August 28, 2018
Public Finance Alert
Public Finance Alert
The SEC recently adopted amendments to Securities Exchange Act Rule 15c2-12 to include two additional events that require notice in continuing disclosure undertakings. Municipal issuers, conduit borrowers and other obligated persons will be required to file a notice with the MSRB when they incur or amend key terms of debt obligations, such as direct placements, or upon the occurrence of any default or similar event that reflects financial difficulties. This alert discusses what municipal issuers, conduit borrowers, underwriters and other market participants need to know.
On August 15, 2018, the Securities and Exchange Commission (“SEC”) adopted amendments (the “Amendments”) to Securities Exchange Act Rule 15c2-12 to include two additional events that require notice in continuing disclosure undertakings. The Amendments require municipal issuers and borrowers to file a notice on the Municipal Securities Rulemaking Board’s (“MSRB”) Electronic Municipal Market Access website (“EMMA”) when they incur or amend key terms of debt obligations, such as direct placements, or upon the occurrence of any default or similar event that reflects financial difficulties.
Rule 15c2-12 provides that an underwriter cannot buy or sell a primary offering of municipal securities with an aggregate principal amount of $1,000,000, or more, unless it has “reasonably determined that an issuer of municipal securities, or an obligated person for whom financial or operating data is presented in the final official statement has undertaken … in a written agreement or contract for the benefit of holders of such securities, to provide” specified information annually and notice within ten business days of the occurrence of specifically identified events. The term “obligated person” generally refers to any person or entity, including a state or local governmental issuer, that is obligated to support payment of all or part of the obligations on such municipal securities.
In recent years, municipal issuers and conduit borrowers have increasingly turned to “direct placements” in the form of bank loans, direct purchase of securities by banks and other non-publicly offered debt. There presently are no federal securities laws or regulations that require municipal issuers or borrowers to immediately disclose information about this debt. While some information about non-publicly offered debt and other obligations is typically provided in annual continuing disclosure filings (e.g., financial statements), there can be a significant time lag between the time an obligation is incurred and the time it is disclosed to the public (if at all), particularly for infrequent municipal issuers. Furthermore, such annual continuing disclosure filings may not include all of the information regarding obligations that is material to holders of outstanding debt of a municipal issuer or borrower.
Currently, there are fourteen listed events in Rule 15c2-12 that require disclosure; the Amendments add required events fifteen and sixteen.
The Amendments add the following to the list of events for which notice must be given within 10 business days of occurrence:
“Financial obligation” is defined as “(i) a debt obligation, (ii) derivative instrument entered into in connection with, or pledged as security or a source of payment for, an existing or planned debt obligation; or (iii) guarantee of (i) or (ii).” Municipal securities as to which a final official statement has been provided to the MSRB consistent with Rule 15c2-12 are excluded from the definition of “financial obligation.”
For securities issued on or after the effective date of the Amendments: (i) listed event (15) will apply only to financial obligations incurred following the issuance of such securities, and (ii) listed event (16) will apply to any financial obligations of the obligated person, whether incurred before or after the issuance of such securities. A financial obligation is generally considered to be “incurred” when it is enforceable against an issuer or obligated person.
The Amendments reflect a narrower approach than the SEC originally proposed. When the SEC proposed the Amendments, it had originally included a much broader definition of “financial obligation,” which included leases and other ordinary financial and operating liabilities. In response to criticism from many commentators, the SEC narrowed the definition to only include debt obligations and related instruments.
Affected issuers and borrowers will need to adopt new policies and procedures.
Municipal issuers and borrowers who issue municipal securities subject to Rule 15c2-12 after the effective date of the Amendments should consider whether their continuing disclosure policies and procedures are sufficient to ensure their compliance with the new requirements. Currently, continuing disclosure policies and procedures are predominately focused on the content and timeliness of the annual continuing disclosure report, which is due at the same time each year. While the other listed events may occur during the course of a year, especially rating changes, the listed events previously have not touched on any general aspect of the financial or operating condition of an issuer or borrower. The Amendments change this. As discussed further below, municipal issuers and borrowers will need to develop continuing disclosure policies and procedures to track the incurrence of, and amendments to, their debt obligations, as well as defaults, in a manner that permits the filing of an event notice within 10 days of the event. In addition, the policies and procedures will need to include a mechanism for assessing the materiality of the financial obligation or related amendment.
The situation is more complicated for large issuers or borrowers with multiple departments responsible for the incurrence of debt obligations. The Amendments require the filing of a notice when any such department incurs, amends or defaults on the debt obligation (subject to the materiality determination). As a result, these issuers and borrowers will need to develop a system to track: (1) the incurrence of, and amendments to, the obligations across departments; (2) any defaults or similar occurrences relative to the obligations; and (3) whether the obligation (or related amendment) is material. In particular, the issuer or borrower will need to develop a policy that standardizes the determination of materiality for each department, to ensure consistent reporting under the Amendments.
The SEC excluded from coverage of the Amendments any municipal securities as to which a final official statement has actually been provided to the MSRB consistent with Rule 15c2-12 (as opposed to municipal securities as to which the underwriter is required to provide the final official statement to the MSRB). This means that municipal issuers and borrowers will now also need to confirm the filing of final official statements on EMMA to ensure that the underwriter complies with its obligation to make that filing; a task that municipal issuers and borrowers also should consider incorporating into policies and procedures.
Affected issuers and borrowers will need to develop an approach as to how to file event notices.
Municipal issuers and borrowers subject to the Amendments will also need to consider how to administratively comply with the new requirements. The SEC’s commentary on this topic suggests that municipal issuers and borrowers have considerable flexibility in determining how they will comply. The SEC states that, “[t]he Commission believes that, depending on the facts and circumstances, it could be consistent with the requirements of [Rule 15c2-12] for issuers and obligated persons to either submit a description of the material terms of the financial obligation, or alternatively, or in addition, submit related materials, such as transaction documents, term sheets prepared in connection with the financial obligation or continuing covenant agreements or financial covenant reports to EMMA. Any such related materials, if submitted as an alternative to a description of the material terms of the financial obligation, should include the material terms of the financial obligation.” Municipal issuers and borrowers will need to proactively consider how they will comply with the new requirements to ensure they provide consistent, effective disclosures of this information. In addition, financial obligations disclosed in event notices pursuant to the Amendments must then be incorporated into primary and secondary offering materials.
Underwriters will need to revise continuing disclosure due diligence policies.
Underwriters will need to revise their continuing disclosure due diligence policies and procedures to address these new event notice requirements. In particular, underwriters should consider what scope of due diligence they should perform with respect to municipal issuers and borrowers to determine whether they have complied with the new requirements. Information regarding the incurrence of, and amendments to, financial obligations, as well as defaults and similar events, could be located in a variety of sources (e.g., financial statements, financing documents and board minutes). In addition, unlike determinations as to whether an issuer has complied with its continuing disclosure obligations and the fourteen events currently required by Rule 15c2-12, due diligence of an issuer’s compliance with the two new required events will not be as objective and easily determinable.
The compliance date for the Amendments is 180 days following publication in the Federal Register.
The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel. If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct.