DPC DATA, a provider of municipal bond disclosure data, has released the second of a series of groundbreaking research reports into disclosure issues in the municipal bond market.
The study uncovered hundreds of trades in bonds in 2008 that are questionable in terms of meeting regulatory standards for investor protection. These standards are promulgated by the US Securities and Exchange Commission and the Municipal Securities Rulemaking Board (MSRB), the self-regulatory organization overseeing underwriters and dealers of municipal bonds.
To identify these suspect trades, the DPC DATA study matched trade data with officially filed disclosures, focusing on material event notices that typically indicate distressed bonds. These notices were Payment Delinquencies, Non-Payment Related Defaults, Unscheduled Draws on Debt Service Reserves, and Unscheduled Draws on Credit Enhancements.
The research report, entitled The Consequences of Poor Disclosure Enforcement in the Municipal Securities Market
Key findings:
In 2008, 667 dealer-to-customer sales were executed at par or higher after a default or other stress notice was filed by the issuer or obligor in the official disclosure system, suggesting possible failure by dealers to ensure suitability or fair pricing in the trades
The majority of these trades occurred during the tumultuous months of September through November when credit markets were imploding.
In half of these sales, there was no way for investors to protect themselves with independent research because no financial statements had been made publicly available in the official disclosure system during the 2007 or 2008 calendar years.
More than 40% of the trades were in par amounts of $50,000 or less, suggesting they were sales to retail (rather than institutional) buyers.
Both default-related notices and sales of apparently distressed bonds to investors jumped dramatically in 2008 over previous years.
-Implications for Investors
“The implications of this study are twofold, and both bode ill for the municipal investor unless significant improvements are made in regulatory oversight and enforcement,” says Peter J. Schmitt, CEO of DPC and author of the study.
“First, the traditional low default rates of municipal bonds as investments can no longer be assumed. The rise in distress notices indicate that issuers and obligors are suffering from the same financial stresses as the rest of the market. Until the economy recovers, this increase in distressed issues is likely to be a continuing trend.
“A second implication arising from this study,” continues Schmitt, “is that the failure of the SEC and the MSRB to address the massive rate of non-disclosure by issuers and obligors, identified in our last study, is now quite possibly contributing to the growth of apparently predatory trades.
“If DPC DATA had not identified these trades as suspect, there is no known initiative by the SEC or MSRB to identify them. Likewise there is no evidence of any investigative effort to identify non-compliant bonds or dealer sales of these bonds to customers. It’s not surprising, given the lack of enforcement, that non-disclosure persists and that questionable trades like these can occur without fear of regulatory repercussions.”
-Increasing Risks to Investors
“At this point, we have natural concerns about the future of this part of our business,” says Schmitt, “but we have more immediate concerns about the increasing risk presented to investors. Unfortunately the current plan to shift ownership of the archives to the MSRB is a meaningless and possibly counterproductive move in investor protection.”
“This study is DPC DATA’s first effort to clarify the real meaning to investors of the regulatory failure to enforce continuing disclosure infractions at the dealer level. It raises the overriding question of the safety of leaving the only mechanism of disclosure-related investor protections in the hands of a self-regulating industry body.”
“Support for MSRB control of the official archive has largely come from the dealer and issuer communities who face the potential cost of increased oversight and enforcement. However we are not alone in our concerns about investor protection, and we hope the implications of this study are considered carefully by lawmakers and regulators.”
L.D.