SEC Issues Investor Alert and Underwriter Best Practices for the Issuance of Municipal Bonds

Posted on March 19th, 2012 at 9:42 AM

The Securities and Exchange Commission (SEC) has issued investor and underwriter guidance with respect to municipal bonds.  For investors, the SEC issued an Investor Bulletin addressing the key concepts associated with investing in municipal bonds.  For underwriters, the SEC issued a National Examination Risk Alert entitled, Strengthening Practices for the Underwriting of Municipal Securities.  Let’s examine the key points of each publication.

            First, regarding the Investor Bulletin, the SEC sets forth a basic definition of municipal bonds.  The bulletin then discusses the two most common types of municipal bonds.  They are: General Obligation bonds (which are bonds backed by the “full faith and credit” of the issuer, which has the power to tax residents to pay bondholders); and Revenue bonds (which are not backed by the government’s taxing power buy only by the revenues generated from the underlying, specific project or source).  Another type of bond is known as a “conduit”.  In those situations, municipal borrowers sometimes issue bonds on behalf of private entities such as a non-profit colleges or hospitals, which then agree to repay the issuer, which in turn pays interest and principal on the bonds.

            The Investor Bulletin also recites some basic risks associated with the ownership of bonds (municipal bonds or corporate bonds).  Those risks are: call risk (the risk that an issuer will pay a bond before its maturity date if interest rates decline); credit risk, including default risk (when the issuer may experience financial problems making it difficult to pay interest and principal in full); interest rate risk (where the price of the bond moves up or down depending upon the movement in interest rates); inflation risk; and liquidity risk (when investors cannot find an active trading market for the bond).  Given all of the risks associated with investing in bonds, investors must do their homework before investing.

            The second SEC publication has resulted from the SEC’s “concerns about the extent of written documentation by broker-dealers of due diligence efforts and supervision of municipal securities offerings.”  This second publication is more technical and substantive than the first publication, and includes best practices for financial services firms to consider implementing to satisfy their duty of due diligence and supervisory review.  Let’s highlight some of the more important points.

            The SEC first establishes that municipal underwriters have a due diligence obligation.  By participating in an offering, the financial services firm underwriting the offering makes an implied representation “that it has a reasonable belief in the truthfulness and completeness of the key representations made in any disclosure document used in the offering.”  In particular and as an example, a municipal securities underwriter must “obtain and review” a “deemed final” official statement, prior to bidding for or purchasing those securities.  The SEC cites its own Release issued in 2010, which set forth a number of requirements.  Among them, the 2010 Release states that “sole reliance on an issuer will not suffice in meeting an underwriter’s ‘reasonable basis’ obligations.”

            Regarding supervisory obligations, the SEC cites particular MSRB (Municipal Securities Rulemaking Board) rules, which require financial services firms to supervise the conduct of their employees in connection with their municipal securities activities.  Firms must establish and enforce written policies and procedures.  Part of enforcement includes implementing “measures to monitor compliance with those policies and procedures and an appropriate system of follow-up and review if red flags are detected.” 

            Helpfully, the SEC provides a non-exclusive list of six factors “that it believes generally would be relevant in determining the reasonableness of an underwriter’s basis for assessing the truthfulness of key representations in a final official statement.”  They are:

  • The extent to which the underwriter relied on municipal officials and other persons whose duties have given them knowledge of particular facts;
  • The role of the underwriter;
  • The types of bonds being offered;
  • The past familiarity of the underwriter with the issuer;
  • The length of time until maturity of the securities; and
  • Whether the bonds are competitively bid or are distributed in a negotiated offering.

The SEC provides additional, helpful examples of practices used by financial services firms which may help to demonstrate due diligence and supervisory reviews.  Those examples are: Commitment Committees (which are firm-wide, senior level committees that review and approve various underwritings); use of diligence checklists; due diligence memoranda (describing due diligence efforts, issues noted and how those issues were resolved); outlines for due diligence calls; on-site examination activities; and recordkeeping checklists.

As one can see, the SEC has issued a pair of publications that will assist both municipal bond investors and municipal bond underwriters alike!  


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Thank You from the bottom of our hearts for all you have done for us. When we realized this was a very bad investment - we did not know where to turn for help. Then we received your name. When we called you - you were so kind to us and then agreed to help us. For this we are so very grateful. The world would be a much nicer place if there were more people like the two of you in it. We will always remember all the help and kindness you have shown us. Thank you so very very much for everything.

Wayne and Judy S.


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