SEC targets shady practices in muni bond market

The SEC's announcement that it is launching an investigation into the municipal bond market is aimed at increasing transparency — and weeding out conflicts of interest. With $2.8 trillion in municipal bonds, about a third of which are held by retail investors and mutual funds, the Securities and Exchange Commission is concerned about gaps in its oversight of the market, Andrew “Buddy” Donohue, director of its Division of Investment Management, said in remarks at the Investment Company Institute's General Membership Meeting in Washington on Friday. In 2008, there were 136 defaults of municipal bond securities, representing $7.5 billion in assets, he added. Given those numbers, “it is surprising that there is such a low level of regulatory oversight,” said Mr. Donahue, reading a speech that SEC Chairman Mary Schapiro was scheduled to deliver. She had to cancel because the SEC is investigating the trading irregularities that led to the 1,000-point intraday market plunge Thursday. The SEC wants to make sure that issuers of municipal securities are held to the same standards as issuers in the corporate world, Mr. Donohue said. To that end, the agency has asked SEC member Elisse Walter to hold a series of field hearings across the country to examine a broad array of municipal securities providers and then issue a report on her findings. The commission also is in discussions with the Municipal Securities Rulemaking Board about how they can work more closely together to address the potential for conflicts of interest. Currently, the SEC has no jurisdiction over municipal securities issuers — just the broker-dealers that sell the securities. Mr. Donahue said there is currently a huge potential for conflicts of interest in the municipal bond world. For example, under current regulations, it's permissible for a banker to help structure a municipal bond offering, resign as an adviser to that deal and then underwrite the offering, he said. “We should forbid this practice,” he said. Mr. Donahue offered up several possible reforms for the municipal bond market. One suggestion: standardizing reporting documents so that “investors can comparison-shop.” He also called for uniform accounting standards for the market, as well as a mechanism for independent funding, such as new fees for new issuances. The agency also recommended that issuers be forced to disclose changes to their financials, such as tax-based changes and lifespan changes that might affect their pension obligations. “Transparency is more than just putting dollars on a page,” he said. “It is eliminating the potential for conflict of interest that can lead to poor decisions by the issuers.” [An expanded version of this story will appear in the May 10 - 14 issue of InvestmentNews]