Federal Government Steps Up Monitoring of Distressed Municipalities

Multiple news outlets have reported that the U.S. Treasury Department has created an Office of State and Local Finance tasked with monitoring the distressed local government sector of the municipal finance market. Kent Hiteshew, a veteran public finance banker at JP Morgan Securities, will head the new office, beginning in May. This development is the latest evidence of the federal government’s intensifying scrutiny of financially distressed municipalities.

The new office will focus on evaluating problems in state and local finance, including unfunded pension and other liabilities, as well as watching the municipal bond market generally. The office will apparently have no authority to write or enforce tax or other regulations or to provide financial assistance to state or local governments. Instead, it is expected to aid in developing potential federal policy responses to financially strapped governments and adverse developments in the municipal bond market relating to such credits.

As numerous state and local governments confronted fiscal distress following the 2008 financial crisis, and still face often daunting problems created by lagging revenue and unfunded pension and other liabilities, some have reached out to the federal government for assistance. The Office of State and Local Finance was apparently organized in response to such inquiries to address them in a centralized and cohesive fashion.

The news reports on the new Treasury Department office follow recent public statements about investigative activity focused on financially distressed municipalities by officials from the Municipal Securities and Public Pensions Unit in the Securities and Exchange Commission's Enforcement Division. The unit is examining whether such municipalities have properly disclosed the nature and extent of their distress and whether the causes of their ongoing financial struggles have been accurately and adequately disclosed to the investor community. The SEC believes that some distressed municipalities may not be adequately disclosing their fiscal challenges, and also may be more likely to lack full and timely compliance with their secondary market disclosure undertakings.

This new SEC scrutiny in this sector harkens back to many of its findings in its cease and desist order and settlement with the City of Harrisburg, Pennsylvania, in 2013, which we previously reported here. The City was charged with making material misstatements in public statements and failing to comply with its continuing disclosure undertakings.

In reaction to the SEC’s perception of widespread noncompliance with secondary market disclosure obligations, the agency recently launched its new Municipal Continuing Disclosure Compliance (MCDC) program described here. The program was designed to encourage local governments to self-report failure to disclose their noncompliance with their continuing disclosure undertakings. The MCDC program offers favorable settlement terms but expires on September 10, 2014.

Local governments facing financial distress should begin reviewing their compliance with secondary market disclosure undertakings over the past decade and confirm that such compliance was accurately reported in all primary offerings in the past five years. If any noncompliance is found, issuers should consult with counsel to determine whether it may warrant self-reporting under the MCDC.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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