How the Recent Amendments to Rule 15c2-12 Will Affect Municipal Bond Issuers

How the Recent Amendments to Rule 15c2-12 Will Affect Municipal Bond Issuers
Randall S. Kulat

Starting early next year, municipal bond issuers will become obligated to publicly disclose certain information regarding their bank loans, municipal leases, direct purchases or private placements of bond issues, derivatives and other types of non-publicly offered financial obligations. The Securities and Exchange Commission (“SEC”), wishing to “add transparency to the municipal securities market by increasing the amount of information that is publicly disclosed about material financial obligations incurred by issuers,” recently adopted two amendments to Rule 15c2-12 (the “Rule”) under the Securities Exchange Act of 1934. These amendments add two new “events” to the list of events required by the Rule to be included in continuing disclosure undertakings and posted on the Municipal Securities Rulemaking Board’s Electronic Municipal Market Access (“EMMA”) website.

​The two new events added by the SEC will, by its own admission, likely result in municipal bond issuers and underwriters incurring additional time and expense in order to comply with the Rule – both before and after these amendments to the Rule take effect on February 27, 2019 (the “Compliance Date”). In order to lessen the impact of the two new event disclosure requirements, issuers, underwriters, municipal advisors and others involved in public finance should become familiar with the changes to the Rule well before the Compliance Date.

New Disclosure Events Added to the Rule

The Rule prohibits an underwriter from buying or selling municipal bonds unless it has reasonably determined that the issuer, or other “obligated person,” has agreed in a written continuing disclosure undertaking to provide specific information on EMMA. The Rule currently lists fourteen specific events for which notice is to be posted on EMMA within ten (10)  business days of occurrence. On August 20, the SEC announced that it will be adding two new events requiring issuers and obligated persons in municipal bond offerings to agree in writing to provide notice of:

  • The incurrence of a financial obligation of the obligated person, if material, or agreement to covenants, events of default, remedies, priority rights, or other similar terms of a financial obligation of the obligated person, any of which affect security holders, if material (new Event Numbered 15); and
  • A default, event of acceleration, termination event, modification of terms, or other similar events under the terms of a financial obligation of the obligated person, any of which reflect financial difficulties (new Event Numbered 16).

The amendments to the Rule will only affect continuing disclosure agreements entered into on or after the Compliance Date. An issuer’s existing continuing disclosure undertakings will be unaffected by the amendments to the Rule.

Financial Obligations Under New Event Numbered 15

The amendments to the Rule define “financial obligation” as a (i) debt obligation; (ii) derivative instrument entered into in connection with, or pledged as security or a source of payment for, an existing or planned debt obligation; or (iii) a guarantee of (i) or (ii). In implementing these amendments, the SEC said that the definition of “financial obligation” does not include ordinary financial and operating liabilities incurred in the normal course of an issuer’s or obligated person’s business, but only an issuer’s or obligated person’s debt, debt-like, and debt-related obligations.

Debt Obligation.  Under the Rule, a “debt obligation” is any short-term or long-term debt obligation of an issuer or obligated person under the terms of an indenture, loan agreement or similar contract, regardless of the length of the debt obligation’s repayment period, such as a direct purchase of municipal bonds or a direct loan by a bank. A lease is not a debt obligation, except when the lease is debt or debt-like. If a lease operates as a vehicle to borrow money, such as an equipment financing lease, it is a debt obligation, but an operating lease is not included in the definition.

Derivative Instrument. The definition of financial obligation includes a “derivative instrument” such as a swap, a security-based swap, a futures contract, a forward contract, an option or similar instrument (or combination) or any similar instrument to which an issuer or obligated person is a counterparty, provided that such instruments are related to an existing or planned debt obligation.

Guarantee.  A “guarantee” is also a financial obligation, as defined in the Rule. A guarantee includes any guarantee provided by an obligated person (as a guarantor) for the benefit of itself or a third party, which guarantees payment of a financial obligation, guarantee of a debt obligation or a derivative instrument entered into in connection with, or pledged as security or a source of payment for, an existing or planned debt obligation.

Materiality Under New Event Numbered 15

Under the new Event Numbered 15, only “material” financial obligations or agreements to terms of financial obligations need to be disclosed on EMMA within ten (10) business days of its occurrence. The SEC stated that not every incurrence of a financial obligation or agreement to terms is material, but it offered no hard and fast rules as to what exactly constitutes materiality. Instead, the SEC wants issuers and obligated persons to assess their disclosure obligations in the context of the specific facts and circumstances, and based on whether the information regarding their financial obligations would be important to the “total mix of information made available to the reasonable investor.” An issuer or obligated person will need to consider whether a financial obligation or the terms of a financial obligation, if they affect security holders, would be important to a reasonable investor when making an investment decision.

What to Report, and When, Under New Event Numbered 15

If, on or after the Compliance Date, an issuer or obligated person determines that it has incurred a material financial obligation, it must disclose such information on EMMA within ten business days of such occurrence. A financial obligation is considered to be incurred when it is enforceable against an issuer or obligated person. A financial obligation incurred before the Compliance Date is not required to be disclosed under new Event Numbered 15, but, as discussed below, a default or other event under such financial obligation may have to be disclosed under new Event Numbered 16.

A disclosure on EMMA under new Event Numbered 15 must include a description of the material terms of the financial obligation, such as the date of incurrence, principal amount, maturity and amortization, interest rate, if fixed, or method of computation, if variable (and any default rates). The SEC has indicated that obligated persons can submit to EMMA either a description of the material terms of the financial obligation, or alternatively, or in addition, submit related materials, such as transaction documents, term sheets prepared in connection with the financial obligation, or continuing covenant agreements or financial covenant reports, as long as such related materials include the material terms of the financial obligation. The amendments do not require disclosure of confidential information such as contact information, account numbers or other personally identifiable information.

Disclosure of Defaults Under New Event Numbered 16

As previously noted, new Event Numbered 15 under the Rule is prospective in that it will require an issuer to provide notice on EMMA, pursuant to a continuing disclosure undertaking executed on or after the Compliance Date, if it enters into certain financial obligations thereafter. New Event Numbered 16, however, is retroactive, in that it will require issuers of municipal securities offered on or after the Compliance Date to enter into continuing disclosure undertakings mandating the disclosure on EMMA of any default or other similar event under any applicable financial obligation, regardless of whether such financial obligation was entered into before or after the Compliance Date.

New Event Numbered 16 requires obligated persons offering municipal bonds on or after the Compliance Date to agree to disclose on EMMA any defaults, accelerations, terminations, modifications and other such events under both new and existing financial obligations, if the event “reflects financial difficulties” of the obligated person. A “default” under the Rule may not necessarily be an “event of default” under a financial obligation. The SEC stated that defaults may reflect financial difficulties even if they do not qualify as “events of defaults” under transaction documents. Similarly, a modification of terms of a financial obligation would have to be reported under a continuing disclosure agreement if the modification “reflects financial difficulties of the issuer or obligated person.”

The key is whether any default, modification, waiver or similar event reflects “financial difficulties”, but the SEC does not provide much guidance as to what constitutes a financial difficulty. Its notice of the amendments to the Rule states that the financial difficulties standard is intended to “target the disclosure of information relevant to investors in making an assessment of the current financial condition of the issuer or obligated person.” Without further explanation from the SEC, issuers and obligated persons will be on their own to determine whether a default, modification of terms or other like event concerning a financial obligation reflects financial difficulties, thereby requiring disclosure on EMMA.

Timing of Compliance

The amendments to the Rule will impact only those continuing disclosure agreements entered into in connection with primary offerings of municipal bonds that occur on or after the Compliance Date. The SEC considers an offering to occur on the date the continuing disclosure agreement is executed. However, if a preliminary official statement is posted or distributed before the Compliance Date, with an expectation that the offering will close on or after the Compliance Date, the preliminary official statement should contain a description of, or attach a form of, a continuing disclosure agreement that reflects these amendments to the Rule.

As noted earlier, the new amendments to the Rule do not affect an obligated person’s responsibilities under continuing disclosure agreements entered into before the Compliance Date. Issuers will not need to disclose new loans, or defaults under any financial obligation, under any continuing disclosure agreement entered into prior to the Compliance Date. However, if it issues bonds on or after the Compliance Date, an issuer will have to sign a continuing disclosure agreement mandating it to provide the notices required by the recent amendments to the Rule.

What to Do Next

The SEC has given the public finance community until the Compliance Date to implement new policies, practices and procedures for complying with the amendments to the Rule. Issuers and their dissemination agents, municipal advisors and legal counsel will need to find ways to determine whether a financial obligation is material, or if a default, termination or modification relating to a new or existing financial obligation reflects financial difficulties of the issuer. Existing financial obligations and continuing disclosure agreements may have to be reviewed in order to determine if the new amendments have any impact on existing documents.

Underwriters will need to make their own determinations regarding an issuer’s financial obligations, and may need to upgrade their due diligence procedures in order to ferret out any undisclosed financial obligations of the issuer. Underwriters will need to review an issuer’s financial obligations, and then determine which are deemed financial obligations under the Rule, which are material and which terms might be considered material to investors. Underwriters will need to judge for themselves whether a default, termination or modification relating to a new or existing financial obligation of an issuer reflects financial difficulties of the issuer.

This won’t be easy for anyone. The SEC already anticipates that issuers and underwriters will have to devote considerable time and expense to implement the amendments to the Rule, and it acknowledged that issuers and underwriters may need to retain outside counsel to help sort it all out.

If you have questions regarding the recent amendments to the Rule, please contact George T. Magnatta (215-972-7126; george.magnatta@saul.com), Josh Pasker (215-972-7783; josh.pasker@saul.com), Randy Kulat (312-876-7877; randall.kulat@saul.com) or any other member of Saul Ewing Arnstein & Lehr’s Public Finance Practice.