Introduction
This Hawkins Advisory provides an update on selected matters of interest to the municipal securities market and its participants. In particular, this Advisory reviews (i) the Financial Data Transparency Act of 2022 (the “FDTA”), which was signed into law on December 23, 2022;[1] (ii) developments in enforcement actions regarding limited offerings; and (iii) the status of certain pending rulemaking by the Securities and Exchange Commission (the “SEC”) and the Municipal Securities Rulemaking Board (the “MSRB”).
Financial Data Transparency Act
The FDTA launches a rulemaking initiative requiring federal financial regulatory agencies (including the SEC) to establish new data standards for certain financial data reported to such agencies or published by them. Of particular importance to the municipal securities market, the FDTA tasks the SEC with implementing these data standards to the extent applicable in connection with information submitted to the MSRB, including information filed by municipal issuers and obligated persons through the MSRB’s Electronic Municipal Market Access website (“EMMA”). This is described in more detail below; however, several features of the FDTA are worth noting at the outset.
First, it is expected that the scope of municipal securities information to be collected or made publicly available should not expand as a result of the enactment of the FDTA and the data standards established thereunder. Notably, with respect to municipal market information, the FDTA expressly states that it may not be construed to affect the operation of existing limits (i.e., the Tower Amendment[2]) upon the authority of the SEC and MSRB to require filings by, or on behalf of, municipal issuers prior to the sale of municipal securities or of the MSRB to require a municipal issuer to furnish information.
Second, significant municipal market input will be available to the SEC as it develops and implements the new data standards. The FDTA requires the SEC to consult market participants in the initial establishment of the new data standards. It is our present understanding that a number of industry groups, including the National Association of Bond Lawyers (NABL), the Government Finance Officers Association (GFOA), the Securities Industry and Financial Markets Association (SIFMA), and the Governmental Accounting Standards Board (GASB), and individual market participants, such as affected municipal issuers and obligated persons, are considering commenting on both the data standards and their implementation.
Third, the FDTA authorizes the SEC to scale the data standards to reduce any unjustified burden on smaller regulated entities and requires the SEC to seek to minimize disruptive changes to the persons affected by the rules. However, given the vast differences in size and sophistication that exist in the municipal securities market, especially with respect to less frequent issuers and other obligated persons, the new data standards may require many municipal market participants to incur additional technology, personnel, and compliance costs. Some of these implementation expenditures could be burdensome.
Fourth, rulemaking under the FDTA will happen in two phases, and it will likely be several years before the new data standards are effective and their full scope is known.
Initial Steps. Under the FDTA, federal financial regulatory agencies (including the SEC, the Department of the Treasury, the Federal Reserve System, the Office of the Comptroller of the Currency, the Bureau of Consumer Financial Protection, the Federal Deposit Insurance Corporation, the Federal Housing Finance Agency, and the National Credit Union Administration) are required to jointly propose data standards by June 23, 2024, and to adopt these in final form by December 23, 2024. Although the FDTA provides that these data standards shall take effect not later than two years after they are actually promulgated, it also provides for the various covered agencies to engage in further rulemaking to separately implement the data standards with respect to the financial information for which the applicable covered agency is responsible.
The SEC has implementation responsibility for several capital market segments under the FDTA. With respect to the municipal securities market, the SEC is to issue rules adopting the applicable data standards for information submitted to the MSRB within two years of their actual promulgation. This permits the SEC to adopt one or more effective dates with respect to its implementing rules.
Each stage of the FDTA rule proposals should include an opportunity for public comment, which will likely generate significant interest from market participants. While there are various steps that need to be completed before the new data standards become a reality for issuers and obligated persons in the municipal securities market, market participants should follow these developments closely as rule proposals take form. Early engagement, even at this stage, could be beneficial for market participants with respect to reducing the ultimate burdens of implementing the data standards.
Data Standards Explained. Under the FDTA, the jointly determined data standards are to include common identifiers for the collection of reported information and, to the extent practicable:
(i) render data fully searchable and machine-readable;
(ii) enable high quality data through schemas, with accompanying metadata documented in machine-readable taxonomy or ontology models, which clearly define the semantic meaning of the data, as defined by the underlying regulatory information collection requirements;
(iii) ensure that a data element or data asset that exists to satisfy an underlying regulatory information collection requirement be consistently identified as such in associated machine-readable metadata;
(iv) be nonproprietary or made available under an open license;
(v) incorporate standards developed and maintained by voluntary consensus standards bodies; and
(vi) use, be consistent with, and implement applicable accounting and reporting principles.
These new data standards will represent a shift away from the current practice of collecting and sharing information on EMMA via hard-copy, PDF, or plain-text html formats and likely toward the eXtensible Business Reporting Language, or “XBRL” financial reporting standard. XBRL is the data reporting standard required for registered companies and regulated parties and their submissions via the Electronic Data Gathering, Analysis and Retrieval system (“EDGAR”).[3]
As mentioned above, while these new data standards will change how municipal issuers and obligated persons report information on EMMA, they should not result in new substantive disclosure requirements.
What is XBRL? XBRL is the open international standard for digital business reporting, which provides a language in which reporting terms can be defined and used to uniquely represent the contents of financial statements or other kinds of compliance, performance, and business reports. The overall functionality of the data standard and ability to provide unique tags for reported facts is meant to promote more accurate and efficient reporting.[4]
XBRL is a part of a concept known as “structured data,” which is “data that is divided into standardized pieces that are identifiable and accessible by both humans and computers.”[5] It can include individual data points, such as a number (e.g., revenues), date (e.g., the date of a transaction), or text (e.g., a name), or multiple individual data points (e.g., an entire section of narrative disclosure). Software, such as XBRL, can analyze vast amounts of structured data without extensive and burdensome manual processing, allowing for easier navigation within documents, comparison of prior documents filed by that issuer or obligated person, or evaluation of different issuers or obligated persons throughout the market.[6]
The SEC’s Office of Structured Disclosure (“OSD”), located within the Division of Economic and Risk Analysis, is dedicated “to design[ing] data structuring approaches for required disclosures, and support[ing] the SEC’s data collections and data usage by designing taxonomies, validation rules, data quality assessments, and tools for conducting data analyses.”[7] It is expected that the OSD will play a key role in designing the new data standards under the FDTA for issuers and obligated persons in the municipal securities market.
The SEC’s website has several resources describing structured data, XBRL, Inline XBRL (a structured data language that allows filers to prepare a single document that is both human-readable and machine-readable), and what to expect when implementing a structured data standard.[8]
More on Rule 15c2-12’s Limited Offering Exemption
On December 21, 2022, the SEC announced a settlement with PNC Capital Markets LLC (“PNC”)[9] in connection with offerings of municipal securities utilizing the limited offering exemption provided by Rule 15c2-12 (the “Rule” or “Rule 15c2-12”).[10] This action represents the continuation of the SEC’s focus on underwriters who fail to meet the legal requirements of the “Limited Offering Exemption”[11] under the Rule. The SEC’s initial enforcement activity in this area was announced in September 2022 and the SEC signaled that more of these actions would be forthcoming. The initial enforcement actions and related matters were described in a Hawkins Advisory, dated September 23, 2022 (the “September 2022 Hawkins Advisory,” which is available at SEC Actions – Rule 15c2-12 Limited Offering Exemption | Hawkins Delafield & Wood LLP).
Key Facts. The facts of the PNC matter are virtually identical to those described in the initial enforcement actions and again highlight how certain elements of the Limited Offering Exemption were overlooked or simply ignored. The SEC outlines how PNC would sell the municipal securities to broker-dealers and/or investment advisers who purchased the securities for separately managed accounts. PNC did not inquire: (i) whether the securities were purchased for more than one account or for distribution; (ii) whether the securities were purchased for investment; or (iii) for whom the broker-dealers and investment advisers were purchasing the securities. As a result, PNC could not establish a reliable factual basis adequate to support a reasonable belief that the securities were purchased for sophisticated investors who possessed the necessary knowledge and experience to evaluate the merits of the investments. Under these circumstances, none of the subject limited offerings could be shown to satisfy all the elements of the Limited Offering Exemption. Where a purported limited offering does not, in fact, satisfy the elements of the Limited Offering Exemption, a clear violation of Rule 15c2-12 occurs, as the securities are being sold without regard to the primary disclosure and continuing disclosure elements of the Rule.
MSRB Rule G-27. The PNC matter also includes MSRB Rule G-27 (“Rule G-27”) violations. This rule outlines requirements for a dealer’s supervision of personnel engaged in activities involving municipal securities activities in order to ensure compliance with federal securities laws. Rule G-27(c) requires dealers to adopt, maintain, and enforce written supervisory procedures reasonably designed to ensure that the conduct of the municipal securities activities of the dealer and its associated persons are in compliance with applicable rules.
In the PNC matter, there were written supervisory procedures, but they were not enforced. In particular, PNC failed to maintain documentation or evidence that the Limited Offering Exemption was met for each of the subject financings.
Penalties. PNC agreed to pay $81,362 in disgorgement plus prejudgment interest and a $100,000 penalty (related to 36 limited offerings).
Proactive Steps for Underwriters. As indicated in our September 2022 Hawkins Advisory, it would be prudent for underwriters to: (i) review their written supervisory procedures (or to adopt new ones); (ii) evaluate their compliance with existing procedures; and (iii) consider the adoption of clear guidelines for requiring investor letters, and for internal approval as to their form, to assure that the elements of the Limited Offering Exemption are met.
The SEC again noted that, as a result of its findings in these Limited Offering Exemption enforcement actions, it has undertaken investigations of other limited offerings structured by other financial institutions and encourages underwriters that believe their practices may not comply with the securities laws to self-report possible violations to the SEC at LimitedOfferingExemption@sec.gov.
Status of SEC and MSRB Rulemaking in 2023
In 2023, it is expected that the SEC and the MSRB will have active regulatory agendas that may impact the municipal securities market, either directly or indirectly.
SEC. The SEC’s rulemaking agenda for 2023 is packed with high profile regulations, some of which are carried over from 2022 (i.e., final rules for cybersecurity, climate change, and ESG, each as described below). While the FDTA will have a direct impact on the municipal securities market once adopted, as described above, several other regulatory initiatives that do not directly apply to the municipal securities market can be expected to color the SEC’s view of municipal disclosures and therefore may be instructive by analogy.
Regulation Best Execution. In December 2022, the SEC proposed “Regulation Best Execution,”[12] which would establish a best execution standard for brokers, dealers, government securities brokers, government securities dealers, and municipal securities dealers. The rules would enhance the existing regulatory framework concerning the duty of best execution by requiring detailed policies and procedures for all broker-dealers and more robust policies and procedures for broker-dealers engaging in certain conflicted transactions with retail customers, as well as related review and documentation requirements. The comment period for “Regulation Best Execution” closes on March 31, 2023.
Cybersecurity. On March 9, 2022, the SEC proposed rules for registered companies to enhance and standardize disclosures regarding cybersecurity risk management, strategy, governance, and cybersecurity incident reporting by public companies that are subject to the reporting requirements of the Securities Exchange Act of 1934.[13] The comment period for these proposed cybersecurity rules closed on May 9, 2022.
Climate Change and ESG. On March 21, 2022, the SEC proposed mandated climate-risk disclosures by public companies that are subject to the reporting requirements of the Securities Exchange Act of 1934.[14] The proposed rules would require certain climate-related information to be included in registration statements and periodic reports. Further highlighting the SEC’s focus on environmental, social, and governance (“ESG”) initiatives, on May 25, 2022, the SEC issued two proposing releases that address the ESG labeling and disclosure practices of investment companies and investment advisers.[15] The comment period for these proposed climate change and ESG rules closed on June 17, 2022 and August 16, 2022, respectively.
MSRB. The MSRB also has an ambitious set of potential rule amendments and interpretive releases on its plate for 2023.
Rule G-3. The MSRB has issued a request for comment seeking feedback on draft amendments to MSRB Rule G-3, on professional qualifications, which would (i) create a new exemption within the rule to allow an individual who was previously qualified as a municipal advisor representative by taking and passing the Municipal Advisor Representative Qualification Examination (Series 50 exam) to forego requalification by examination if certain conditions are met; and (ii) replace the provision on waivers in extraordinary circumstances that currently appears in the rule. Comments on this proposal are due by January 30, 2023.
Rule G-14. The MSRB is in the process of reviewing responses to its request for information on Rule G-14 on transaction reporting obligations. Rule G-14 prohibits dealers from distributing or publishing reports of purchases or sales of municipal securities unless the report is made with knowledge or reason to believe that the transaction was effected, and without any reason to believe that the reported transaction is fictitious, or in furtherance of any fraudulent, deceptive or manipulative purpose, and establishes transaction reporting requirements and procedures. The request for information seeks input on a potential amendment to Rule G-14 to require that, absent an exception, transactions are reported as soon as practicable, but no later than within one minute of the time of trade. Comments on this proposal were due by October 3, 2022.
Along these same lines, the MSRB has also indicated that it expects to issue a request for information on its time of trade disclosure rule, Rule G-47. That rule requires dealers to disclose to customers at or prior to the time of trade all material information known or available publicly through established industry sources. The request for information is expected to seek feedback on expanding the scope of such disclosures.
Rule G-32. The MSRB is seeking comment on draft amendments to Rule G-32 to clarify and streamline the timeline for underwriters to submit information on Form G-32. Rule G-32 requires underwriters to submit certain information to the EMMA system and dealers to provide certain information to customers in connection with primary offerings. The proposed amendments would not alter the data collected, but would modify the timing for submission of the data. Comments on this proposal were due by January 17, 2023.
[1] The FDTA constitutes one part of the “James M. Inhofe National Defense Authorization Act for Fiscal Year 2023”; see H. R. 7776, Title LVIII – Financial Data Transparency, available at https://www.congress.gov/117/bills/hr7776/BILLS-117hr7776enr.pdf.
[2] Under the Securities Exchange Act of 1934:
Neither the [SEC] nor the [MSRB] is authorized…by rule or regulation, to require any issuer of municipal securities, directly or indirectly through a purchaser or prospective purchaser of securities from the issuer, to file with the [SEC] or the [MSRB] prior to the sale of such securities by the issuer any application, report, or document in connection with the issuance, sale, or distribution of such securities. [15 U.S.C. § 78o-4(d)(1)].
The [MSRB] is not authorized…to require any issuer of municipal securities, directly or indirectly through a municipal securities broker, municipal securities dealer, municipal advisor, or otherwise, to furnish to the MSRB or to a purchaser or a prospective purchaser of such securities any application, report, document, or information with respect to such issuer… [15 U.S.C. § 78o-4(d)(2)].
[3] EDGAR is the primary system for companies and others submitting documents under the Securities Act of 1933, the Securities Exchange Act of 1934, the Trust Indenture Act of 1939, and the Investment Company Act of 1940. See https://www.sec.gov/edgar/about.
[4] See https://www.xbrl.org.
[5] See https://www.sec.gov/structureddata/what-is-structured-data.
[6] Id.
[7] See https://www.sec.gov/structureddata.
[8] See id.; https://www.sec.gov/news/speech/crenshaw-lessons-structured-data-111021; and https://www.sec.gov/structureddata/osd-inline-xbrl.html.
[9] In the Matter of PNC Capital Markets LLC, SEC Rel. No. 34-96558 (Dec. 21, 2022); SEC.gov | SEC Charges PNC Capital Markets LLC for Violating Municipal Bond Disclosure Law.
[10] The full text of Rule 15c2-12 can be found at 17 C.F.R. §§ 240.15c2-12; eCFR :: 17 CFR 240.15c2-12 -- Municipal securities disclosure.
[11] Rule 15c2-12(d)(1)(i) provides that the primary disclosure and continuing disclosure elements of the Rule will not apply to offerings of municipal securities issued in denominations of $100,000 or more that are sold to no more than thirty-five (35) persons if the underwriters have a reasonable belief that each purchaser: (A) has such knowledge and experience in financial and business matters that it is capable of evaluating the merits and risks of the prospective investment; and (B) is not purchasing for more than one account or with a view to distributing the securities.
[12] See https://www.sec.gov/news/press-release/2022-226.
[13] SEC Rel. Nos. 33-11038; 34-94382, Cybersecurity Risk Management, Strategy, Governance, and Incident Disclosure (Mar. 9, 2022); https://www.sec.gov/rules/proposed/2022/33-11038.pdf.
[14] SEC Rel. Nos. 33-11042; 34-94478, The Enhancement and Standardization of Climate-Related Disclosures for Investors (Mar. 21, 2022); https://www.sec.gov/rules/proposed/2022/33-11042.pdf.
[15] SEC Rel. Nos. IA-6034; IC-34594, Enhanced Disclosures by Certain Investment Advisers and Investment Companies about Environmental, Social, and Governance Investment Practices (May 25, 2022); https://www.sec.gov/rules/proposed/2022/33-11068.pdf; and SEC Rel. Nos. 33-11067; 34-94981; IC-34593, Investment Company Names (May 25, 2022); https://www.sec.gov/rules/proposed/2022/33-11067.pdf.
