or planned debt obligation (a hedge)
  • A guarantee of either (which the GASB terms as a nonexchange financial guarantee)

What Does This All Mean?
Incurrence of a financial obligation upon agreement with a lender (or potentially even a lessor) may change the status of the standing of any entity or person who is owed from the debt issuance. For example, assume a city signs a lease that is material with a landlord that requires the landlord to be paid in advance of all other debt, and therefore, the landlord has a senior lien to all the other holders. However, an issue arises when all other covenants on existing debt are supposed to be in a senior lien position. Due to the signed lease agreement, the debt holders no longer have senior lien status. The SEC would then require the other holders to be notified on EMMA, usually within 10 days and in accordance with existing continuing disclosure agreements. Securities holders may have a problem with this change, as the value of their debt may not be the same as it was prior to the lease signing.

In addition, related to the financial obligation definition is the disclosure of events reflecting financial difficulties. This may include the requirement of acceleration of payments, terminations and modifications of terms, which reflect financial difficulties. Continuing with the example of the lease that is material, assume that the city agrees with the landlord to restructure the payment terms due to some circumstance. Instead of paying monthly, the lease is paid annually with an interest rate adjustment. If this is material, disclosure would be required as it may reflect financial difficulties at the city.

Caution: All Forms of Debt Are Included
The SEC rule changes do not distinguish between bonds, certificates of participation, notes, loans, direct borrowing, direct placement or other forms of debt. As governments are implementing GASB Statement Nos. 87, Leases and 88 Certain Disclosures Related to Debt Including Direct Borrowing and Direct Placements, these new rules should be understood. For example, if a lease that is currently an operating lease is now required to be reclassified to a lease liability in accordance with the provisions of GASB-87, the SEC rules may be triggered.

Disclosure also appears to be required retroactively by the SEC for all existing forms of debt, but this should be confirmed with bond counsel.

What if Governments Do Not Comply?
Noncompliance could be a serious matter. At the very least, bond offering statements may be required to give notice of the noncompliance for five years. This may also hinder access to potential buyers of the government’s debt and may increase interest rates. The nationally recognized statistical ratings organizations (rating agencies) may adjust the government’s debt ratings or outlook based on the noncompliance. Finally, cases have occurred where the SEC has charged the issuer with securities fraud and levied fines due to inaccurate filing of EMMA notices.

What Should I Do Now?
First, consult with bond counsel on these changes and how they may impact your government. Next, if the disclosure is material, file the proper EMMA notice and include the information in the annual financial report. Your Eide Bailly professional is here to work with you to provide assurance that the disclosure is in accordance with generally accepted accounting principles.

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