Proposed Securities Rule Changes for Municipal Issues Focus on Bank Loans, Other Private Placements

March 30, 2017

SEC Proposed Amendments to Rule 15c2-12

On March 1, 2017, the Securities and Exchange Commission (SEC) proposed amendments to Rule 15c2-12 under the Securities Exchange Act of 1934 that would add two new events that municipal issuers or obligated persons must report as part of their continuing disclosure undertaking. 

Consistent with all other event notices, issuers or obligated persons would have to give notice within 10 business days after:

  • the incurrence of a financial obligation of the obligated person, if material, or agreement to covenants, events of default, remedies, priority rights, or other similar terms of a financial obligation of the obligated person, any of which affect security holders, if material; and
  • the default, event of acceleration, termination event, modification of terms, or other similar events under the terms of a financial obligation of the obligated person, any of which reflect financial difficulties.

The proposed amendments define a “financial obligation” to mean a debt obligation, lease, guarantee, derivative instrument, or monetary obligation resulting from a judicial, administrative or arbitration proceeding.

If adopted as proposed, the amendments would require that every new continuing disclosure undertaking entered into in connection with a primary offering of municipal securities include the two new events. (Continuing disclosure undertakings entered into prior to the effective date of the amendments would be unaffected.) As a result, every time an issuer or obligated person incurred a “material” financial obligation, the issuer or obligated person would be required to file an event notice on the Electronic Municipal Market Access (EMMA) system of the Municipal Securities Rulemaking Board (MSRB) that describes the terms of the financial obligation. Further, any time there was a modification, default, acceleration or other event affecting any financial obligation that reflects financial difficulties (even if that obligation existed prior to the effective date of the new events), the issuer would have to file a notice to EMMA describing that event.

SEC has indicated that the proposed amendments are designed to increase transparency in the secondary market regarding direct placements (such as bank loans from financial institutions and other lenders). For several years, the MSRB, Government Finance Officers Association (GFOA) and others have repeatedly called for voluntary disclosure of such arrangements.  The MSRB called for voluntary disclosure in 2012 and again in 2015, the GFOA released an alert in 2016.  As proposed, these amendments are broader than the disclosure parameters promoted by the MSRB and GFOA, especially the definition of “financial obligation.”

SEC staff indicated that the definition of “financial obligation” was derived from Form 8-K, which applies to registered companies. Under the proposed amendments, the lease of office equipment, a commodity supply contract, derivatives and obligations related to a judicial, administrative or arbitration proceeding would be “financial obligations” that must be reported if the arrangement was material to a specific party. Depending on the type of issuer or obligated person, there may be a large volume of financial obligations incurred in a given year — each of which would need to be scrutinized to determine whether it was material.  Further, the individuals responsible for continuing disclosure compliance (typically a finance professional) may not be aware that the issuer or obligated person has even entered into a “financial obligation.”

In the proposing release accompanying the proposal, the SEC indicated that the use of a “materiality” qualifier was designed to strike an appropriate balance between what is reported and what is not. However, the SEC did not provide any guidance on the meaning of the term “material.” Without a bright-line test, the proposed amendments would increase the amount of resources that both underwriters (as defined under Rule 15c2-12) and issuers and obligated persons would need to dedicate to promote compliance with the amended Rule 15c2-12. 

For example, issuers and obligated persons would need to identify all transactions that might meet the definition of a “financial obligation,” and then determine whether the transactions on that list were “material” and therefore needed to be filed on EMMA. The underwriters would need to undertake as part of their due diligence a significant level of investigation to determine whether each issuer or obligated person had complied with its undertakings related to these items. (Per the 2012 Risk Alert from the Office of Compliance Inspections and Examinations, underwriters cannot rely on representations of an issuer or obligated persons. See There could be significant discrepancies between the issuer’s view of what was “material” and that of the underwriter, leaving both parties in a difficult position regarding past continuing disclosure compliance.

Issuers and obligated persons would need to determine how best to disclose the material terms of each financial obligation on EMMA. The disclosure of material terms could be accomplished by posting the applicable documents in full (except for redactions consistent with those referenced in MSRB Rule G-34) or by drafting a summary of the financial obligation. Legal counsel may need to be engaged to review a summary as the EMMA posting would be subject to securities anti-fraud rules.

The full text of the proposed amendments to Rule 15c2-12 is available here. The proposed amendments are not yet effective; rather, the SEC is taking comments on the proposed amendments. The comment period will be open until May 15, 2017. As currently written, the revisions would become effective no earlier than three months after final approval of the proposed amendments, should they be adopted.

MSRB Proposed Amendments to Rule G-34

On March 1, 2017, the MSRB published draft amendments to, and clarification of, MSRB Rule G-34 (CUSIP Numbers, New Issues, and Market Information Requirements).  These amendments would, among other things:

  • broaden the definition of “underwriter” for purposes of Rule G-34 to make it clear that dealers acting as placement agents in private placement transactions, including direct purchases, are required to obtain a CUSIP number for the issue;
  • expand the application of Rule G-34 to include both dealer and non-dealer municipal advisors in competitive sales of new issues of municipal securities; and
  • clarify when a new CUSIP number is required for secondary market securities (for example, in cases where insurance is obtained for a portion of the issue or a remarketing results in changes to the terms of part of a maturity of an issue).

The effect of these amendments would be to require CUSIP numbers for privately placed transactions conducted through a placement agent. It is not clear whether the CUSIP requirement would also apply to a direct placement to a bank that is selected through a request-for-proposal (RFP) process, either handled directly by an issuer or obligated person or by a financial advisor rather than a placement agent. It is also not clear whether the CUSIP would need to be “DTC-eligible.”

MSRB staff indicated that these amendments are designed to protect secondary market participants when directly placed securities are transferred. Many direct purchasers and other lenders currently require that no CUSIP be obtained as part of a direct purchase transaction. There are several reasons why a lender may not want a direct purchase instrument to have a CUSIP number. Many view a CUSIP number as a factor that weighs in favor of determining a direct purchase instrument to be a security rather than a loan. Whether a direct purchase instrument is a loan or a security has a wide-ranging impact on both dealer and non-dealer municipal advisors, issuers, obligated persons and direct purchasers, including, in particular, banks.

MSRB indicated that it does not view a CUSIP number as a factor in the loan/security analysis. MSRB cited syndicated lending transactions in the taxable market that carry a CUSIP number (that is not DTC-eligible) that are regularly characterized as loans instead of securities. 

MSRB has asked for comments on several aspects of the amendments. Most importantly for many direct placement participants, the MSRB has asked whether the amendments should contain an exemption for direct placements to a single purchaser.

The deadline for submitting comments on the proposed amendments is March 31, 2017. The full text of the amendments and the request for comment are available here.