The Securities and Exchange Commission (the "SEC") is proposing to amend its Rule 15c2-12 to expand the list of event disclosures that must be provided by issuers of municipal securities ("issuers") and conduit borrowers ("obligated persons") pursuant to continuing disclosure undertakings required in most new offerings of municipal securities (the "SEC Proposal").[1] The SEC Proposal is designed to make more widely available information about financial obligations of issuers and obligated persons, such as bank loans and direct bond sales, that could have an impact on holders of outstanding municipal securities but for which disclosure generally is not available through the Electronic Municipal Market Access (EMMA) system operated by the Municipal Securities Rulemaking Board (the "MSRB").
While arising from concerns regarding the impact on bondholders of the growth of the bank loan and direct sale market as an alternative to traditional municipal bond offerings, including the lack of disclosure regarding the incurrence and terms of such alternative financings,[2]the SEC Proposal reaches well beyond these types of transactions to include disclosure of the incurrence of, and the occurrence of certain adverse events with respect to, a broader range of so-called "financial obligations" of issuers and obligated persons. If adopted as proposed, the potential breadth of the SEC Proposal may have considerable impact on the level of effort required of issuers, obligated persons and underwriters in connection with municipal securities disclosure.
The SEC Proposal will be open for comment until 60 days after publication in the Federal Register. Issuers, obligated persons and underwriters should consider carefully what new efforts they would need to undertake in light of the SEC Proposal so that they can provide constructive comments to the SEC, with the goal of ensuring that any new requirement that the SEC may ultimately adopt is properly tailored to meet the goal of better disclosure to investors without creating undue disruptions or other burdens to the municipal market that might outweigh the desired benefits.
PROPOSED NEW CATEGORIES OF EVENT NOTICES
The SEC Proposal would establish two new categories of information relating to "financial obligations" of an issuer or obligated person[3] for which an event notice would be required under Rule 15c2-12, in addition to the existing 14 categories of event notice disclosures. The issuer of or obligated person would be required to file with EMMA, within ten business days of occurrence, notice of:
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incurrence of a financial obligation of the issuer or obligated person, if material, or an agreement to covenants, events of default, remedies, priority rights, or other similar terms of a financial obligation, any of which affect security holders, if material; and
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a default, event of acceleration, termination event, modification of terms, or other similar event under the terms of a financial obligation, any of which reflects financial difficulties.
Financial Obligations. The SEC Proposal defines "financial obligation" as a (i) debt obligation, (ii) lease, (iii) guarantee, (iv) derivative instrument, or (v) monetary obligation resulting from a judicial, administrative, or arbitration proceeding. The term excludes any bond issues for which the official statement has been filed with EMMA consistent with Rule 15c2-12.
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Debt obligation - includes short-term and long-term debt obligations under an indenture, loan agreement, or similar contract
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includes transactions not subject to Rule 15c2-12, such as a direct purchase of municipal securities by an investor and a direct loan by a bank
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while excluding municipal securities issues subject to Rule 15c2-12 for which an official statement has been filed with EMMA, it does not exclude issues:
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exempt from Rule 15c2-12 that: (a) are under $1 million; (b) are sold in limited offerings to no more than 35 sophisticated investors in denominations of $100,000 or more; (c) mature in nine months or less; or (d) are puttable with reset periods of nine months or less (e.g., variable rate demand obligations), sold in denominations of $100,000 or more[4] - in effect, even though no official statement is required for these issues, a notice of incurrence of debt would now be required for each of these exempt issues
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subject to Rule 15c2-12 but where the underwriter fails to file the official statement with EMMA
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Leases - includes capital leases as well as operating leases that may not normally be considered a debt instrument under existing law
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Guarantees - includes contingent financial obligations to secure obligations of the issuer or obligated person, or of a third party (i.e., not limited to guarantees incurred in connection with an issuer's or obligated person's own debt obligations), and would include self-liquidity facilities or other similar contingent arrangements
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Derivative instruments - includes swaps, security-based swaps, futures contracts, forward contracts, options or similar instruments to which an issuer or obligated person is a counterparty, including instruments that may be developed in the future, and is not limited to derivatives entered into in connection with an issuer's or obligated person's debt obligations but would also include arrangements such as commodity supply forward contracts or similar derivative products
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Monetary obligations resulting from judicial, administrative, or arbitration proceedings - includes monetary obligations resulting from a final judgment or decision, as well as from a settlement order or consent decree, in such proceedings, which proceedings need not have any relation to debt obligations of an issuer or obligated person[5]
With regard to materiality, the SEC suggests that a financial obligation may be in an amount sufficiently small that, absent other circumstances, it would not raise the concerns that the SEC Proposal is intended to address.
Contract Terms of Financial Obligations. The SEC Proposal covers not just the incurrence of financial obligations, but also specific key terms of such financial obligations. The SEC Proposal would require disclosure of an agreement by an issuer or obligated person to covenants, events of default, remedies, priority rights or other similar terms of a financial obligation, if any of these terms affect security holders and if material. The SEC provides a broad basis for assessing the sweep of the term "other similar terms" by stating that such provisions could be those creating liquidity, credit or refinancing risks that could affect the liquidity and creditworthiness of an issuer or obligated person or the terms of the securities they issue.
The SEC Proposal includes several examples illustrating terms of a financial obligation that would be covered by this provision, such as:
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Covenants more restrictive than those applicable to outstanding municipal securities, such as a requirement to maintain a higher debt service coverage ratio
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Events of default differing from those applicable to outstanding municipal securities so that the counterparty to the financial obligation could assert remedies prior to existing security holders
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Different remedies from those provided to existing security holders (such as an earlier acceleration trigger) that would effectively prioritize the payment of the financial obligation over outstanding municipal securities
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Superior rights in assets or revenues previously pledged with respect to outstanding municipal securities
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As an example of "other similar terms," a balloon payment at maturity creating a refinancing risk that could compromise the issuer's or obligated person's liquidity and creditworthiness, or its ability to repay outstanding municipal securities
With regard to materiality, the SEC notes that a financial obligation term providing senior position in the debt payment priority structure that affects existing security holders likely would require disclosure, potentially even if the amount of the financial obligation otherwise might be sufficiently small that it would not typically raise the concerns that the SEC Proposal is intended to address.
Events Reflecting Financial Difficulties. The SEC Proposal would require notice of default, event of acceleration, termination event, modification of terms or other similar event under the terms of a financial obligation, if such event reflects financial difficulties. While this provision does not have a materiality standard, the event must reflect financial difficulties.[6] In contrast, such an event could occur, with substantial financial or other consequences, but would not trigger an event notice if it did not reflect financial difficulties, but instead simply constituted a permitted exercise of rights.
In distinguishing a "default" from an "event of default," the SEC observes that a non-monetary default may, if not cured within the permitted cure period, become an event of default. Nonetheless, this provision of the SEC Proposal applies to "defaults," rather than "events of default," raising the potential that a non-monetary default with a cure period in excess of ten business days would be disclosable even if the default is cured before giving rise to an event of default.
Further, in illustrating the term "other similar events," the SEC suggests that an event notice could be required if an issuer or obligated person fails to meet, due to financial difficulties, a construction deadline for a facility financed with a financial obligation, and this failure results in the lender becoming entitled to take possession of the facility and complete construction, even if the failure is not a default under the financial obligation.
NATURE OF NEW EVENT NOTICES
Timing. An event notice must be filed with EMMA no later than ten business days after the occurrence of the event. The actual incurrence of a financial obligation would trigger the obligation to disclose. Generally, this is when the obligor agrees to the specific contract terms of the financial obligation and the simultaneous incurrence of the associated financial obligation. It appears that any new or material changes to such covered terms agreed to after the initial incurrence of the associated financial obligation would trigger a separate notice that must be filed within ten business days after agreement to such new or materially changed term. Notices of events reflecting financial difficulties would be triggered by the occurrence of such events.
Content. The SEC states that a notice of incurrence of a financial obligation and agreement to specific terms thereof generally should include a description of the material terms of the financial obligation, such as the date of incurrence, principal amount, maturity and amortization, interest rate, if fixed, or method of computation, if variable (and any default rates). The SEC states that other terms may be appropriate as well, depending on the circumstances. Further, the SEC states that such notice would include the agreed-to covenants, events of default, remedies, priority rights or other similar terms of the financial obligation that may impact security holders.
With regard to the content of a notice of an event reflecting financial difficulties, the SEC states that such notice generally should include a description of the event and the consequences of the event, if any.
OPERATIONAL CONSIDERATIONS FOR ISSUERS AND OBLIGATED PERSONS
The breadth of the types of financial obligations (including the need to determine whether a financial obligation is material), the relevant contract terms thereof (including the need to determine whether a term materially affects security holders), and the events that can trigger a notice requirement (including the need to determine whether an event reflects financial difficulties) suggests the potential for far-ranging impacts on the manner and extent of self-monitoring and reporting that issuers and obligated persons will need to institute in connection with their outstanding bonded debt and other financial obligations. Whereas existing continuing disclosure requirements under Rule 15c2-12 are focused specifically on matters relating to an issuer's or obligated person's municipal securities issues (or, in limited circumstances, related to significant overarching organizational matters such as audited financial statements, bankruptcy or merger), these new disclosures may include obligations or activities that in some cases are remote from the issuer's or obligated person's bond program, including in particular activities that are not viewed primarily as financial in nature. Because these disclosures are event notices, disclosable information must be identified on an on-going "as it happens" basis, rather than as a periodic activity, and the information must be routed, assessed, summarized and filed with EMMA within ten business days of occurrence. Many issuers and obligated persons, depending on the nature of their capital and other financial programs, may find that they need to establish significant new processes in order to stay in compliance with the SEC Proposal.
Note that, unless significant changes are made by the MSRB to the submission and public access process on EMMA with respect to the SEC Proposal, the disclosures relating to financial obligations would primarily appear as continuing disclosures indexed to existing municipal bond offerings, rather than as standalone disclosures indexed to the issuer's or obligated person's financial obligations. In this regard, issuers and obligated persons would need to determine whether the new disclosures required under the SEC Proposal would be posted as continuing disclosures to all of their municipal bond offerings or only to specific issues for which the issuer or obligated person has determined such disclosure is material.
OPERATIONAL CONSIDERATIONS FOR UNDERWRITERS
Underwriters may find that they need to apply heightened levels of effort in undertaking their required due diligence for new issues of municipal securities in connection with the issuer's or obligated person's official statement disclosures regarding past continuing disclosure compliance. In particular, underwriters will need to consider whether they have a reasonable basis to believe that the issuer or obligated person has properly disclosed any instances of material non-compliance with these new obligations, which entail the issuer or obligated person being able to properly identify and assess its material financial obligations, the relevant contract terms materially affecting security holders, the occurrence of relevant events reflecting financial difficulties, and the outstanding issues of municipal securities for which the financial obligations are material.
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[1] See Exchange Act Release No. 80130 (March 1, 2017).
[2] The MSRB has highlighted regulatory implications of alternative financing options and urged voluntary disclosure through EMMA. See, e.g., MSRB Notice 2016-12 (April 4, 2016); MSRB press release dated September 26, 2016. More recently, the MSRB and other market participants have asked the SEC to amend Rule 15c2-12 to include disclosures of bank loans and direct purchases.
[3] While the rule language only refers to obligated persons and not to issuers, Rule 15c2-12 includes issuers within the definition of obligated person to the extent the issuer retains some responsibility for repayment of the bonds and for making continuing disclosures. The SEC Proposal would not apply to financial obligations of a conduit issuer that is not an obligated person.
[4] It is not clear whether an issue exempted under Rule 15c2-12 but for which an official statement has been filed with EMMA (under MSRB Rule G-32 or on a voluntary basis) would be considered a financial obligation triggering the event notice requirement.
[5] While payments owed by an issuer or obligated person under a non-financial contract might not be considered a financial obligation, if a dispute with regard to the contract resulted in a judicial, administrative or arbitration judgment, decision or settlement that included a payment obligation (even if in a lesser amount than the contract payment amount), the monetary obligation arising from such dispute would itself be considered a financial obligation.
[6] Presumably, an event that in itself is not material may be viewed by the SEC as a "canary in the coal mine" if it nonetheless has been triggered by the financial difficulties of the issuer or obligated person.
