HomeMy WebLinkAboutDisclosure Requirements R[~IVED
APR 2 9 1996
~ To,#n Clerk
CONTINUING DISCLOSURE
REQUmEMENTS
OF
SEC RULE 15c2-12
Hawkins, Delafield & Wood
67 Wall Street
New York, New York 10005
First Interstate World Center
Los Angeles, California 90071
CityPlace
Hartford, Connecticut 06103
One Gateway Center
Newark, New Jersey 07102
1015 Fifteenth Street, N.W.
Washington, D.C. 20005
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MEMORANDUM
TO:
FROM:
DATE:
RE:
All Interested Persons
Hawkins, Delafield & Wood
March 25, 1996
Continuing Disclosure Requirements of SEC Rule 15c2-12
The Securities and Exchange Commission (the "SEC") adopted on November 10, 1994
amendments to Rule 15c2-12 (17 CFR 240.15c2-12) (the "Rule") regarding continuing disclosure.
Hawkins, Delafield & Wood prepared a firm memorandum dated November 30, 1994 which summarized
the new requirements and provided suggestions for complying with them. Since that date, the SEC staff
has issued three interpretive letters addressing various questions raised by the National Association of
Bond Lawyers and the American Bar Association, has issued no-action letters and exemptive orders
regarding the Rule, and has provided advice at various seminars. In addition, in representing issuer and
underwriter clients over the course of the last year, we have provided interpretive advice regarding the
application of the Rule in numerous transactions which have raised novel issues.
This memorandum is intended to serve as a comprehensive guide to the Rule and
incorporates all formal advice, and all informal advice of which we are aware, provided to date by the
SEC staff. The memorandum outlines the Rule's basic requirements regarding continuing disclosure and
addresses the application of such requirements to particular financial structures.
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CONTINUING DISCLOSURE REQLqREMENTS
OF SEC RULE 15c2-12
TABLE OF CONTENTS
Page
Introduction
"Plain Language" Overview ............................................ 1
Summary of Requirements of the Rule ...................................... 3
Effective Dates .................................................... 8
Detailed Analysis ................................................... 8
Further Information .................................................. 16
Appendix A ..................................................... A-1
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CONTINUING DISCLOSURE REQUIREMENTS
OF SEC RULE 15c2-12
Introduction
The Securities and Exchange Commission (the "SEC't) adopted on November 10, 1994
amendments to Rule 15c2-12 (17 CFR 240.15c2-12) (the "Rule") regarding continuing disclosure. The
Rule imposes obligations on (1) underwriters when they purchase or sell a municipal security in a primary
offering and (2) brokers, dealers and municipal securities dealers when they recommend the purchase or
sale of a municipal security in either the primary or secondary market. The Rule also imposes obligations
on issuers and obligated persons (as defined below), indirectly, by requiring undertakings by them as a
condition to underwriters purchasing or selling municipal securities in a primary offering. The Rule
provides both securities and transactional exemptions from all or a part of its provisions.
This memorandum analyzes the continuing disclosure obligations of the Rule that were adopted
in November 1994 but does not, in general, analyze the provisions of the Rule adopted in June 1989,
which impose obligations on underwriters to review near final official statements before offering or
selling municipal securities.
The principal sources of formal advice used in the preparation of this memorandum are set forth
in Appendix A.
There follows a "plain language" overview of the requirements of the Rule and certain procedures
to be followed in complying with it, a more detailed summary of all of the Rule's requirements, and an
analysis of certain aspects of the Rule that present particular interpretive or implementation difficulties.
"Plain Language" Overview
Requirements and Procedures. In general terms, the Rule prohibits underwriters from purchasing
or selling municipal securities unless they reasonably determine that the issuer or obligated persons for
whom operating data and financial information have been presented in a final official statement have
undertaken, in a written agreement or contract for the benefit of the holders of the securities, to provide
the secondary market with three types of disclosure (discussed below). Obligated persons are defined as
those persons who are committed by contract or other arrangement to pay or support payment of debt
service on the securities, either generally or through an enterprise, fund or account, and may include the
issuer or others. Depending on the type of financing, there may be one or more obligated persons on
any particular transaction.
The effect of these requirements is that disclosure obligations with respect to obligated persons
will depend on whether information relating to them is disclosed in the official statement; in other words,
if a person is material enough to be the subject of initial disclosure, secondary market disclosure also will
be required of such person.
Similarly, the nature and scope of the secondary market disclosure will depend on what is
disclosed in the official statement. In this regard, you should note that only financial information and
operating data need be provided pursuant to the Rule, not other discussion or demographics or updated
forecasts or projections. There is no need to prepare an updated official statement.
The three types of disclosure are as follows:
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1. Annually, by a date determined in advance (e.g., by 6 months after the close of the fiscal
year) financial information for each obligated person for whom financial information or operating data
is presented in the official statement, or for each obligated person meeting the objective criteria used to
determine for whom such disclosure is made in the official statement. Obligated persons could include
the issuer, departments or agencies of the issuer, enterprises of the issuer, conduit borrowers or other
entities supporting the financing, depending on the circumstances of the particular financing.
2. Annually, as part of the annual financial information, audited financial statements for each
obligated person described above, and, if not available at such time, then when and if available.
3. From time to time, notice of eleven enumerated events with respect to the securities, but
only if material.
In the case of issuer-supported debt, therefore, the issuer will be involved in formulating the
nature and scope of this written agreement or contract, which must be in place by the time the securities
are issued and will set the stage for many of its future secondary market disclosure activities. In doing
so, it will have the benefit of advice from its bond counsel and other advisors. Because the Rule imposes
the primary burden on the underwriters to make the "reasonable determination" described above, the
issuer also will be consulting with the underwriters and counsel to the underwriters.
After this, if the issuer is required by the undertaking to perform secondary market disclosure,
it must perform as required by the Rule and the undertaking. This will involve activity in each of the
three areas mentioned above, as follows:
1. Procedures should be put in place to provide the annual financial information by the date
agreed upon. This may be available from one department or agency, or several. Whatever the case, the
appropriate people must be educated in the requirements of the undertaking, and responsibilities must be
assigned (and perhaps reminders should be delivered) sufficiently far in advance to permit the responsible
persons to generate the required information on time.
2. For most issuers, audited financial statements are prepared annually and procedures for
developing these statements already are in place. If financial information is required to be disclosed and
audited financial statements are not available at such time, the annual financial information should include
unaudited financials and the audited financial statements should be provided when they become available.
3. The eleven enumerated events that must be disclosed if material usually provide more
compliance difficulty, in part because of their irregular occurrence and in part because of the necessity
to determine materiality. First, responsibility for identifying when such an event occurs must be assumed
by or assigned to some person, department or agency. Second, a determination must be made and
adequately communicated as to the flow of this information from all relevant persons, departments and
agencies to the person responsible for further action. Third, responsibility must be assumed or assigned,
or a methodology agreed upon, for determining whether any of the events are material. Only if they are
material need they be disclosed.
4. The annual or event-specific information to be disclosed must be disseminated to
repositories and others as required by the Rule and the undertaking. The issuer or an obligated person,
through a designated individual or otherwise, can agree in the undertaking to do this directly, or the
undertaking can provide for the information to be passed on to a trustee or other agent to do it.
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Relationship to Official Statement. One important point to keep in mind is that the requirements
of the Rule should have no important impact on the necessary scope or details of the disclosures made
in the official statement. Disclosure in the official statement must be accurate, complete and not
misleading. This is required by, among other things, Rule 10b-5, and is not modified at all by Rule
15c2-12. Conversely, because of the responsibility to ensure that the initial disclosure includes relevant
financial information and operating data about obligated persons, the nature of the information that will
be required to be disclosed annually under the Rule and the undertaking will be determined with reference
to the information in the official statement. What we have seen is issuers and obligated persons taking
the opportunity of required compliance with the Rule to reexamine the content of official statements to
eliminate non-material information that perhaps has crept in over the years, and to tighten up the
presentation and format of material information that remains.
Another related, but important, point is that even as the issuer or others are complying with the
Rule and the undertaking after the securities are issued, they must be aware that Rule 10b-5 may require
additional disclosure. For example, disclosure of annual financial information or one of the eleven
enumerated events, if material, may require additional explanation in order to be complete and not
misleading. Or, an event not included among the eleven enumerated events may be material and, if there
otherwise is a duty to disclose it (because, for example, such event has been disclosed already to limited
segments of the financial market), a general dissemination may be required. Filing a description of such
event with repositories would provide an effective method of achieving this additional dissemination.
Summary of Requirements of the Rule
Disclosure. A broker, dealer, or municipal securities dealer may not act as an underwriter in a
primary offering of municipal securities with an aggregate principal amount of $1,000,000 or moret
unless the underwriter has reasonably determined that either the issuer or "an obligated person for whom
financial or operating data is presented in the final official statement" (for convenience of reference
herein, a "Named Obligated Person") has undertaken, in a written agreement or contract for the benefit
of holders of the securities, to provide the following information:
a. Annual financial information for each Named Obligated Person or for "each obligated
person meeting the objective criteria specified in the undertaking and used to select the obligated
persons for whom financial information or operating data is presented in the final official
statement" ("Objective Criteria Obligated Persons", and, together with each Named Obligated
Person, the "Obligated Persons").2 The capitalized term "Obligated Person" as used in this
Memorandum is a subset of the broader term "obligated person" as defined in the Rule, in that
the capitalized term is limited to those obligated persons for whom financial information and
operating data are presented in the final official statement, whether by express naming or by the
use of objective criteria;
b. Notice of a failure of any Obligated Person to provide in a timely manner the required
annual financial information;
c. Audited financial statements for each Obligated Person, if and when prepared; and
For a description of 'pr'mary offer'ngs' and of exemptions from application of the Ru e, see Eremptions below.
2 If the municipal security is a pooled obligation, the Rule requires that the undertaking specify the objective
criteria. See "DETAILED ANALYSIS - Obligated Person - Pooled Financings." For non-pooled obligations, the
financing participants have the option to either name the Obligated Persons or specify objective criteria for selection.
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d. Notice, in a timely manner, of the following events, if material:
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
principal and interest payment delinquencies;
non-payment related defaults;
unscheduled draws on debt service reserves reflecting financial
difficulties;
unscheduled draws on credit enhancements reflecting financial
difficulties;
substitution of credit or liquidity providers, or their failure to perform;
adverse tax opinions or events affecting the tax-exempt status of the
security;
modifications to rights of security holders;
bond calls;
defeasances;
release, substitution, or sale of property securing repayment of the
securities;
rating changes; and
any other information as agreed to in the undertaking.
Please note that although annual financial information must be supplied with respect to Obligated
Persons, and not necessarily issuers, the requirement that timely notice of the enumerated material events
be given is not so limited but applies "with respect to the securities being offered". Depending on the
relationships of issuers and Obligated Persons in the context of the offering, one or more of them may
be responsible for these material event disclosures.
The information in items a. and c. must be provided to each NRMSIR an.__d.d to the appropriate state
information depository, if any. The information in items b. and d. must be provided either to each
NRMSIR o~r to the MSRB, and to the appropriate state information depository, if any.
If audited financial statements are not available by the time the annual financial information must
be provided, unaudited financial statements must be included as part of the annual financial information.
The audited financial statements are to be distributed at such time as they are available. (NABL I, Resp.
6) If, on the other hand, the audited financial statements have been submitted to the appropriate
repositories prior to the time that the annual financial information is available, the SEC staff has advised
informally that it is not necessary to prepare updated unaudited financial statements at the time the annual
financial information is available -- a cross-reference to the existing audited financial statements is
sufficient.
Annual financial information must be provided regarding each Named Obligated Person until such
time as such person has no liability for repayment of the municipal securities. For this purpose, even
an economic defeasance of the municipal securities is not sufficient; it must be a legal defeasance. (NABL
I, Resp. 16) It is not sufficient that such payment obligation be considered not material under standards
of federal securities law. (NABL I, Resp. 15) With respect to an Objective Criteria Obligated Person,
however, annual financial information must be provided only so long as the specified objective criteria
are satisfied.
If objective criteria relating to a percentage of debt service support are to be used to establish the
test for obligated person disclosure, what is an appropriate threshold? When the Rule was proposed for
comment, the disclosure requirement related to "significant obligors" rather than obligated persons, and
significant obligor was defined as "any person who, directly or indirectly, is the source of 20 percent or
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more of the cash flow servicing the obligations on the municipal securities." In the Release, the SEC
stated that "there is no need to include a specified percentage of payment in the definition of obligated
person, because . . . [it is a] materiality determination .... ', but provided the following footnote as
guidance:
"Guidelines and practices that have developed in other contexts may be
useful in analyzing both the materiality of an obligated person to the
municipal financing and the appropriate level of disclosure relating to
such obligated person. For example, in connection with securitization
of non-recourse commercial mortgage loans, the 10 percent and 20
percent property assets concentration tests described in Staff Accounting
Bulletins 71 and 7lA are applied. These percentages are applied by
analogy in other asset-backed financings."
In light of such guidance, objective criteria are often established using a percentage of between 10 and
20.
Written Agreement or Contract. The written agreement or contract by which the issuer or a
Named Obligated Person undertakes to provide the disclosures described above must identify each
Obligated Person (i.e., each person for whom annual financial information and notices of material events
will be provided) either by name or by the objective criteria used to select them, and for each such
Obligated Person must:
a. specify, in reasonable detail, the type of financial information and operating data to
be provided as part of the annual financial information;
b. specify, in reasonable detail, the accounting principles that will be used to prepare the
financial statements and whether they will be audited; and
c. specify the date by which the annual financial information will be provided and to
whom it will be provided.
The written agreement or contract may provide that the continuing obligation to provide annual financial
information and notices of material events may be terminated with respect to an Obligated Person at such
time as such person is no longer an "obligated person" as defined in the Rule. As indicated above, such
termination with respect to a Named Obligated Person requires a legal defeasance of the bonds; for
Objective Criteria Obligated Persons, such termination may occur at such earlier time as the specified
objective criteria are no longer satisfied.
Annual Financial Information; Incorporation by Reference. The term "annual financial
information" means financial information or operating data, provided at least annually, of the type
included in the final official statement with respect to each Obligated Person.
The Rule expressly permits inclusion of financial information or operating data by specific
reference, and through interpretation the SEC staff has agreed that other information also may be included
by cross-reference (ABA, Resp. 5)3, to documents previously provided to each NRMSIR and to a state
3In the ABA Letter, the SEC staff was responding to an inquiry as to whether information "such as demographic
information" may be included by cross-reference. At this point, it is unclear whether the SEC staff's response was
intended to permit cross-reference in a final official statement to a broad range of information, such as indentures,
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information depository, if any, or filed with the SEC. If the document included by reference is a final
official statement, it must be available from the MSRB but need not have been provided to any NRMSIR
or state information depository or the SEC. (NABL II, Resp. 8)
Dealer Recommendations to Buy or Sell Municipal Securities. A broker, dealer, or municipal
securities dealer cannot recommend the purchase or sale of a municipal security unless it "has procedures
in place that provide reasonable assurance that it will receive prompt notice" of the events listed above
as items ! through 11 (Disclosure, subsection d.) and of a failure of any Obligated Person to provide in
a timely manner the required annual financial information (Disclosure, subsection b.).
Exemptions. The Rule applies to primary offerings4 of municipal securities with an aggregate
principal amount of $1,000,000 or more. The Rule provides exemptions from all or specified portions
of its provisions, depending on the particular exemption, for (a) private placements, (b) commercial paper
and tender bonds, (c) small issuers, (d) short-term municipal securities which have a stated maturity of
18 months or less, (e) exempted transactions, and (f) other exemptions afforded by the SEC. These
exemptions are described below.
a. Private placement exemption. The securities must be sold to no more than 35
persons, each of whom the underwriter reasonably believes is sophisticated and is not purchasing
the securities with a view to distribution. The authorized denominations must be $100,000 or
more. This exemption provides a complete exemption from Rule 15c2-12.
b. Commercial paper and tender bonds exemption. The securities must have a maturity
of nine months or less or be subject to optional tender by the securities holders not less frequently
than every nine months until maturity or earlier redemption. The authorized denominations must
be $100,000 or more. This exemption provides a complete exemption from Rule 15c2-12.
c. Small issuer exemption. The offering must be one in which no obligated person will
be an obligated person with respect to more than $10,000,000 in aggregate principal amount of
outstanding municipal securities, including the offered securities and securities sold in offerings
that were exempt because they were under the $1,000,000 threshold, but excluding any securities
exempt pursuant to the private placement exemption. This exemption is conditioned on a limited
disclosure undertaking. Specifically, the issuer or Named Obligated Person must agree, either
individually or in combination with other issuers and Obligated Persons, in a written agreement
or contract for the benefit of the holders of securities, to provide financial information and
operating data regarding each Named Obligated Person upon request to any person or at least
annually to the appropriate state information depository, if any; and in a timely manner, notice
of material events either to each NRMSIR or to the MSRB, and also to the appropriate state
information depository, if any. The final official statement must identify how to obtain the
foregoing information. Although under this exemption the official statement establishes about
whom financial information must be provided, the official statement does not establish what
financial information or operating data must be provided. Rather, the exemption establishes the
loan agreements, etc., with the result that detailed summaries of such documents would not have to be set forth in
a final official statement.
4"Primary offerings" of municipal securities include remarketings upon conversion of the interest rate on such
securities from a variable rate to a fixed rate. Thus, such remarketings would be required to comply with the
"deemed final" official statement requirement of Rule 15c2-12(b)(1) as well as the continuing financial disclosure
requirements.
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following minimal standard for what financial information and operating data should be provided:
"financial information and operating data which is customarily prepared by such obligated person
and is publicly available." (Emphasis added) Members of the SEC staff have made public
statements at law conferences that "publicly available" should be broadly interpreted to include
information which is required to be made publicly available in response to a proper Freedom of
Information Act request. That is, even information which is not currently in the public domain
but would be required to be made publicly available would, under this interpretation, be deemed
to be "publicly available" for purposes of the exemption. If, however, the "publicly available"
information "is more extensive than that provided in the final official statement, the undertaking
may be limited to providing the information that would comprise annual financial information for
non-exempt offerings."(NABL I, Resp. 18) This exemption provides an exemption only from
the continuing disclosure requirements of the Rule.
The $10,000,000 limit must be tested for each obligated person, regardless of whether
that obligated person is one for whom financial information or operating data is presented in a
final official statement. This presents a problem for state bond guarantee funds established to
benefit small local issuers. In general, such funds will be "obligated persons" within the meaning
of the Rule, and thus the small issuer exemption would not be available for those issuers whose
issues are supported by such a fund. The SEC recently provided an exemptive order for the
Texas Permanent School Fund, which has outstanding guarantees for bond issues with a principal
amount close to $8 billion. The exemptive order provided that the underwriters could participate
in offerings by Texas independent school districts which were utilizing the small issuer exemption
and whose bond issues were secured by the Texas Permanent School Fund. In granting such
relief, the SEC staff indicated that the Texas Education Agency has agreed to comply with the
provisions of the Rule regarding the Texas Permanent School Fund to the same extent as if the
offerings of the guaranteed bonds were fully subject to the provisions of the Rule.
In testing the $10,000,000 limit, it is only necessary to include that portion of a securities
issue for which an obligated person is obligated to pay debt service:
"If a person is obligated to pay only 20% of the principal amount on a
$I0,000,000 bond issue, and has no liability to pay the balance of the
principal amount of the bond issue, then that person is an obligated
person with respect to $2,000,000 for purposes of determining the
amount of an issuer's outstanding debt for the $10,000,000 small issuer
exception."
ABA, Resp. 4
d. 18 month maturity exemption. An exemption is afforded to offerings of municipal
securities if they have a stated maturity of 18 months or less. This exemption provides an
exemption from the continuing disclosure requirements regarding annual financial information,
but the issuer or a Named Obligated Person must undertake to provide notice of the material
events specified by the Rule (.Disclosure, subsection d.).
e. Exemptions from dealer recommendation prohibition. The dealer recommendation
requirements do not apply to municipal securities that otherwise are exempt from the underwriting
prohibitions and annual financial information undertakings under one of the above-described
exemptions, with one exception. The dealer recommendation requirements continue to apply to
those offerings covered by the limited $10 million small issuer exemption described above
(because such exemption is conditioned on a limited disclosure undertaking).
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f. Transactional exemption. The SEC may exempt any dealer or underwriter from any
requirement of the Rule if it determines that an exemption is consistent with the public interest
and the protection of investors. The SEC has exemptive authority with respect to both
participating underwriters in primary offerings and brokers, dealers, and municipal securities
dealers recommending transactions in the secondary market.
For a multi-modal bond issue, whether an exemption applies at a particular time depends upon
the mode at such time. Thus, a written undertaking entered into with respect to a multi-modal bond issue
that is issued in a mode to which the Rule applies may provide that the obligations thereunder may be
suspended or terminated at such time as the municipal securities are in a mode to which an exemption
applies.
Effective Dates
In general, the new obligations imposed on underwriters in primary offerings regarding
undertakings for annual financial disclosure apply to any participating underwriter that has contractually
committed to act as an underwriter on or after July 3, 1995. Under transitional exceptions to this general
effective date, (1) issuers were not required to provide annual financial information for fiscal years ending
prior to January 1, 1996; (2) the dealer recommendation provisions became applicable on January 1,
1996; and (3) the limited undertakings under the $10 million small issuer exemption regarding financial
information, material events, and official statements did not apply to primary offerings commencing prior
to January 1, 1996, although the exemption itself was available prior to that date. The SEC staff has
advised with respect to the small issuer exemption that (1) the phrase offerings "commencing prior to
January 1, 1996" should be read to mean offerings for which a dealer is contractually committed prior
to January 1, 1996 to act as an underwriter and (2) the exemption provides transitional relief from both
the material events and annual reporting requirements for any bond issue commencing prior to January
1, 1996 for the life of the issue.
Detailed Analysis
Annual Financial Information; Written Agreement. As described above, the Rule requires an
undertaking to provide annual financial information with respect to Obligated Persons. However, the
Rule does not specify what information is material, or the persons for whom such information must be
provided. Instead, these matters are left for the participants in the primary offering to determine and
reflect in the final official statement. As a guide to making such determination, the Release refers to the
Interpretive Release (SEC Rel. Nos. 33-7049; 34-33741 (Mar. 9, 1994)) as a "source of guidance as to
the disclosure obligations of issuers of municipal securities, as well as the role of brokers, dealers, and
municipal securities dealers." See also O~cial Statement below.
Once that determination is made, however, the underwriter must reasonably determine that the
issuer or a Named Obligated Person has undertaken in a written agreement or contract for the benefit of
bondholders to provide on a continuing basis annual financial information and notices of certain material
events with regard to all Obligated Persons. The Release indicates that such written agreement could take
the form of a covenant in the trust indenture, a bond resolution or a separate written agreement. The
Rule also provides that the undertaking may be provided by more than one entity, and further that the
undertaker may be a designated agent or the bond trustee. For example, the bond trustee could
contractually agree with the issuer in the bond indenture to provide notices to the appropriate repositories
of certain of the material events listed in the Rule, e.g., principal and interest payment delinquencies,
unscheduled draws on debt service reserves or credit enhancements reflecting financial difficulties, bond
calls, and other similar events. All of the events specified in the Rule, with the possible exception of
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adverse tax opinions or events and rating changes, will normally come to the attention of the bond trustee.
The issuer or Named Obligated Person could then agree to undertake to provide the required annual
financial information as well as the material events not within the bond trustee's responsibility.
It is important to understand the time when such written agreement must be effective. The Rule
provides that an underwriter must not "purchase or sell" absent a reasonable determination regarding
continuing disclosure. Such reasonable determination must exist at the time the bond purchase agreement
is executed, but the actual written agreement or contract containing the undertaking to provide ongoing
disclosure generally would be executed, together with other closing documents, at the time the
underwriter accepted delivery of the municipal securities. This is in contrast to the prohibition in Rule
15c2-12(b)(1) concerning the "deemed final" official statement, which must be obtained and reviewed by
an underwriter prior to the time the underwriter "bids for, purchases, offers, or sells municipal
securities." The SEC staff has interpreted the term "offer" to include the use of a preliminary official
statement.
Official Statement. The final official statement establishes the baseline standard for continuing
financial disclosure. The "annual financial information" that must be provided is "for each obligated
person for whom financial information or operating data is presented in the final official statement, or,
for each obligated person meeting the objective criteria specified in the undertaking and used to select
the obligated persons for whom financial information or operating data is presented in the final official
statement .... " The definition of obligated person is discussed below under Obligated Person. In
making the decision as to which obligated persons will have related financial information or operating
data presented in the final official statement, materiality serves as the litmus test. In this regard, it is
important to note that the definition of "final official statement" refers to a document including
information relating not to obligated persons, but instead to all persons that are material to the offering
("information, including financial information or operating data, concerning such issuers of municipal
securities and those other entities, enterprises, funds, accounts, and other persons material to an
evaluation of the Offering .... ") Thus, for example, even though providers of municipal bond
insurance are expressly excluded from the definition of obligated persons, nevertheless information about
such providers is material and should be included in a final official statement.
Materialitv of Specified Events. The antifraud provisions of the federal securities laws are
violated with respect to omitted information if (1) the information is material and (2) there was a duty
to disclose. The governing principle under federal securities laws for whether an omitted fact is
"material" is whether there was a "substantial likelihood that, under all the circumstances, the omitted
fact would have assumed actual significance in the deliberations of a reasonable [investor]." (Interpretive
Release, p. ll) With regard to the second prong of the antifraud test, the duty to disclose, in the
corporate context such duty is imposed through the periodic reporting requirements of the Securities
Exchange Act of 1934. No comparable duty is imposed by law on municipal issuers. By virtue of the
Rule, however, issuers or obligated persons will contractually agree to provide to securities holders
notices of certain specified events, if material. The failure to provide such information will result in a
breach of the written agreement or contract entered into for the benefit of securities holders. The
contractual consequences of such breach, including remedies, are a matter of negotiation to be set forth
in the written agreement or contract.
Under the Rule, only eleven specified events (and additional events if agreed to) must, if material,
be provided to the appropriate information repositories. An interesting issue is whether, if one or more
of the specified eleven events has occurred and has been determined to be material such that disclosure
must be made, whether it is necessary at such time to provide disclosure of all other material events
regardless of whether on the list of specified events. Clearly, any disclosures that are made must be fair,
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accurate and complete and not misleading. Furthermore, in the Interpretive Release the SEC advised that
"when [a municipal issuer] releases information to the public that is reasonably expected to reach
investors and the trading markets, those disclosures are subject to the antifraud provisions." The SEC
staff has taken the position that it is only necessary to provide disclosure of the eleven specified events,
if material, plus any other related information necessary to fully explain or place into context the
disclosure being made. This is consistent with the position that the federal securities laws, in the
municipal context, do not affirmatively require the disclosure of even material information absent a duty
to disclose.
The eleven specified events, regardless of applicability (e.g., no debt service reserve or no credit
or liquidity providers), must be set forth in the undertaking "in the same language as is contained in the
role, without any qualifying words or phrases, except as the staff has indicated otherwise with respect
to mandatory redemption of bonds." (NABL II, Resp. 2) With respect to those events which are clearly
inapplicable in a particular case, although the event must be set forth in the undertaking, to avoid
confusion it would be appropriate for the undertaking to clarify the applicability of such event (e.g., if
there is then no debt service reserve, a statement to that effect could be included). With respect to
mandatory redemptions, the SEC staff has advised that "notice of the occurrence of a mandatory,
scheduled redemption, not otherwise contingent upon the occurrence of an event, is not required under
the role if the terms under which the redemption is to occur are set forth in detail in the final official
statement, and the only open issue is which bonds will be redeemed in the case of a partial redemption."
(NABL I, Resp. 8) The conclusion is the same even if there has been a reduction in the sinking fund
schedule resulting from other redemptions or bond purchases. (NABL II, Resp. 10)
Time of Disclosure of Specified Material Events. Notice of the specified events, if material, must
be provided in a timely manner. The Rule does not define "timely." If the event is one for which the
bond trustee has undertaken to provide disclosure, then such disclosure would in general occur as soon
as practicable after the trustee had notice. If, on the other hand, the notice will be coming directly from
the issuer or an Obligated Person, the Release contemplates that the determination must consider the time
needed to discover the event, to analyze its materiality, and to prepare and disseminate the notice. An
Obligated Person may not condition its obligation to give a material event notice upon its having
knowledge of the event. (ABA Letter, Resp. 3)
Obligated Person. The term "obligated person" is defined to mean "any person, including an
issuer of municipal securities, who is either generally or through an enterprise, fund, or account of such
person committed by contract or other arrangement to support payment of all, or part of the obligations
on the municipal securities to be sold in the Offering (other than providers of municipal bond insurance,
letters of credit, or other liquidity facilities)." We examine below the application of that definition to a
variety of financings.
Parity Bonds. The Rule requires underwriters to reasonably determine that an issuer or
an Obligated Person has contractually agreed to provide continuing annual financial information
with respect to Obligated Persons for whom financial information is presented in the final official
statement, yet if the Obligated Persons became Obligated Persons pursuant to a contract entered
into before the effective (or proposed) date of the Rule, such contract would not have
contemplated continuing disclosure obligations.
In a recent no-action letter which was the first such letter regarding the continuing
disclosure provisions of Rule 15c2-12, the SEC staff provided relief to a major public power
issuer. (Letter to Hawkins, Delafield & Wood, dated Oct. 26, 1995) The SEC staff agreed to
permit the issuer to use its "best efforts" to obtain the required continuing financial disclosure
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from the power sales purchasers even though the Rule by its terms does not authorize such a
qualification. The letter is interesting in that it presented the SEC staff with the opportunity to
interpret the "obligated person" definition to being limited to contracts or other arrangements
entered into subsequent to the effective date of the Rule. The SEC staff instead limited the letter
to the facts and circumstances presented. Important factors in the staff's deliberations were (1)
the contracts were entered into in 1978, (2) no amendments were being made to such contracts
in connection with the 1995 bond issue and the issuer did not contemplate any future
amendments, (3) there was a general provision in the power sales contract by which the
purchasers agreed to provide such information as necessary in connection with the financing of
the project, (4) the issuer agreed to use its best efforts to obtain the required continuing financial
disclosure, including enforcement of the foregoing general contractual provisions and (5)
information about the obligated persons is currently available from public sources.
Clearly, the SEC staff does not want to put municipal parity bond issuers in the posture
that their bond issues cannot be underwritten because they cannot contractually obligate to provide
continuing financial disclosure with respect to the Obligated Persons that secure the debt service
on such bond issues.
Pooled Financings. The Rule provides that annual financial information must be provided
for either the Named Obligated Persons or the Objective Criteria Obligated Persons, but that "in
the case of pooled obligations, the undertaking shall specify such objective criteria." The SEC
staff reiterated such position in the recent ABA Letter: "[i]n all pooled financings, objective
criteria are required to be established and must be applied on a consistent basis, both in the
official statement and on an ongoing basis." In that letter, the SEC staff stated in addition that
even if objective criteria are specified, annual financial information should also be provided
regarding the pool itself:
"Undertakings in a pooled financing also should be provided as to the
pool itself, because (1) it is committed to make payments with respect to
the securities and (2) it is either an issuer of separate securities or a fund,
enterprise or account of an issuer of municipal securities."
ABA, Resp. 1
This position is consistent with the definition of "obligated person," which is defined to include
"an issuer of municipal securities who is either generally or through an enterprise, fund or
account of such person committed by contract or other arrangement to support payment of all,
or part of the obligations on the municipal securities to be sold in the Offering .... "
Thus, in a large pooled financing in which no borrower would satisfy the objective
criteria, annual financial information would nevertheless be required regarding the pool as the
Obligated Person. For example, in special, limited obligation financings involving loans to third
parties, such as single family housing financings, the pledged assets constitute the Obligated
Person. The continuing disclosure agreements would require the issuer to provide, on an annual
basis, material information regarding the pledged assets.
On a similar note, in the context where an issuer of special, limited obligation bonds
chose not to include its audited financial statements in the final official statement, the SEC staff
stated in NABL II:
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"In a financing involving an issuer of special limited obligation bonds, if audited
financial statements are not prepared with respect to the specific funds and
accounts pledged to repayment of the bonds, the issuer, if an obligated person,
is required to submit its audited general purpose financial statements, when and
if available, regardless of whether separate information regarding such fund or
accounts, or related underlying assets, are separately presented."
NABL II, Resp. 1 !
The SEC staff has stated publicly that the foregoing response should not be limited to instances
in which the issuer is an obligated person. Regardless of whether the issuer itself is an obligated
person, if there are no audited financial statements for the special funds and if the general audited
financial statements provide financial disclosure regarding the special funds even if not separately
stated, then such audited financial statements should be considered part of the annual financial
information. The disclosure regarding the audited financial statements should caution, however,
that the municipal obligations are only secured by the specified pledged funds.
"Start-up" Obligated Person. If an obligated person or project is newly created at the
time of a financing, so that there is no financial information or operating data regarding such
person or project presented in the final official statement, must a written undertaking include an
obligation to provide annual financial information regarding such person or project? We have
concluded that it should do so, because the obligated person or project is the principal entity
responsible for debt service. If financial information or operating data regarding such person or
project had existed at the time of the final official statement it clearly would have been included
therein, and annual financial information regarding such person or project is material to investors.
Successor Obligated Person. In the ABA Letter, the SEC staff advised that "[a]s a
Reneral matter, the contractual obligations of an obligated person under the Rule should apply to
a Successor."
GIC Provider. We have taken the position that generally the providers of guaranteed
investment contracts resemble providers of investment obligations and should not be considered
to be committed by contract or other arrangement to support payment of debt service on the
municipal obligations.
GNMA, FNMA, FHA. The definition of "obligated person" includes persons
"committed by contract or other arrangement to support payment of all, or part of the obligations
on the municipal securities to be sold in the Offering (other than providers of municipal bond
insurance, letters of credit, or other liquidity facilities)." The SEC advised in the Release that
these entities referenced in the parenthetical exclusion would, but for such exclusion, be
considered to be obligated persons: "It]he concept of 'obligated person' encompasses these
entities because they are committed, at least conditionally, to support payment of principal and
interest obligations." On that rationale, those entities which do not support debt service on the
municipal securities, but rather secure underlying assets, should not be considered to be obligated
persons. This issue was presented to the SEC staff in NABL I (Resp. 22):
"[E]ntities such as the Government National Mortgage Association, the Federal
National Mortgage Association and the Federal Housing Administration may
provide credit enhancement with respect to municipal securities by guaranteeing,
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or entering into other contractual arrangements to enhance, all or part of the
obligations underlying the municipal securities e(_~g.., mortgage loans). Are such
types of entities, to the extent they may provide credit enhancement as described
above, either fa) not considered within the definition of an 'obligated person' or
(b) considered to be providing 'other liquidity facilities' and therefore specifically
excluded from the definition of 'obligated person'?"
The SEC staff declined the invitation to exclude as a category those entities which secure
underlying assets. Rather, the staff based its "no action" position on the public availability of
information:
"In light of the fact that the Government National Mortgage Association,
the Federal National Mortgage Association and the Federal Housing
Administration and similar entities are United States government sponsored
enterprises or government agencies, and public information regarding such
entities is readily available, the staff would not object if such entities were not
covered by an undertaking."
Because the SEC staff response did not address directly the argument that an entity cannot
be an obligated person if it secures only the underlying assets, the issue was raised again in
NABL II (Resp. 9). The SEC staff clarified that entities that secure underlying assets ma,/be
obligated persons:
"Entities that insure or guarantee performance of assets that have been
pledged to secure the repayment of the municipal obligation may fall within the
definition of 'obligated person,' and ongoing information may be required on
such parties, unless such insurance or guarantee has been obtained prior to and
not in contemplation of any offering of municipal securities, the insurance or
guarantee relates only to the individual pledged assets, and the insurance or
guarantee exists independent of the existence of a municipal obligation. The
ultimate determination as to whether an insurer or guarantor is an obligated
person depends on the relationship to the financing itself -- a factual analysis."
The phrase in the foregoing quotation -- "unless such insurance or guarantee has been
obtained prior to... any offering of municipal securities" -- is troublesome in the student loan
context, absent another applicable exemption, because the guarantee attaches when the loan is
made (which is subsequent to the municipal securities offering). The SEC staff has advised
informally, however, that to the extent the guarantee is a "programmatic feature of the loan," it
will not be necessary to treat the guarantee agency as an obligated person about whom continuing
disclosure must be provided. This response assumes that the guarantee agency is separate from
the issuing agency, as is the case in many states. If, however, they are the same agency, or if
they are distinct legal entities but there exists "practical common control" between the guarantee
agency and the issuing agency, then continuing disclosure may be required regarding the
guarantee agency unless otherwise not required because of, for example, the public availability
of information (see analysis, above, of NABL I, Resp. 22).
Enforcement by Bondholders. The SEC staff advised in NABL I (Resp. 1) that the provision in
the Rule that the written agreement or contract be "for the benefit of holders of [the municipal] securities"
(1) requires that each beneficial owner be able to enforce the obligations in the written undertaking to
provide annual financial information and notices, but (2) permits imposing an obligation to act in concert
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with other beneficial owners, in the same manner as required under the bond resolution or indenture, with
regard to challenges to the adequacy of the annual financial information so provided. Thus, each
beneficial owner must be able to enforce individually the readily determinable failures to satisfy the
written undertaking, although such beneficial owner may be required to act in concert with others
regarding the less readily determinable issue of the adequacy of the disclosure.
Amendments. The SEC staff is of the view that once a written agreement or contract is executed
to provide certain annual financial information, that this constitutes a contractual obligation that then
governs the relationship between the contracting parties regardless of any future changes in the Rule.
From that perspective, the staff provided in NABL I (Resp. 2) a limited safe harbor for the amendment
of a written undertaking. In addition, we believe that amendmems to a written undertaking also should
be permitted if amendments to the Rule or interpretations of the Rule are adopted or issued subsequent
to the date of the written undertaking but are intended to apply retroactively to the time of the
undertaking. The SEC staff has stated publicly that an amendmem provision may provide simply that
the agreement may be amended in accordance with the Rule without setting forth the conditions for the
amendment established by the staff in NABL I.
Forecasts; Feasibility Studies. We advised in our November 30, 1994 firm memorandum
summarizing the Rule that forecasts were not required to be updated:
"Members of the SEC staff have indicated in recent public statements that
because financial forecasts, by their very nature, speak as of a particular date, there is
no need to provide updates to such information as part of the continuing disclosure
required by the Rule. Nonetheless, there may be continuing disclosure responsibilities
with respect to forecasts under general disclosure principles, as discussed in the
Interpretive Release."
The SEC staff formalized such position in NABL I (Resp. 5), and also addressed feasibility studies:
"Forecasts regarding the obligated persons's operations contained in a final
official statement do not need to be updated because the forecasts themselves are not
operating data. The components of these forecasts (i.e., sources of revenue or expenses),
however, would identify the type of actual operating data to be provided as part of annual
financial information. Similarly, if a feasibility study or other type of expertised report
included in the final official statement contains components of operating data, only the
results of these actual operations need be provided on an annual basis pursuant to the
undertaking."
Liability. The Rule applies to municipal securities underwriters. The Rule provides that a
municipal securities underwriter must reasonably determine that the issuer or an Obligated Person has
undertaken certain continuing disclosure obligations in a written agreement or contract. If the issuer or
Obligated Person undertaking the disclosure obligation fails to provide the necessary disclosure, then there
is a breach of the written agreement or contract. The remedies of the bondholders for such a breach are
not dictated by the Rule but are to be established by the financing participants and presumably set forth
in the written agreement or contract. There is no express private right of action against either an
underwriter or an issuer for a violation of Rule 15c2-12, and courts have been reluctant to create implied
private rights of actions beyond that found for Rule 10b-5.
Issuers or Obligated Persons that have undertaken a continuing disclosure obligation pursuant to
a written undertaking may be subject to antifraud liability in private rights of action under Rule 10b-5
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in connection with materially misleading statements or omissions in the annual disclosures or material
event notices provided pursuant to a continuing disclosure agreement. In brief, the elements of a Rule
10b-5 cause of action are (1) materially misleading statements or omissions (in the case of omissions,
there also must be a duty to disclose to the plaintiff), (2) upon which a plaintiff justifiably relied, (3)
which statements or omissions were made or omitted with scienter, (4) in connection with the purchase
or sale of a security, and (5) which resulted in damages to the plaintiff.
A separate issue is the remedies of the SEC. The Securities and Exchange Act of 1934 permits
the SEC to issue cease and desist orders against anyone who causes a violation of that Act or the rules
thereunder, regardless of whether such person is regulated under the Act. The Rule contains numerous
requirements relating to dissemination of final official statements, including the requirement that the
underwriter provide a copy of the final official statement to potential customers on request. The SEC
staff has advised that if, for example, a municipal issuer did not provide the underwriter with final official
statements in a timely fashion and in sufficient quantity to permit the underwriter to satisfy its obligations
under the Rule, then the municipal issuer could be the subject of a cease and desist order of the SEC.
Recommendations. The Rule requires that a dealer recommending the purchase or sale of a
municipal security have "procedures in place that provide reasonable assurance that it will receive prompt
notice" of any of the specified material events regarding such municipal security. Although the Rule does
not require that such dealer review the ongoing financial disclosure, existing MSRB rules have been
interpreted to require that such disclosure be taken into account:
"[T]he MSRB repeatedly has emphasized that secondary market disclosure information
publicized by issuers must be taken into account by dealers to meet the investor
protection standards imposed by its investor protection rules. Specifically, MSRB rule
G-17 requires dealers to disclose material facts of a transaction to the customer; MSRB
rule G-19 requires dealers to ensure that any transaction recommended to the customer
is suitable for that customer; and MSRB rule G-30 requires dealers to ensure that the
prices set for customer transactions are fair and reasonable...
For example, if a dealer reviews an electronic reporting system for material
events relating to a security, and finds that an issuer has submitted a notice that it has
failed to provide annual financial information on or before the date specified in the
written agreement or contract, that fact would be a significant factor to be taken into
account when the dealer formulates the basis for a recommendation of such securities.
While the dealer would not be prohibited per se from recommending such municipal
securities, notice that the issuer has failed to provide annual financial information would
be the type of material information required to be disclosed to the customer pursuant to
MSRB rule G-17. Such a notice also would trigger a further inquiry by the dealer to
assure itself that it is cognizant of the condition of the issuer or obligated persons, despite
the absence of promised information. This also would be true if a dealer attempts to
obtain an issuer's annual financial information, finds that it has not been submitted to any
repository, and the dealer had no record of the issuer submitting a notice to this effect.
In such cases, further research may be necessary or advisable prior to making a
recommendation in the issuer's securities." (Footnotes omitted) Release, pp. 47-48.
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Further Information
The principal author of this Memorandum is John M. McNally of our Washington, D.C. office.
Please feel free to contact any of our offices if you have any questions about this Memorandum or if we
can be of any further assistance. The general phone numbers of our offices (together with the principal
contact person in each office for Rule 15c2-12 matters) are:
New York (Steven I. Turner) .......................... (212) 820-9300
California (Arto C. Becker) ........................... (213) 236-9050
Connecticut (Richard L. Sigal) ......................... (203) 275-6260
New Jersey (C. Steven Donovan) ....................... (201) 642-8584,
Washington, D.C. (John M. McNally) .................... (202) 682-1480
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Appendix A
PRINCIPAL SOURCES
SEC Releases
2.
3.
4.
5.
Rel. No. 34-34961 (Nov. 10, 1994) (the "Release").
Rel. No. 34-33742 (Mar. 9, 1994).
Rel. No. 33-7049; 34-33741 (Mar. 9, 1994) (the "Interpretive Release").
Rel. No. 34-26985 (June 28, 1989).
Rel. No. 34-26100 (Sept. 22, 1988).
Interpretive and No-Action Letters; Exemptive Order
1. Letter from Catherine McGuire to the Subcommittee on Public Securities of the
Public Finance Committee of the State and Local Government Law Section of the
American Bar Association. dated March 15, 1996 ("ABA Letter" or "ABA").
2. Exemptive Order regarding Texas Permanent School Fund, granted by letter
from Catherine McGuire to Texas Education Agency, dated February 9, 1996.
3. Letter from Janet W. Russell-Hunter to Hawkins, Delafield & Wood re North
Carolina Municipal Power Agency Number 1, dated Oct. 26, 1995.
4. Letter from Catherine McGuire to National Association of Bond Lawyers, dated
Sept. 19, 1995 CNABL liD.
5. Letter from Robert L.D. Colby to National Association of Bond Lawyers, dated
June 23, 1995 CNABL I").
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