Tower Amendment

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The Tower Amendment is a 1975 amendment to the Securities Exchange Act of 1934 (Exchange Act). Tower creates a carveout from the disclosure requirement for municipal issuers. Generally it prohibits the federal government from requiring specific disclosure to investors prior to offering debt securities for sale.

  • Prevents SEC and MSRB from imposing corporate-style registration scheme for muni issuers
  • SEC Rule 15c2-12 does not violate Tower Amendment
  • Post-sale production of official statement
  • Post-sale material events notices and annual reports

Amendment specifics

Tower was added to the Exchange Act when Congress created the Municipal Securities Rulemaking Board (MSRB) to oversee the municipal market.

The amendment has two parts, which say that neither the SEC nor the MSRB can require municipal issuers to file documents before they sell bonds.

While Section 15B of the Exchange Act provides the Board with broad authority to write rules governing the activities of dealers in the municipal securities market, it does not provide the Board with authority to write rules governing the activities of other participants in the municipal finance market such as issuers and their agents (e.g., independent financial advisors, trustees, etc.).

Municipal securities also are exempt from the registration and prospectus delivery requirements of the Securities Act of 1933 and are exempt from the registration and reporting requirements of the Exchange Act.

In adopting Section 15B of the Exchange Act, Congress provided in subsection (d) specific provisions that restrict the Board and the SEC from regulating the disclosure practices of issuers in certain ways.

  • Paragraph (1) of subsection (d) prohibits the Board (and the SEC) from writing rules that directly or indirectly (i.e., through dealer regulation) impose a presale-filing requirement for issues of municipal securities.
  • Paragraph (2) of subsection (d) prohibits the Board (but not the SEC) from adopting rules that directly or indirectly require issuers to produce documents or information for delivery to purchasers or to the Board. Paragraph (2), however, specifically allows the Board to adopt requirements relating to such disclosure documents or information as might be available from “a source other than such issuer.”

San Diego

The authorities delegated to the SEC for oversight of the municipal securities markets relate to fraud provisions. Securities regulators can take actions that hopefully will serve as examples to other parties in the markets and deter similar behavior. A recent example are the actions of the SEC against the city of San Diego.

The SEC sanctioned the city of San Diego, CA in November, 2006 saying it committed fraud when selling bonds to investors in 2002 and 2003 without disclosing the unfunded liability in its pension plan.

The SEC found that the city's disclosures about its pension and retiree health care obligations and its ability to pay those obligations were misleading. The SEC found that the city failed to disclose that the city's unfunded liability to its pension plan was projected to dramatically increase, growing from $284 million at the beginning of fiscal year 2002 to an estimated $2 billion by 2009, and that the city's liability for retiree health care was another estimated $1.1 billion.

According to the SEC's Order, the city also failed to disclose that it had been intentionally under-funding its pension obligations so that it could increase pension benefits but defer the costs, and that it would face severe difficulty funding its future pension and retiree health care obligations unless new revenues were obtained, pension and health care benefits were reduced, or city services were cut. The SEC further found that the city knew or was reckless in not knowing that its disclosures were materially misleading.

The SEC determined that the city made these misleading statements through three different means.

  • First, the city made misleading statements in the offering documents for five municipal offerings in 2002 and 2003 that raised over $260 million from investors. The offering documents containing the misleading statements included the "official statements," which were intended to disclose material information to investors, and the "preliminary official statements," which were used to gauge investors' interest in a bond issuance.
  • Second, the city made misleading statements to the agencies that gave the city its credit rating for its municipal bonds.
  • Finally, the city made misleading statements in its "continuing disclosure statements," which described the city's financial condition and were provided by the city to the municipal securities market with respect to prior city bond offerings.

Attempts to repeal

"Next year will bring significant changes in the municipal securities market if Congress passes sweeping financial regulatory reform in what would be the biggest overhaul of financial regulation since the Great Depression.

At the very least, regulatory reform is expected to lead to federal oversight of currently unregulated financial, swap, and other advisers in the muni market as well as changes to the composition of the 15-member Municipal Securities Rulemaking Board to make it a majority-public self regulator. Currently, the MSRB is dominated by representatives from 10 dealer firms.

Last week, Senate Banking Committee chairman Christopher Dodd, D-Conn., and the panel’s ranking Republican, Richard Shelby, R-Ala., issued a joint statement suggesting they may have revised draft regulatory reform legislation ready by the time the Senate returns next month.

But aside from such legislation, which has already cleared the House, a key question that will shape munis is the extent to which the Securities and Exchange Commission plans to pursue additional legislation that would give it greater authority over munis, as called for generally this year by SEC chairman Mary Schapiro and outlined with more detail in an October speech by commissioner Elisse Walter.

In her speech, Walter said that Congress should repeal the so-called Tower Amendment and other securities law exemptions for municipal issuers so the SEC can require issuers to comply with certain disclosure requirements as well as with generally accepted governmental accounting standards.

Walter called for Congress to allow the SEC to require nongovernmental conduit borrowers to meet the same corporate-style registration and disclosure requirements that would apply if they directly sold the bonds. She also called for lawmakers to give the SEC authority over all financial intermediaries in the municipal market and to “seriously consider” combining muni market rulemaking and enforcement authority into one self-regulatory organization.

Though Walter called for the repeal of Tower — an amendment added in 1975 to the Securities Exchange Act of 1934 that prohibits the SEC and MSRB from collecting disclosures prior to bond sales — she indicated that her primary concern is the timing of secondary-market disclosures rather than those in the primary market. As with previous SEC commissioners who have called for enhanced muni authority, she said issuers should not necessarily be required to receive pre-approval for their offerings from the SEC the way corporations do.

Though the issue of whether to repeal Tower is important, some market participants believe the SEC can accomplish what it wants without repealing the amendment, which over the years has become a politically contentious subject and would be difficult to achieve legislatively.

While a majority of the five-member SEC has strongly urged for an expansion of the commission’s muni authority, only one other commissioner, Luis Aguilar, has publicly said that a repeal of Tower is needed. In an interview this month, he reiterated that position, adding that, while Tower’s repeal is not all that needs to be done, it is emblematic of the need for Congress to act to expand the SEC’s authority

“Either way you analyze it, we’re going to need congressional action to give us sufficient authority in this area,” he said, noting that he first publicly called for boosting muni disclosure standards in a speech a year ago to the North American Securities Administrators Association in which he cited recent muni-related scandals in Jefferson County, Ala., and San Diego.

Still, issuers remain strongly opposed to legislative changes that would enhance the SEC’s authority — especially the repeal of Tower — and so far appear to have the backing of key lawmakers, such as House Financial Services Committee chairman Barney Frank, D-Mass. Frank has repeatedly said he is opposed to disclosure changes that would be unduly burdensome for issuers.

Ben Watkins, director of Florida’s bond finance division and a member of the Government Finance Officers Association’s debt committee, has little confidence the SEC would “get it right” if they received greater authority over the market, owing to what he described as years of SEC bungling of continuing disclosure.

For instance, he said the SEC did not require the former national disclosure repositories — which were replaced this year by a single repository run by the MSRB — to include CUSIPs and uniform cover sheets as part of secondary market filings, making it difficult to keep track of the disclosures. In addition, he said there were no performance measures of the repositories to gauge how well they were functioning.

“It took until 2009 to create a uniform system through EMMA,” he said, referring to the MSRB’s Electronic Municipal Market Access site. “So I don’t have a high degree of confidence that they would get it right ... and I think it’s incumbent on them to spell out with specificity what their plan is, rather than saying, 'Trust me, I’m from the government, I’m here to help you. Just repeal Tower, don’t worry, we’ll get this right.’”

Watkins thinks Walter essentially got it backwards when she argued in her speech for a tiered system that would subject larger muni issuers to more corporate-like disclosure requirements. It’s more likely that smaller issuers, which do not have a lot of resources and are less frequently in the market, would provide inadequate disclosure, he said

Asked about Watkins’ remarks, Martha Mahan Haines, the SEC’s municipal securities chief, acknowledged that Schapiro’s calls for increased legislative authority over munis would “raise considerable debate in the industry.”

Haines said that while most people now believe the multiple repository system was a disappointment, the SEC’s original proposal for a central repository received numerous complaints that it would undermine private competition.

Meanwhile, in an interview with The Bond Buyer last month, Schapiro said the SEC will try to reach broad market consensus where it can, “but if we can’t then we’ll have to figure out what’s the right thing to do.”

She said the SEC will likely vote to adopt final changes to its Rule 15c2-12 on disclosure “very early” in 2010 and will then meet with lawmakers to see what can be done to expand its authority over the muni market.

The changes to 15c2-12, which regulates issuers indirectly through dealers, generally would expand the types of events issuers must disclose on a continuing basis and require the disclosures to be filed within 10 days of occurrence rather than on a “timely basis.” But once the rule is changed, Schapiro said the SEC is very close to having exhausted the limits of its authority..."

"That's what the amendment says. What it means, or what most people take it to mean, is that the SEC doesn't regulate the states and municipalities that sell bonds.

Back in March, 2007 former SEC Chairman Christopher Cox made headlines when he told the Bond Buyer newspaper that the commission was reviewing the rules governing the municipal market, and that it might be time for Congress to take another look at Tower to see if it still makes any sense.

The market has been waiting since then, for a lot of things. The first is the result of this "review". The second is whether there will be any enforcement action in connection with the criminal probe into what the commission described only as ``anticompetitive practices (including bid-rigging, price- fixing and kickbacks) last November."

Tower repeal implictions

If Tower was repealed perhaps the SEC would get to specify what is in bond-offering documents, and review the disclosure with the issuer prior to completion of the underwriting and if need be challenge the adequacy and accuracy of the information contained in documents.

This is exactly what issuers don't want to happen, of course, and they can be expected to resist the repeal of Tower vigorously. Municipal issuers assume that more regulation just means more cost and bother for them. The other side of the argument is that for smaller issuers their funding costs would likely be reduced as larger numbers of potential investors could review their financial position and evaluate the risk and return of purchasing the issuer's securities.

How would other participants in the market line up in any fight?

It's hard to imagine investors being unhappy with more and presumably better disclosure. The comprehensive annual financial reports filed by issuers now vary a great deal. Some, those produced by the largest and most frequent bond issuers, are detailed and timely, and are often available on their Web sites.

'Listing' Standard

"What would happen if the SEC asks Congress to repeal the part of Tower that applies specifically to the SEC?

"Repealing that part wouldn't accomplish much without other statutory changes that give positive authority to the SEC to take affirmative regulatory steps, says Robert Doty, president of American Governmental Financial Services Co. in Sacramento, California, and a long-time observer of the market. ``Tower was very carefully and tightly negotiated.

Christopher Taylor, former executive director of the MSRB for almost its entire existence, said the repeal of Tower may lead to a "listing" standard for municipal securities.

Issuers wouldn't have to register their securities as corporations do, but would have to include certain standard financial information in their bond-offering documents, Taylor said in an e-mailed response to questions.

Doty said the SEC would perhaps select certain types of bonds, particularly those that default most often, like health- care corporate debt and land-based financings, and specify what kind of information those issuers would be required to disclose."

The National Federation of Municipal Analysts outlined specific types of disclosure that might be useful in a listing standard.

  • For interest rate swaps and similar instruments the ability to track exposure to counterparties would be useful. The structure of a swap, the counterparties involved, and in particular the transaction’s terms and triggers should be included.
  • How rating downgrade triggers are determined for the replacement of counterparties and the consequences for non-compliance.
  • For borrowers who had purchased guaranteed investment contracts (GICs) from institutions, the collateral triggers, replacement of counterparties, or cash funding requirements would be important.
  • For bank-supported variable rate obligations, the bank letter of credit agreements and terms of reimbursement.
  • Similarly, how much money a municipality gets up front in a “swaption” should be revealed and the size of the termination payment to unwind a swap.

Each of these events has material credit consequences for municipal borrowers and their investors.

Current status of disclosure

Source:Letter to members of Congress from the National Federation of Municipal Analysts, June 4, 2009

"Due to existing federal law, the SEC has had to approach disclosure through the broker/dealer community and Rule 15c2-12. However, as a recent report from DPC Data* indicates, compliance with this rule is inconsistent. Short of a fraud investigation, there is no enforcement mechanism available that is similar to remedies imposed for publicly traded corporate securities. With no one regulatory authority overseeing the municipal bond market, there are also no formal disclosure standards or definitions of material information to be provided, and disclosure quality varies significantly.

Viewed from the perspective of a corporate investor, it is unlikely that one would consider buying shares in a company whose filings are two years old, nor consider investing without complete and open disclosure of all material facts about a company. Yet this lack of disclosure has been tolerated and excused in the municipal market for a range of reasons. (“It is too much trouble/cost/burden for small, infrequent issuers”; “Municipalities have low default rates, so what difference does it make?” etc.)

The National Federation of Municipal Analysts (NFMA) views the launch of the Municipal Securities Rulemaking Board’s (MSRB) new Electronic Municipal Market Access (EMMA) disclosure system as a step in the right direction, and we look forward to continued development of this system. Although EMMA has improved the delivery of information, it does not improve the quality of that information for new issue offerings or for annual 15c2-12 reports.

Complete and accurate disclosure for investors should focus not only on financial results but on all material information. Operating data, competitor information, projections, and the terms and counterparties of contingent activities such as swaps, other derivatives, guarantees, and liquidity agreements are often material.

In many cases, these items are routinely missing from today’s disclosure. Especially with the scarcity of “AAA” credit enhancement and the absence of underlying credit ratings, analysts are working as quickly as possible to evaluate the securities in their portfolios."

Smaller issuer disclosure

The disclosure for smaller, infrequent issuers, and the municipal market is primarily made up of such entities, varies greatly. Some don't file information at all; others file sketchy reports that are years old by the time they reach EMMA or any of the nationally recognized municipal securities information repositories (NRMSIRs).

Underwriters are likely to side with the SEC and against states and municipalities. Under the SEC's rule 15c2-12, which dates from 1989, the onus is on underwriters and dealers to obtain and disseminate official statements from the issuers. Underwriters have long felt the burden.

Asked about what the repeal of Tower might mean, Robert Dean Pope, a bond lawyer and partner at Hunton & Williams in Richmond, Virginia, said, ``My first reaction is that it would permit Rule 15c2-12 to be amended to apply directly to issuers. Currently, the rule is an underwriter-conduct rule and the commission cannot really come after issuers for failure to file.

Pope is author of "Making Good Disclosure, published by the Government Finance Officers Association in 2001.

The SEC will have to make a case if it wants to heighten regulation in the municipal market. It may have a very good one if it lays out the ``anticompetitive practices enforcement action and people in Congress start asking what in the world is going on in this municipal-bond market.


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