Call it the law of unintended consequences. When the Municipal Securities Rulemaking Board (MSRB) issued a market advisory on selective disclosure back last September, it didn’t intend to discourage communications between municipal issuers1 and bondholders. But for some, it did.
The MSRB advisory raised concerns from analysts that issuers will no longer take their calls because of the risk of insider trading charges if non-public information is shared and impacts bond prices.
In many cases, these concerns are well founded, because for hospitals and for the rest of the borrowers in the public markets, the line between material and non-material information is a blur.
Selective disclosure is a situation when some investors are given information but not others. This can occur inadvertently when taking a call from a bondholder, replying to an email, or holding a conference call with institutional investors.
Selective disclosure is not inherently a problem. But it can become one when the information is material, because an investor could use it to gain an unfair advantage in buying or selling the borrower’s bonds, a practice also known as insider trading.
Much to the chagrin of the MSRB, SEC Regulation FD addresses selective disclosure for publicly-traded companies, but does not apply to the municipal markets. However, municipal issuers are still subject to SEC antifraud provisions, which prohibit material omissions or misrepresentations associated with the sale of securities.
The challenge is that materiality is based on facts and circumstances, and guidance from regulators has been minimal.
The Supreme Court defined materiality as information that a reasonable investor would consider important when making an investment decision. This is rather vague and could include any information that could have a measurable impact on bond prices.
As a result, it can be very difficult for issuers to sort through what is material and what isn’t, and rather than risking crossing the line, some hospitals simply opt out of individualized, one-on-one communications with bondholders.
The SEC is proposing to add more continuing disclosure events to Rule 15c2-12, including financial obligations that could “materially” affect existing securities holders, and various defaults, accelerations, terminations, and modifications of terms.
As with the capital markets in general, the municipal markets rely on transparency, but this should not come at the cost of shutting down individualized discussions. With more guidance from regulators on specific examples of material information, municipal issuers are less likely to shun individual investors.
Until then, issuers should work with legal counsels and municipal advisors to develop procedures to alert management to the need to keep material information confidential, as well as protocols to process inquiries from third parties.
1 We use the term “issuer” to include “obligors” and “obligated persons” such as private, not for profit hospitals and health systems.
© 2009-2018 HFA Partners, LLC.