Municipal Bond Regulation: Time to Repeal the Tower Amendment?

Is it time to repeal the Tower Amendment? While politically such a change may be something of a hot potato, sometimes it takes a market adjustment to bring common sense to legislation. This is not the first time repeal has been floated of Tower, the 1975 amendment to the Securities Exchange Act of 1934 named for the then Texas Republican Senator John Tower which prohibits the SEC or the MSRB from requiring disclosures from municipal bond issuers before those securities can be sold to investors. But whether the mood in Congress is currently receptive to repeal or not, the SEC has been active in revamping municipal securities oversight and regulation.

The SEC in May approved more robust disclosure rules, and on Dec. 7, the SEC held the second “Field Hearing on the State of Municipal Markets featuring Chairman Mary Schapiro and three of the four SEC Commissioners. The new Rule 15c2-12, “prohibits brokers, dealers, and municipal securities dealers from purchasing or selling municipal securities unless they reasonably believe that the state or local government issuing the securities has agreed to disclose such things as annual financial statements and notices of certain events, such as payment defaults, rating changes and prepayments,” according to the SEC’s May announcement.

Tower Amendment Background

As SEC Commissioner Elisse Walter noted in a speech last year, the Tower Amendment was inserted into the Securities Acts Amendments of 1975, which created the Municipal Securities Rulemaking Board (MSRB). The amendment barred the “MSRB from requiring any issuer of municipal securities, either directly or indirectly, to make any filings with the Commission or the MSRB prior to the sale of securities,” Walter said in her speech. Some changes requiring more disclosure by municipalities have been made, but some are mandatory and others are “voluntary.”

In her speech, Walter also notes that the three reasons given for allowing municipal securities to remain exempt from these filings or disclosures “are no longer compelling.” The reasons were: “(i) the lack of perceived abuses in the municipal securities market, compared with the corporate market; (ii) the fact that the typical purchasers of municipal securities are institutional investors with financial expertise; and (iii) intergovernmental comity.^”

Investors’ demands for more transparency by municipalities, revealing the localities’ fiscal health—including ongoing pension liabilities—are not out of line. States and local municipalities are under pressure from three main sources: lower tax revenues because of falling home values and higher unemployment (reducing consumption), high pension liabilities for local and state workers and, in some cases, losses on securities that in certain cases were, perhaps, less than appropriate for the often unsophisticated elected officials in charge of investing for municipalities.

Due Diligence: Devil in the Details

Wealth managers and investment advisors of all kinds have turned to fixed-income securities, including tax-free and taxable municipal bonds, to provide income and diversification in clients’ portfolios. But fulfilling due diligence requirements is more complicated than ever with municipal bonds because of growing distrust of ratings agencies in the wake of the credit crisis, and the near-ruin of several of the monoline insurers of municipal bonds after their forays into insurance for derivative securities. No longer can investors rely on the rating or insurance alone—much deeper digging is required.

Issues with municipalities and underwriters of munis have led the SEC to require more disclosure of municipal “events” to the Municipal Securities Rulemaking Board’s (MSRB’s) new electronic “EMMA”  (Electronic Municipal Market Access System) system, as in the list below from the MSRB’s Dec. 1 announcement:

·         “principal and interest payment delinquencies

·         non-payment related defaults, if material

·         unscheduled draws on debt service reserves reflecting financial difficulties

·         unscheduled draws on credit enhancements reflecting financial difficulties

·         substitution of credit or liquidity providers or their failure to perform

·         adverse tax opinions, IRS notices or material events affecting the tax status of the security

·         modifications to rights of security holders, if material

·         bond calls, if material

·         defeasances

·         release, substitution or sale of property securing repayment of the securities, if material