SEC turns gaze to municipals

The Securities and Exchange Commission is turning its enforcement attention to municipal bond issuers, who have escaped close attention for too long. The development is important for individual investors, particularly retirees, and their advisers because municipal bonds have long been a choice vehicle for tax-free income. But since the Great Recession in 2008-09, investor faith in the muni bond market has been shaken by the financial difficulties of cities such as Detroit and Stockton, Calif., and counties such as Jefferson County, Ala., which have all sought protection from creditors. (Don't miss: SEC examining hidden prices in bond trading)

INVESTIGATIONS

Now the SEC has opened investigations into whether some municipalities might have misled investors about their financial health before they issued bonds. In a sign of its new interest in making sure municipalities play fair with investors, last year, the regulator charged Harrisburg, Pa., with securities fraud for issuing misleading public statements when its financial condition was deteriorating. The SEC said the financial information that was made available to municipal bond investors was either incomplete or outdated. (See also: Muni regulator pursues rule to increase price transparency) The SEC found that Harrisburg failed to comply with requirements to provide certain financial information and audited financial statements for the benefit of investors holding hundreds of millions of dollars in bonds issued or guaranteed by the city. Harrisburg settled the case without admitting the agency's charges. The SEC has told issuers and underwriters that they will face less severe penalties if they self-report violations than if it launches enforcement actions against them. The new spotlight on municipal bond issuers and underwriters is welcome. At about $3.7 trillion, the municipal bond market is important for investors and local governments. If investors lose any more confidence in municipal bonds, both will be hurt. The SEC's investigations should serve as a warning to municipalities and their underwriters that they must be brutally honest about their finances when they issue bonds, and they should reassure investors that the agency is working to protect them. For advisers, the SEC's actions should reinforce the need to vet fully any and all muni bonds they put into client portfolios.