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Cox Recommends Legislation to Improve Municipal Securities Market

SEC Chairman Christopher Cox, in remarks at the Town Hall of Los Angeles, said the provision of basic consumer protection in the municipal securities market is long overdue. Cox noted that a number of government issuer associations are considering steps to avoid compliance with the Governmental Accounting Standards Board's standards for municipal securities issuers. He suggested a couple of approaches to prevent securities fraud in the municipal markets. The most straightforward approach is through legislation to establish a limited regulatory regime that reflects the realities of today's municipal securities markets, he said. The second approach is through more aggressive monitoring and examinations by the existing regulatory authorities.

Since the federal securities laws were adopted at a time when municipal finance was a relatively small market, they do not reflect the current size and importance and the increase in holdings by individual investors. Today's investors deserve the same level of disclosure in the municipal market as in the corporate market, according to Cox. He said the need for better quality disclosure became evident in the Orange County bankruptcy and the San Diego securities fraud.

The SEC is able to address municipal securities fraud after the fact. However, if the SEC fines a municipal issuer, Cox noted that the defrauded victims would have to pay the penalty since municipalities have no money of their own. The SEC has no authority to require the same disclosure in the municipal market that is required in the corporate securities market. Cox believes the expensive disasters in Orange County and San Diego could have been avoided if there had been a regime of full and fair disclosure and securities law compliance.

Cox called for immediate steps to improve governmental accounting and to ensure that issuers provide prompt financial information. Unfortunately, he said the trend appears to be going in the wrong direction. He pointed to recent legislation enacted in Texas to permit local governments to avoid the rules of GASB. Connecticut also considered such legislation, but it was vetoed by the governor. Cox characterized efforts to avoid GASB rules as a clear and present danger to investors in municipal securities.

Cox believes that issuers of municipal securities should be subject to GASB standards just as corporate issuers are to FASB standards. The SEC does not have the authority to require the use of proper accounting standards by municipal issuers. Cox said a number of government issuer associations have called for a freeze in GASB's funding level because of their dissatisfaction with recently adopted standards and a particular GASB project. GASB's independence is under assault, according to Cox, but the need for that independence is just as great in the municipal market as in the corporate market.

Cox also noted that the auditor's role is not the same in the municipal market. Municipal issuers sometimes include audit opinions and audited financial information in their disclosure documents without the auditor's consent. Without the auditor's consent, there is no assurance that procedures were performed to detect any events since the date of the audit opinion that may have a material impact on the issuer's financial condition. A lot of information provided in municipal offerings is stale, he advised

Cox said that too many members of municipal issuers' governing bodies are not involved enough in the disclosure. In addition, many issuers lack disclosure controls, policies and procedures to ensure accurate disclosure.

Cox emphasized that he does not believe the full registration and regulation model that applies to companies is necessary for states and local governments, nor does he believe the SEC should review the disclosure documents of municipal issuers. Legislation could establish a limited regulatory regime aimed at the municipal market to ensure that investors in primary offerings receive the information they need prior to the sale on which to base their investment decisions. Legislation could also mandate that municipal issuers use generally accepted governmental accounting standards, he said

Cox said the legislation could provide an independent funding mechanism for GASB, and could permit the SEC to oversee GASB as it does the FASB. Congress could also clarify the legal responsibilities of the government officials and the responsibilities of the underwriters with respect to the offering statements for municipal offerings.

Meanwhile, Cox said the SEC's examiners will conduct focused reviews in the municipal market in which they will look at broker-dealer compliance with the pay-to-play rule. The staff will also look at the nationally recognized municipal securities information repositories and the role they play in providing disclosure to investors and brokers.

California has paid a steep price for its lesson in the municipal markets, Cox advised. He urged the state to provide a template for the rest of the nation in improving municipal issuers' financial disclosure.

Jacquelyn Lumb