By William Selway and Jesse Westbrook
March 7 (Bloomberg) -- The U.S. Securities and Exchange Commission may seek to force greater disclosure from state and local government borrowers and is increasing its efforts to crack down on fraud by bond sellers, a spokesman said.
SEC Chairman Christopher Cox initiated a review of the rules governing the municipal bond market to see whether they should require greater disclosure to give investors more information, spokesman John Nester said. The agency also plans to increase its enforcement actions against those who make false disclosures covering municipal bonds.
``Increased transparency in municipal bond disclosure will better benefit and protect Main Street investors and the cities and towns they live in,'' Nester said.
The initiative follows the agency's sanctioning of San Diego for inadequate disclosures made to buyers of its debt. It also comes as federal prosecutors conduct a criminal investigation into the business of selling derivatives and investments to state and local governments, which have $2.3 trillion of debt outstanding. The SEC is also investigating the sale of investment contracts to municipalities.
The amount of information available to buyers of municipal bonds is less than what is available to purchasers of publicly traded stocks, even though individuals are the largest buyers of the debt, accounting for more than one-third of the outstanding bonds, according to the Federal Reserve Board.
Fewer Requirements
Municipal borrowers aren't required to file documents with the SEC, as corporations that sell securities do, because of exemptions granted to them under the 1933 Securities Act and because of a 1975 law known as the Tower Amendment, which prevents regulators from using a 1934 law to impose such requirements.
The lack of disclosure in the municipal bond market was highlighted by the 1983 default on bonds sold by the Washington Public Power Supply System, which helped usher in the passage of SEC rule 15c2-12. The rule, requiring underwriters to make available copies of official statements for most municipal bond issues, was later amended to require issuers to agree to disseminate information, such as payment delinquencies, that could affect bondholders.
Those rules, and whether the Tower Amendment should be reconsidered, are part of the review, Nester said. The initiative was reported earlier today by the Bond Buyer.
``It's been almost 14 years since the commission really took the temperature of all participants in the market,'' said Paul Maco, who in the late 1990s led the SEC's Office of Municipal Securities.
San Diego Lapses
San Diego's lapses in disclosing the state of its pension fund renewed concerns among regulators about the quality of the information that states, cities and government agencies provide to investors.
Starting in 1996, San Diego boosted pension-fund benefits, failed to invest enough money to cover what it would eventually owe to workers and used earnings from the retirement fund to pay for medical benefits. After the U.S. stock market entered a three-year rout in 2000, the fund was left with a deficit.
The city's looming shortfall was never adequately disclosed to investors when it sold $260 million of bonds in 2002 and 2003, according to the SEC's administrative complaint against the city in November. When, in 2003, it disclosed more information about its pension plan, it failed to note that the funding gap was projected to soar by the decade's end and that it owed some $1.1 billion in health benefits it had no money for, the complaint said.
Derivatives
San Diego's straights drew comparison to nearby Orange County, which in 1994 became the site of the biggest municipal bankruptcy in U.S. history after the county treasurer lost money with bad bets on interest-rate derivatives. At the time, Cox, a Republican, represented a district in Orange County in Congress.
Since the Orange County bankruptcy, U.S. state and local governments have increasingly purchased derivatives, not as assets in their investment funds but as a means of locking in interest rates for future projects or wagering on ways to cut their bills to investors. Such agreements often aren't disclosed, because they are private contracts not subject to the rules of the SEC or the Municipal Securities Rulemaking Board.
Derivatives are financial contracts whose values are derived from changes in the value of stocks, bonds, loans, currencies or commodities.
The SEC has already shown interest in investigating the use of interest rate swaps tied to municipal bonds. In December, the commission subpoenaed three current and two former Jefferson County, Alabama, commissioners, asking for records related to bond issues since January 2002 and its $5.8 billion of interest- rate swaps. Among other information, the SEC sought records on payments, gifts and fees relating to the transactions.
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