Disclosure and Accounting Practices in the Municipal Securities Market

Disclosure and Accounting Practices in the Municipal Securities Market

Introduction

Many critically important aspects of American life, from airports to sewers and schools to hospitals, depend on the municipal securities market for financing. All bonds, notes and other debt securities issued by states and local governments and their respective agencies and instrumentalities are “municipal securities.” They are issued by such government entities to pay for a variety of public projects, cash flow and other governmental needs and, by acting as a conduit on behalf of private organizations who wish to obtain tax-exempt interest rates, to fund non-governmental private projects.1 Maintaining the health of this key component of our capital markets is important to every resident of the United States not least to the millions of individuals who invest in municipal bonds. To this end, staff of the Divisions of Corporation Finance, Enforcement and Market Regulation and of the Office of Chief Accountant of the Securities and Exchange Commission would like to bring to your attention some of our ongoing concerns about investor access to full and accurate information regarding municipal issuers and their securities.

A number of Commission enforcement actions have highlighted continued disclosure weaknesses, raised concerns about governmental accounting, and suggested the need for improvements to disclosure practices. These enforcement actions involved allegations that in disclosure documents used in offerings or other information provided to investors:

• the City of San Diego, California failed to disclose the gravity of its enormous pension and retiree health liabilities or that those liabilities had placed the City in serious financial jeopardy;2

• the City of Miami, Florida failed to disclose an unprecedented cash flow shortage which it had eased, in part, by spending the proceeds of bonds issued for other purposes for operating costs;3

• Maricopa County, Arizona failed to disclose a material decline in its financial condition and operating cash flow, the substantial deficit in its general fund, and increased deficit in another fund;4

• the City of Syracuse, New York falsely claimed a surplus for its general and debt service funds, materially overstated its ending fund balances in those funds, and misled investors by describing certain financial information as audited;5

1 The Internal Revenue Code delineates the purposes for which tax-exempt municipal bonds may be issued for the benefit of organizations other than states and local governments, i.e., conduit borrowers.

2 In the Matter of the City of San Diego, SEC Release No. 34-54745 (November 14, 2006).

3 Opinion of the Commission In the Matter of the City of Miami, Florida, SEC Release No. 34-47552 (March 21, 2003).

4 In re Maricopa County, SEC Release No. 33-7354, 34- 37779 (October 3, 1996).

5 In re City of Syracuse, New York, Warren D. Simpson, and Edward D. Polgreen, SEC Release No. 34-39149 (September 30, 1997).

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• Orange County, California made misleading statements and failed to disclose material information about the County's high risk investment pool and financial condition that brought into question the County's ability to repay its securities – facts about which members of its Board of Supervisors were aware, but failed to take appropriate steps to assure were disclosed;6

• A lawyer serving as bond counsel was responsible for misrepresentations and omissions in an official statement and in his legal opinions, which failed to provide investors with full information concerning the substantial risk that the IRS would find a municipal securities issue to be taxable;7 and

• A group of 15 broker-dealer firms engaged in a variety of violative practices in the auction rate securities market and in certain other practices that were not adequately disclosed to investors in auction rate securities, some of which had the effect of favoring certain customers over others, and some of which had the effect of favoring the issuer of the securities over customers, or vice versa.8

6 Report of Investigation in the Matter of County of Orange, California as it Relates to the Conduct of the Members of the Board of Supervisors, SEC Release No. 34-36761 (January 24, 1996).

7 Weiss v. SEC, 468 F.3d 849 (D.C.C. 2006) (upholding the Commission’s decision In the Matter of Ira Weiss, SEC Release No.34- 52875 (December 2, 2005)).

8 In the Matter of Bear, Stearns & Co.