On August 20, 2018, the Securities and Exchange Commission (the “SEC”) announced that it adopted amendments to Rule 15c2-12 of the Securities Exchange Act of 1934, as amended (the “Rule”). The SEC stated that it adopted the amendments to “enhance transparency in the municipal securities market” by focusing “on material financial obligations that could impact an issuer’s liquidity, overall creditworthiness, or an existing security holder’s rights.” Below are some of the “highlights” of the new changes to the Rule and the effects on continuing disclosure.
Before these amendments to the Rule, there were 14 “events” required to be reported to the Municipal Securities Rulemaking Board (the “MSRB”) (via the Electronic Municipal Market Access (“EMMA”) Website) not in excess of ten business days after their occurrence. The amendment adds two more such events, which are the following (and these events will need to be listed in any new continuing disclosure agreements that an issuer or obligated person may execute in connection with any bond issue it may undertake after 180 days from publication of the Rule amendments in the Federal Register):
(15) 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 securities holders, if material; and
(16) 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.
The term “financial obligation” means 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) guarantee of (i) or (ii). The Rule excludes “financial obligations” involving municipal securities as to which a final official statement has been provided to the MSRB (posted on EMMA).
The SEC uses the word “material” in the events but does not define the word. Rather, the SEC cites to case law for a definition. Issuers of municipal securities and “obligated persons” (any person, including an issuer, who is either generally or through an enterprise, fund, or account of such person committed by contract or other arrangement to support payment of all, or part of the obligations on the municipal securities to be sold in an offering) must assess whether a piece of information at the time of issuance is of a character that there is a substantial likelihood that, under all the circumstances, “the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information available.” Although this guidance is not entirely helpful, it is consistent with the SEC’s views.
For purposes of determining the timing of filing under EMMA, “incurrence” of a “financial obligation” occurs when the “financial obligation” is enforceable against an issuer or an obligated person. The example given is a “draw-down” loan with a bank, where documents are executed but no funds are received (or not all funds are drawn at the time of execution), which date of execution triggers the 10 business days, not the draw-down date.
The question arises as to what an issuer or an obligated person must submit. The SEC Release provides an option to either submit 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 to EMMA. Any such related materials, if submitted as an alternative to a description of the material terms of the financial obligation, should include the material terms of the financial obligation. The amendments do not require the provision of confidential information such as contact information, account numbers, or other personally identifiable information to EMMA.
As defined, “financial obligation” includes a “debt obligation” (either short-term or long-term), which could be a direct purchase of municipal securities by an investor or a direct loan by a bank to an issuer. In addition, “debt obligation” generally includes lease arrangements entered into by an issuer that “operate as vehicles to borrow money.” Types of leases that could be debt obligations include (i) lease-revenue transactions (where an issuer or obligated person borrows money to finance an equipment or real property acquisition or improvement and a lease secures the issuer’s or obligated person’s obligation to make principal and interest payments to the lender) and (ii) certificates of participation transactions (where the issuer or obligated person sells certificates of participation and the proceeds of the certificates are used, typically, to finance an equipment or real property acquisition or improvement by the issuer or obligated person).
The definition of “financial obligation” also includes “derivative instruments”, such as an interest rate swap, security-based swap, futures contract, forward contract, option, any combination of the foregoing, or any similar instrument to which an issuer is a counterparty. The third leg of the definition of “financial obligation” is a “guarantee,” which could raise two disclosure filings under the Rule, one for the guarantor and another for the beneficiary of the guarantee. For example, if a local government were to guaranty some portion of an issuer’s or obligated person’s debt, then both entities would be subject to a potential filing under EMMA.
Under “Event (16)” above, “defaults” that would require posting on EMMA include both monetary and non-payment related defaults. Additionally, defaults requiring posting may be ones that have not yet matured into “events of default.” In “Event (16)”, modification of terms would be reported under a continuing disclosure agreement only if the modification “reflect[s] financial difficulties of the issuer.” “Modification of terms” could include a written or verbal waiver of a deal provision.
As for the effective date of these amendments, the amendments will only affect those continuing disclosure agreements entered into on or after the compliance date (180 days after publication in the Federal Register) for the amendments. However, an event under the terms of a financial obligation pursuant to Event (16) (e.g., a default) that occurs on or after the compliance date must be disclosed regardless of whether such obligation was incurred before or after the compliance date.