0001
 1   UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 2   
 3   In the Matter of:                )
 4                                    ) OC-0729
 5   FIELD HEARING ON THE STATE OF    )
 6   THE MUNICIPAL SECURITIES MARKET  )
 7   
 8   ADMINISTRATIVE PROCEEDING
 9   PAGES:  1 through 328
10   PLACE:  Rosewood Hall
11           2850 19th Street South
12           Homewood, Alabama  35209
13   DATE:   Friday, July 29, 2011
14   
15        The above-entitled matter came on for hearing,
16   pursuant to notice, at 8:30 a.m.
17   
18   
19   BEFORE:
20        ELISSE B. WALTER, SEC COMMISSIONER
21   
22   
23   
24           Diversified Reporting Services, Inc.
25                      (202) 467-9200
0002
 1              P R O C E E D I N G S
 2                 COMMISSIONER WALTER:  Good
 3   morning.  We'll get started in one moment.
 4                 MR. MCBRAYER:  Good morning.
 5   Good morning.  This is the South now.  My
 6   name is Scott McBrayer.  I'm the Mayor
 7   here in the City of Homewood.  I wanted to
 8   take the opportunity to, first of all,
 9   welcome you to the City of Homewood.  We
10   have a great city and there are quite a
11   few people in the audience.  I believe I
12   saw Commissioner Bowman and Knight,
13   Attorney General Strange.  Who am I
14   missing?
15           And before we also get started, I
16   would like to take just a second to thank
17   J.J. Bischoff, J.J.'s my Chief of Staff
18   back there in the back, and I know he's
19   been working with Alicia and a lot of you
20   to hopefully make your stay here very
21   comfortable and as nice as it can be.  And
22   then I would also like to recognize
23   Councilman David Hooks.  David is over
24   here to my left, your right.  David serves
25   as the chairman of our finance committee
0003
 1   here in the City of Homewood.  He is
 2   Commissioner Stephens' Chief of Staff for
 3   Jefferson County, and David also serves as
 4   chair of the finance committee for the
 5   National League of Cities, so we have a
 6   lot of expertise with David and the things
 7   that he can bring to us as a city, so,
 8   David, thank you very much for all you do
 9   for us and for the National League as
10   well.
11           I'll be very brief.  I usually
12   tell people since I'm short I'll be brief,
13   but one thing I know this morning in your
14   discussions with municipal bonds and those
15   kind of things you could not be in a more
16   perfect place to be discussing those type
17   things.  This building that you're in now
18   a lot of people don't believe that this
19   used be the old Huffstutler's Hardware
20   store.  It was literally a lumber yard in
21   downtown Homewood.  And through the public
22   and private sector and being able to take
23   advantage of bonds and things like that we
24   were able to build what is now Soho, and I
25   personally believe it saved downtown
0004
 1   Homewood because of the businesses that it
 2   brought in.  The Loft Hotel, I know where
 3   many of you have stayed across the street,
 4   is now the highest hotel as far as
 5   occupancy in Birmingham, so it's been so
 6   convenient to stay at the hotel, and you
 7   can walk across the street, there's plenty
 8   of restaurants and shops, and so it did
 9   exactly what we hoped it would do.
10           And then a lot of people don't
11   realize either three of the four floors in
12   City Hall is public, but on the third
13   floor we have a private business and it's
14   the largest reader of x-rays in the United
15   States right here on the third floor, so
16   very pleased that they're doing that, so,
17   again, welcome to the City of Homewood.
18   If we can do anything while you're here to
19   make your stay more enjoyable, we're
20   certainly willing and able to do that.
21   Y'all enjoy your time here and let us know
22   if we can help you in any way.  Thank you.
23                 COMMISSIONER WALTER:  Good
24   morning.  And I want to thank, on behalf
25   of all of us, I want to thank Mayor
0005
 1   McBrayer for those kind opening remarks,
 2   and I will say, although I am even shorter
 3   than he is, I will not be as brief so
 4   please bear with me for a few minutes.
 5           It's a pleasure to be here with so
 6   many knowledgeable municipal market
 7   participants who are joining us today to
 8   give us the benefit of their expertise on
 9   issues of central importance to the
10   municipal securities market.  For those of
11   you joining by Webcast, thank you for
12   tuning in.  I'm sure that all of you were
13   looking forward to hearing from SEC
14   Chairman Mary Schapiro this morning.
15   Unfortunately, due to a family health
16   emergency, Chairman Schapiro is not able
17   to participate in today's hearing, but she
18   asked me to send you her sincere regrets.
19           The distinguished Chairman of the
20   House Financial Services Committee, the
21   Honorable Spencer Bachus, had also hoped
22   to be with us today; however, as we all
23   know, Capitol Hill is a particularly busy
24   place at this moment.  Due to the urgency
25   of the national debt ceiling negotiations,
0006
 1   Chairman Bachus is also unable to attend
 2   today's hearing in person.  We're very
 3   pleased, however, that Larry Lavender
 4   sitting to my right, the Majority Staff
 5   Director of the House Financial Services
 6   Committee, will be speaking to you on
 7   behalf of Chairman Bachus after I conclude
 8   my opening remarks.
 9           Given the SEC's limited authority
10   over municipal securities, our options for
11   addressing problems in this market have
12   historically been quite limited.  However,
13   as a municipal market grows larger and
14   more complex, it is increasingly important
15   that we redouble our efforts and give this
16   critical marketplace much needed
17   concentrated and greater attention -- and
18   we are doing just that.
19           As many of you know, the SEC was
20   created to be in the words of one artfully
21   Commissioned Chairman, "the investor's
22   advocate".  That means we work to help
23   ensure that investors are protected and
24   have the information they need to make
25   informed decisions.  As their advocates,
0007
 1   we are concerned that investors in the
 2   municipal securities market may not have
 3   the protections and access to information
 4   that they need.  We are also concerned
 5   that they may not be able to make fully
 6   informed investment decisions regarding
 7   the prices of securities they wish to buy
 8   or sell in many cases or the spreads
 9   demanded by the brokers who make the
10   market.  These conditions can lead to
11   market distortions and prevent investors
12   from accurately calculating risks when
13   making investments, potentially leaving
14   them more exposed than they understand or
15   wish to be.
16           That is why we have undertaken a
17   concentrated and concerted effort to study
18   the municipal securities market.  Last
19   year, Chairman Schapiro asked me, and I
20   should have said I'm Elisse Walter, to
21   lead an initiative to review the state of
22   the municipal market by gathering input
23   from market participants and identifying
24   ways in which the Commission could improve
25   the state of the market for investors.
0008
 1   Today's hearing is the third in a series
 2   of field hearings designed to elicit the
 3   analysis and opinions of a broad array of
 4   participants in the municipal market.  Our
 5   first hearing was in San Francisco last
 6   September, and our second was held in
 7   Washington, D.C., in December.
 8           We scheduled these hearings
 9   because we believe policy-makers should be
10   informed by experiences of those who live
11   and work outside of Washington, D.C..
12   This is particularly true with respect to
13   municipal securities, given their impact
14   on local communities and retail investors.
15           In addition to these field
16   hearings, our team has spent a tremendous
17   amount of time over the past year meeting
18   and speaking with interested parties on
19   issues spanning from disclosure, to
20   accounting, to market dynamics, to credit
21   ratings, and beyond.  I can say from
22   experience-- having participated in most
23   of these meetings-- that this has been an
24   extremely interesting, informative and
25   rewarding process.
0009
 1           As we draw to the close of the
 2   "information gathering phase" of our
 3   initiative, Commission staff will begin to
 4   prepare a report concerning what we have
 5   learned, including their recommendations
 6   for further action that we should pursue.
 7   These may include recommendations for
 8   changes in legislation, regulations, and
 9   industry practice.
10           The SEC's focus is and should be
11   on protection of investors.  However,
12   investors who place their funds in
13   municipal securities often are also
14   residents and taxpayers of those
15   municipalities.  And investors, taxpayers,
16   and municipal officials often have the
17   same concerns about transparency and fair
18   dealings in municipal finance.
19           The case that may most starkly
20   illustrate the alignment of investor and
21   taxpayer interests happened right here in
22   Jefferson County.
23           In 2009, the SEC brought
24   enforcement action resulting in a
25   settlement with JP Morgan, in which we
0010
 1   asserted that JP Morgan used corrupt
 2   political contacts to win the role of
 3   underwriter for sewage system bond
 4   offerings, and then helped Jefferson
 5   County enter into some of the financing
 6   and refinancing strategies that cost
 7   county ratepayers hundreds of millions of
 8   dollars.  As a result of the SEC action,
 9   JP Morgan paid a 25 million dollar penalty
10   which was sent to Jefferson County, and
11   also paid Jefferson County an additional
12   50 million dollars in compensation.  And,
13   most significantly, JP Morgan agreed to
14   cancel more than 6 hundred 47 million
15   dollars in claimed termination fees.
16           But I strongly suspect that
17   enforcement alone is cold comfort to many
18   of those who have been effected by what
19   has happened in Jefferson County.
20           As you know, this has been a
21   particularly difficult time.  Over the
22   past month the county has been operating
23   under a standstill agreement, in an
24   attempt to avoid filing for bankruptcy.
25   While our project began over a year ago,
0011
 1   the confluence of events highlights the
 2   importance of municipal securities not
 3   only to the securities markets and
 4   investors, but also to communities and
 5   taxpayers, and it reinforces the fact that
 6   investors need to get good information
 7   from municipalities, and municipalities
 8   need to get fair and honest advice from
 9   financial professionals.
10           We are here to explore whether
11   investors need additional tools so that
12   they can make better decisions and whether
13   regulators need additional tools to do
14   their best to enhance the soundness of,
15   and investor confidence in, the municipal
16   securities markets.
17           Today's panels will focus on
18   issues related to distressed communities,
19   small issuers, disclosure, derivatives and
20   pre-trade price transparency.
21           Our first panel on distressed
22   communities will explore some of the
23   causes of financial distress for
24   municipalities, the options available to
25   distressed municipalities, including
0012
 1   bankruptcy, and the consequences of
 2   various courses of action.
 3           Next, our panel on small issuers
 4   will provide an opportunity to hear about
 5   the practical implications of issuer size
 6   on issuers' activities in the market,
 7   their interactions with financial
 8   intermediaries, and their ability to meet
 9   regulatory requirements.
10           And, our panel on derivatives will
11   touch on municipal entities' use of
12   derivatives, municipal officials'
13   understanding of derivatives' risks, the
14   role of other market participants in
15   municipal derivatives, and disclosures
16   relating to these complex agreements.
17           We will also be addressing the two
18   topics that have been our principal areas
19   of focus-- disclosure and pre-trade price
20   transparency.
21           On disclosure we have heard
22   consistently that investors need more
23   timely and accurate information from
24   issuers in order to make informed
25   decisions.  On the other hand, we hear
0013
 1   from issuers about the practical
 2   limitations they face:  Difficulties
 3   aggregating fiscal information from
 4   constituent governments, resource
 5   constraints, and other challenges.  Our
 6   panel on disclosure will feature issuer
 7   and investor representatives, and I look
 8   forward to an engaging discussion
 9   exploring both sides' perspectives.
10           Regarding pre-trade transparency,
11   investors tell us that they face
12   challenges because municipal securities--
13   like other types of bonds --are traded for
14   the most part through decentralized,
15   dealer intermediated, over-the-counter
16   markets.  Unfortunately, information about
17   quotes and trading interest in these
18   markets is not readily available to retail
19   investors.  Now, great strides have been
20   made in terms of post-trade transparency
21   of information in the last few years,
22   thanks to real-time reporting and the EMMA
23   system available via the website of the
24   Municipal Securities Rulemaking Board, or
25   MSRB.  However, because of the low
0014
 1   liquidity levels of many municipal bonds,
 2   trade data can be weeks or months old
 3   because there have been no trades, and,
 4   therefore, not very helpful to investors
 5   who are trying to assess bond pricing.
 6           Investors need better information.
 7   They also need better access both to tap
 8   liquidity and to provide it.  Our panel on
 9   pre-trade price transparency will focus on
10   the existing landscape for pricing
11   information in the municipal market, and
12   ways in which the market can move toward
13   giving investors better information, and
14   consequently, greater confidence in
15   pricing.
16           We have gathered an impressive
17   group of knowledgeable individuals
18   representing a wide spectrum of viewpoints
19   for all of our panels today, and I am
20   confident that they will shed light on --
21   and advance the discussion of -- all of
22   these important issues.  What we hear from
23   today's panelists, along with what we have
24   gleaned from our prior hearings and
25   countless meetings and conference calls,
0015
 1   will be instrumental in informing the
 2   recommendations that will be included in
 3   the SEC staff report.
 4           And now, let me take a moment to
 5   introduce you to my colleagues who are
 6   here with us today.  I'll be joined at the
 7   table by Robert Cook, the Director of the
 8   Division of Trading and Markets, the SEC
 9   Division that helps the Commission carry
10   out its mission of maintaining fair,
11   orderly and efficient markets for the
12   benefit of investors.  Robert's division
13   currently houses the SEC's Office of
14   Municipal Securities.
15           Our role will be to listen, learn,
16   and engage with the panelists by asking
17   questions.  And in addition to welcoming
18   you, I must remind you on behalf of myself
19   and all other Commission participants of
20   the Commission standard disclaimer-- that
21   is that our remarks today represent our
22   own views, and not necessarily those of
23   the Commissioner -- Commission, my fellow
24   Commissioners, or members of the staff.
25           The moderators of today's panels
0016
 1   are David Sanchez, Attorney-Fellow, Office
 2   of Municipal Securities, Division of
 3   Trading and Markets; Amy Starr, the Chief
 4   of the Office of Capital Market Trends in
 5   the Division of Corporation Finance; and
 6   Alicia Goldin, Special Counsel in the
 7   Office of Chief Counsel, in the Division
 8   of Trading and Markets.  My appreciation
 9   goes as well as to my counsels Cyndi
10   Rodriguez and Lesli Sheppard, who have
11   been by my side throughout this effort, to
12   the entire team of municipal securities
13   experts at the Commission-- including Will
14   Hines, from the Division of Corporation
15   and Finance, and Suzi McGovern from the
16   Office of Compliance, Inspections and
17   Examinations-- who are here with us today;
18   and to all of those who are busy at work
19   back in D.C., including Rachel Hurnyak
20   from Chairman Schapiro's office who has
21   handled the logistics for all of our
22   hearings.  Rachel has been incredibly
23   helpful to us up until her very last day
24   at Commission headquarters-- which happens
25   to be today --and we will miss her
0017
 1   greatly.  We also want to thank Ammani
 2   Nagesh from Chairman Schapiro's office--
 3   who probably greeted you as you walked in
 4   today -- and who is ensuring that today's
 5   event runs smoothly.  And, we are happy to
 6   be joined as well by the Director of the
 7   Commission's Atlanta Regional Office, Rhea
 8   Dignam, as well as Peter Diskin from that
 9   office, Judy Burns from the Office of
10   Public Affairs, and our audio-visual
11   experts, Myron Fears and Tony Cook.
12           I would also like to welcome and
13   introduce our fellow regulators in
14   attendance:  From the MSRB, we have Ernie
15   Lanza, Deputy Executive Director and
16   General Counsel; and from the Financial
17   Industry Regulatory Authority, or FINRA,
18   we have Mac Northam, Director of Fixed
19   Income Securities.  The MSRB and FINRA, as
20   you know, play critical roles in
21   regulating professionals who operate in
22   the municipal market and their assistance
23   has been invaluable.
24           Also participating in today's
25   event are former SEC Commissioner Rick
0018
 1   Roberts and the Director of the Alabama
 2   Securities Commission, Joe Borg.  We have
 3   with us as well a number of other highly
 4   knowledgeable state and local officials--
 5   I'll give a second mention to some and I
 6   hope I won't forget others-- Luther
 7   Strange, the Alabama Attorney General; Bob
 8   Scott, Assistant City Manager and Chief
 9   Financial Officer of the City of
10   Carrollton, Texas; Charlie Duggan, City
11   Manager of the City of Auburn, Alabama;
12   Ben Watkins, Director of the Division of
13   Bond Finance for the State of Florida; and
14   Mary-Margaret Collier, Director of the
15   Office of State and Local Finance in the
16   State of Tennessee.  I'm also delighted
17   that Treasurer David Lillard from the
18   State of Tennessee and, I believe, a
19   number of Jefferson County Commissioners
20   are in the audience today.  And, of
21   course, we are extremely grateful to all
22   of our panelists for agreeing to
23   participate in our field hearing, many of
24   whom have traveled in order to join us
25   today.  Thank you so much.
0019
 1           Last, but not least, I'd like to
 2   thank Chairman Bachus for taking a strong
 3   interest in these important issues.  We
 4   very much appreciate the assistance that
 5   Chairman Bachus' staff has provided as we
 6   planned this meeting, and we're pleased
 7   that Larry Lavender, Walton Liles and
 8   Kevin Edgar are here with us today.
 9           I would now like to welcome Larry
10   Lavender to make a few remarks this
11   morning.  Larry.
12                 MR. LAVENDER:  Good morning.
13   As I'm sure everyone is aware Congressman
14   Bachus is stuck in Washington.  He would
15   much rather be here.  I would much rather
16   he were here also.  He, however, has to
17   attend to important business in Washington
18   today.
19           Thank you, Commissioner Walter --
20   thank you, Commissioner Walter for those
21   remarks, and Congressman Bachus asked that
22   I specifically thank Chairman Schapiro for
23   making these hearings possible and for
24   responding favorably to his request for
25   the SEC to come to Jefferson County for
0020
 1   this important hearing.
 2           Commissioner Walter, thank you for
 3   leading the SEC's review of the municipal
 4   securities market and for organizing
 5   today's roundtable.  Because the House
 6   remains in session working on legislation
 7   to address the Nation's debt crisis, I am
 8   unable to join you in Alabama today as I
 9   had planned.  While I will not be able to
10   be with you, my staff from the Financial
11   Services Committee is present and will
12   keep me apprised of all the proceedings.
13           The Financial Services Committee
14   is committed to working with the SEC to
15   ensure that efficient, vibrant and stable
16   municipal securities market exists in the
17   United States.  The municipal securities
18   market is vitally important to our
19   country.  It enables state and local
20   governments, universities, hospitals, and
21   utilities to raise funds to support
22   important services such as education,
23   health care and infrastructure
24   improvements.  Municipal securities were
25   among the casualties of the financial
0021
 1   crisis-- the collapse of the bond
 2   insurers, the failure of the auction rate
 3   securities market, and the resulting
 4   credit constriction which began in 2009
 5   and continues to this day were all
 6   elements of "the perfect storm" that has
 7   reeked havoc in the financial -- municipal
 8   financial arena.
 9           While municipal securities can and
10   should continue to play an important role
11   in financing the operations of state and
12   local governments across the country, the
13   events of the past three years have
14   exposed series regulatory and market
15   deficiencies that warrant both
16   Congressional and SEC attention.  One of
17   the purposes of these roundtables is to
18   ensure that situations like Jefferson
19   County never happen again.  The sewer
20   financing fiasco has been a nightmare for
21   Jefferson County residents.  No locality,
22   taxpayer or ratepayer should ever have to
23   go through a similar experience again.
24   While it is an extreme case in municipal
25   finance gone wrong, there are important
0022
 1   lessons to be learned from the situation
 2   in Jefferson County, lessons that can help
 3   make our public finance markets better and
 4   far more resilient.  One critical lesson
 5   is that the SEC and the regulatory
 6   community must refocus their attention to
 7   encompass the taxpayers and ratepayers of
 8   the issuing authorities in addition to
 9   investors.  Taxpayers and ratepayers are
10   the closest equivalent to stockholders
11   that municipal insurers have and they
12   deserve the same regulatory protections.
13           Thank you to all the round table's
14   participants for giving of their valuable
15   time to assess the SEC in developing
16   reforms.  No market is perfect so I
17   encourage all participants to listen and
18   think critically about how best to improve
19   the municipal market structure.
20           The Financial Services Committee
21   will examine the SEC's municipal
22   securities report once it is released and
23   will carefully monitor implementation of
24   the Dodd-Frank Act's municipal securities
25   provisions which we all know have been the
0023
 1   subject of extensive comments.  The
 2   Committee and I stand ready to work with
 3   the SEC and all market participants to
 4   ensure that necessary reforms are made to
 5   this critical segment of our capital
 6   markets.
 7           I will close with that, and say
 8   thank you on behalf of Congressman Bachus,
 9   and also point out that a couple of years
10   ago he wrote an article that appeared in
11   the Law Review at Cumberland University
12   which lays out in great detail his
13   thoughts about the Jefferson County sewer
14   financing crisis, how it got there, and I
15   recommend it to everyone.  It can be seen
16   on the website for his office,
17   Congressional office, the entire report is
18   available there.  Thank you again.
19                 COMMISSIONER WALTER:  Thank
20   you, Larry.  And having read that Law
21   Review article, I personally can recommend
22   it to you as well.
23           I just want to conclude by
24   providing a brief overview of the
25   mechanics for today's hearing.  We have an
0024
 1   exciting agenda, we think, packed with
 2   interesting and timely topics.  The format
 3   will entail five panels.  As moderators,
 4   Dave, Amy and Alicia will introduce their
 5   topics and panelists.  Each panelist will
 6   then make brief opening remarks.
 7   Following the opening marks, the panelists
 8   will be asked questions by the moderator
 9   and those of us at this table.
10           We will look to each panel to help
11   us understand better the particular
12   concerns of the different market
13   participants, highlight key areas for
14   improvement, and provide some concrete
15   ideas for moving forward.  At our past
16   hearings, panelists have engaged with us
17   and with each other in candid and lively
18   discussions, and I look forward to similar
19   engagement today.
20           A few housekeeping items before we
21   again.  First, we'd like to ask if you can
22   remember, the panelists, moderators, and
23   other questioners to stand your nameplate
24   vertically when you would like to speak.
25   Second, there will be a lunch break from
0025
 1   12:30 to 2:00.  There are a number of
 2   restaurants within walking distance of
 3   Rosewood Hall.  Third, perhaps most
 4   important, if you go out the back doors,
 5   there are bathrooms and phones both to the
 6   left and right, and our last panel of the
 7   day will conclude by 4:00 p.m..  A live
 8   video stream of the hearing is available
 9   on the Commission's website, and a written
10   transcript of today's events will also be
11   made available on our website as well as
12   any statements and presentations provided
13   by the panelists.
14           Finally, we want to encourage
15   investors and all other interested parties
16   to submit comments related to the
17   municipal securities market by using the
18   comment form on the SEC website or sending
19   an e-mail to munifieldhearings@sec.gov.
20           Once again, we're extremely
21   pleased that you are here today and hope
22   this will prove to be an enlightening
23   experience for all.  I'll turn it over to
24   Dave to start our first panel.
25                 MR. SANCHEZ:  Thank you,
0026
 1   Commissioner Walter.  Our first panel of
 2   the day is entitled Distressed
 3   Communities.  This panel will explore some
 4   of the causes of financial distress for
 5   municipal entities, and in particular any
 6   early warning signs that should be
 7   recognized and disclosed to the market.
 8   In addition, panelists will focus on the
 9   pros and cons of municipal bankruptcy and
10   other potential solutions for communities
11   in financial distress.
12           We're pleased to have such a
13   diverse and knowledgeable panel, and I
14   will introduce them in the order in which
15   they will make their opening remarks,
16   starting to my immediate left.
17           Jim Spiotto is head of the Special
18   Litigation, Bankruptcy and Workout Group
19   with the law firm of Chapman and Cutler.
20           Foster Clark is a partner in the
21   Birmingham law firm of Balch Bingham and
22   serves as Chair of that firm's public
23   finance practice.
24           Bill Fallon is President and Chief
25   Operating Officer of MBIA and CEO of
0027
 1   National Public Finance Guaranty
 2   Corporation Municipal Bond Insurers.
 3           Bill Dotts is the President of
 4   Public FA, Inc., an independent financial
 5   advisor to public, non-profit and
 6   corporate debt issuers headquartered in
 7   Huntsville, Alabama.
 8           And Bob Brooks is the Wallace D.
 9   Malone, Jr. Endowed Chair of Financial
10   Management at the University of Alabama
11   and is a family partner of BlueCreek
12   Investment Partners.
13           Jim, do you want to start us off?
14                 MR. SPIOTTO:  Thank you,
15   David, and thank you, Commissioner Walter
16   and members of the staff of the SEC and
17   members from FINRA and the MSRB and
18   distinguished guests.
19           One of the key ingredients to the
20   success of the state and local government
21   is their ability to decide locally what
22   infrastructure, improvements they will
23   provide to their constituents; make that
24   decision locally and be able to enforce
25   that they have access to the capital
0028
 1   markets.  It's a key ingredient to our
 2   form of government, unique in the world.
 3   In times of economic distress the question
 4   is always how will that be effected.  We
 5   clearly know that during these times local
 6   and state governments not only
 7   appropriately increase taxes and cut
 8   costs, but attempt to deal with these
 9   issues as best they can.
10           One of the important things to
11   keep in mind is that state and local
12   governments, at least historically, have
13   done almost anything they can to make sure
14   they avoid default and continue that
15   access at a low price.  If you look at
16   defaults historically, the rating agencies
17   and others have indicated that whether
18   rated or unrated bonds, they're a mere
19   fraction of what corporate defaults are.
20           As far as Chapter 9, Chapter 9 is
21   even rarer than Chapter 11 or other forms
22   of bankruptcy.  Since 1937 there's only
23   been 6 hundred and 24 Chapter 9's, mainly
24   small special tax districts, small
25   municipalities.  Between 1980 and today
0029
 1   there have been 2 hundred and 53 Chapter
 2   9's, only three of any real size-- Orange
 3   County in '94; Bridgeport, Connecticut in
 4   '91, which was dismissed; and Vallejo, the
 5   City of Vallejo, which confirmed their
 6   plan and debt adjustment yesterday.
 7           One problem with Chapter 9 it does
 8   not provide any additional revenues.  It
 9   does not provide a simple solution, it's
10   complex, it involves all the creditors, it
11   takes time, and it is a process which was
12   intended to be and is a last resort.  The
13   tradition has been to solve the problem
14   before you get there.  One of the
15   important things to keep in mind, the
16   Bankruptcy Code itself encourages
17   distressed municipalities to find a way
18   out.  Not only does it provide for special
19   revenues and statutory liens, which are,
20   basically, immune from interference or any
21   type of impairment from Chapter 9,
22   allowing a distressed municipality to
23   borrow funds, even if they're close to a
24   difficult situation and meltdown with the
25   promise that they will be paid if they
0030
 1   file a Chapter 9 or not, so that is an
 2   important ingredient that Congress
 3   provided and is available.
 4           States have provided all sorts of
 5   unique opportunities and alternatives--
 6   financial control boards, oversight
 7   commissions, refinance authorities, the
 8   old adage doctors bury their mistakes in
 9   municipal financing, they refinance them
10   has traditionally been true.  New York
11   City in 1975 with Municipal Assistance
12   Corporation took a difficult situation and
13   turned it around, Cleveland in '78,
14   Philadelphia in 1991, many other examples
15   follow.  Traditionally states have
16   provided all sorts of rights and remedies
17   for bondholders, unique to their
18   situation, and have allowed the
19   bondholders and the municipalities to find
20   a solution that they believe works for
21   all.
22           The issue that faces us today is
23   access to the market in an economic down
24   time is important.  If you look at ten
25   year bonds from Greece versus ten year US
0031
 1   Treasuries, the cost to borrow, what would
 2   have to be paid back during that ten year
 3   period is almost double.  Our local and
 4   state governments have had an access to
 5   the market at low price so that taxpayers
 6   and the citizens at large can enjoy an
 7   uptake in the economy with the increased
 8   expenditures that help improve the economy
 9   by increased capital -- by increased
10   employment and GDP growth.  In the last
11   nine downturns since 1949 there has been
12   increased governmental spending, increased
13   governmental borrowing on a local level
14   which has helped lead to the recovery,
15   obviously access this time is just as
16   important.
17           So hopefully working together,
18   this access to the market at a low price
19   will continue, both historically and into
20   the future.
21                 MR. SANCHEZ:  Thank you.
22   Foster.
23                 MR. CLARK:  Good morning.
24   First of all, like others, I would like to
25   thank Commissioner Walter for arranging
0032
 1   this and Larry Lavender for his comments
 2   on behalf of Congressman Bachus.  We
 3   appreciate their continued support for us
 4   here in Jefferson County.
 5           Since the introductions were made
 6   the other County Commissioners have
 7   arrived, so I would just like to let you
 8   know that all five of the Jefferson County
 9   Commissioners are here, including George
10   Bowman and Joe Knight on the front row,
11   Sandra Little Brown I saw some place back
12   there in the back, and Jimmie Stephens and
13   David Carrington over here, so in a show
14   of bipartisanship better than we seem to
15   be able to do in Washington, they're all
16   here.
17           The topics we're going to discuss
18   today are timely and important, and as we
19   all know, the choice of Birmingham as the
20   site of this hearing was largely due to
21   the troubles that have already been
22   described for Jefferson County.
23           The Jefferson County story has
24   been widely publicized over the last three
25   years in local and national press, in
0033
 1   countless workshops, in law school
 2   symposia, and unfortunately in some state
 3   and local courts.  For example, if you go
 4   to Google and search for "Jefferson County
 5   teetering", you get 6 million 5 hundred
 6   and 60 thousand hits.  As a reality check,
 7   I put in Kim Kardashian and her recent
 8   psoriasis, and you only get 8 hundred and
 9   46 thousand.
10           Since early 2008 my law firm has
11   assisted the County in its efforts to deal
12   with the problems that are ongoing and to
13   find a workable way out.  That effort is
14   still ongoing as you read in the paper
15   every day, including today, so I'm sure
16   you'll understand that there will be some
17   confidential topics that I just can't
18   address today.
19           The goal for these hearings and
20   this panel in particular are to elicit
21   some "real world" information that might
22   prove useful to the SEC, and perhaps
23   Congress, as they evaluate the
24   effectiveness of the Federal securities
25   laws and regulations applicable to public
0034
 1   finance.  Some of the relevant questions
 2   that we've talked about for this panel
 3   perhaps are:  What causes a city or a
 4   county to find itself in financial
 5   distress?  Are there some early warning
 6   signs that should be recognized and
 7   perhaps disclosed?  How does that kind of
 8   stress affect a municipality's ability to
 9   access the public finance markets and to
10   provide good disclosure?  And, finally,
11   what can the SEC do to help a distressed
12   communities as it struggles to maintain or
13   regain access to the market?
14           The national recession of 2008 and
15   2009 and the slow recovery that we've had
16   since then have not spared our cities,
17   counties and states.  As you all know,
18   hardly a day goes by without a report in
19   The Bond Buyer or elsewhere about some
20   community that's struggling to satisfy its
21   obligations to its retired employees and
22   its debt service payments to its creditors
23   while at the same time providing essential
24   government services.
25           Our cities and counties and other
0035
 1   public entities are very varied.  We have
 2   over 3 thousand counties in the United
 3   States, 36 thousand cities and towns, 37
 4   thousand special districts and 14 thousand
 5   public school systems.  Because of their
 6   different structure, their different sizes
 7   and their different purposes the causes of
 8   financial stress can take a number of
 9   different forms.  In looking at the
10   reports of the last few years it seems to
11   me that there maybe seven categories that
12   those problems can fall under -- I'm sure
13   there are others -- number one might be
14   specific events, some particular
15   disastrous event, financial or otherwise,
16   that hits the city.  An example of that
17   would be the failure of a waste/energy
18   facility in Harrisburg, Pennsylvania that
19   was financed with the credit of the city.
20   Rapid deindustrialization might be number
21   two; think about some of the cities in
22   Michigan.  Corruption and mismanagement,
23   see Bell, California.  Exploding employee
24   pension and health care costs-- stories of
25   Central Falls, Rhode Island; Los Angeles,
0036
 1   California; and small town Prichard,
 2   Alabama come to mind.  Number -- what am I
 3   up to, five, what I would call a
 4   spendthrift mentality, and that is cities
 5   and communities that adopted ambitious
 6   programs and projects during times of
 7   highly, you know, rising property taxes
 8   and property values and tax basis,
 9   examples might include Las Vegas, Phoenix,
10   and Orlando.  Shifting demographics has
11   effected a number of areas where many
12   upper income families leave, leave the
13   area, and sometimes they are replaced by
14   lower income families with greater demands
15   on local schools and social services.
16   That's been happening in New England and
17   California.  And finally, the disparate
18   effects of the recession.  Some
19   communities have weathered it better than
20   others.  Communities with significant
21   technology or governmental employment
22   bases seem to have done better than
23   communities that depend on construction,
24   service and retail industries.
25           Closer to home, what happened?
0037
 1   How did Jefferson County get in the mess
 2   that it's in?  If you look at the
 3   statistics on the effects of the economy
 4   on our area, I think you have to conclude
 5   that although we've been hit, we haven't
 6   been hit notably different than anybody
 7   else.  I don't think that can be blamed as
 8   the source of these problems.  Our
 9   statistics on unemployment, gross
10   metropolitan product, housing prices and
11   median family income are not good, but
12   they are not the reasons for the problems
13   that we're experiencing.
14           Rather, and as Larry suggested at
15   one point, the financial problems of
16   Jefferson County are particularly
17   attributable really to two things-- to the
18   financings that were done and what
19   occurred to those financings in the last
20   few years, I'll mention in a minute, and
21   to the County's loss of its primary
22   revenue stream for its general fund.
23   Again, the story of the financings has
24   been widely told.  I've tried to put down
25   a few bullet points just to give you the
0038
 1   litany of "the perfect storm" that Larry
 2   referred to.
 3           In 2002 and 2003 the sewer
 4   financing structure, which at that point
 5   was largely traditional fixed rate debt, I
 6   think it was 95 percent fixed rate debt,
 7   was converted to 93 percent variable rate
 8   debt.  Along with that, the County entered
 9   into a series of what turned out to be
10   ill-advised interest rate swaps that
11   failed in early 2008 when the SIFMA index,
12   which was being paid by the County, spiked
13   and the 67 percent of one month LIBOR that
14   the County received plummeted.  The result
15   for a period of time was an implied annual
16   basis cost to the County loss of 32
17   million dollars.
18           The meltdown of the bond insurance
19   industry hurt us.  As the ratings for the
20   bond insurance companies spiraled
21   downward, much of the variable rate debt
22   of the County was put back to liquidity
23   providers.  8 hundred and 50 million
24   dollars of sewer warrants were put back to
25   liquidity providers, a hundred and 10
0039
 1   million dollars of general obligation
 2   warrants, and a hundred and 80 million
 3   dollars of school warrants, where they are
 4   still all held at penalty interest rates.
 5           The liquidity facility agreements
 6   governing those puts have accelerated
 7   redemption features to them for general
 8   obligation and the sewer warrants.
 9           I won't go into great detail, but
10   suffice it to say that the annual
11   redemption requirements solely for the 8
12   hundred and 50 million of sewer warrants
13   exceeded the total revenues of the sewer
14   system, without paying anything else.
15           The County's rating fell down
16   during all of this.  In a period of four
17   months, from February 2008 to April 2008
18   the County's underlying sewer rating went
19   from "A" to "D".  From March of 2008 to
20   September 2008 its underlying GO rating
21   went from "AA" to "D".
22           It was unable to replace a surety
23   bond that was held in one of the reserve
24   funds.  That surety bond became ineligible
25   because of the loss of rating on the
0040
 1   company that provided it.  It was a 29
 2   million dollar surety bond.  Unlike other
 3   issuers that were able to refinance their
 4   way out of those kinds of problems,
 5   Jefferson County was not.
 6           Collapse of the auction rate
 7   market hurt us.  About 2 billion dollars
 8   of the sewer debt was in the form of
 9   auction rated bonds.  As you know, a
10   receiver was appointed last year for the
11   sewer system and that has changed the way
12   that program is operated.
13           After I think 17 years of various
14   kinds of litigation, the County's
15   occupational tax was once again declared
16   unconstitutionally adopted by the
17   Legislature.  That tax amounted to
18   approximately 40 percent of the revenue
19   for the County's general fund.  It was
20   struck down by the court for having been
21   invalidly adopted by the State
22   Legislature, and the State Legislature
23   failed and refused to replace it, so the
24   County is without approximately 40 percent
25   of its general fund revenue right now.
0041
 1           The SEC has filed civil actions
 2   against many of the participants in these
 3   financings, and as the Commissioner
 4   described, at least one of those resulted
 5   in significant recoveries to the County
 6   which we appreciated.
 7           Finally, all of that produced a
 8   cloud of corruption and distrust.  Locally
 9   we had 22 criminal convictions arising out
10   of these financings, and you can imagine
11   that in that environment the public and
12   political support for a solution becomes
13   very difficult.
14           Dave, I'm probably just about out
15   of time.  I'll mention in the face of all
16   of that, maybe one suggestion of what can
17   be done-- we can discuss it more at length
18   --is for the SEC and some of the industry
19   participants to come together and work on
20   some sort of system of early warning for
21   communities that are encountering
22   financial distress.
23           There are a number of warning
24   signals that one might look for, including
25   budget deficits and imbalances, service
0042
 1   cuts, furloughs, layoffs, high unfunded
 2   pension liabilities, decreases in property
 3   value and per capita income, and local
 4   officials frequently being seen in
 5   handcuffs.
 6           I appreciate the opportunity to be
 7   here with this panel today, and I look
 8   forward to our further discussions.  Thank
 9   you.
10                 MR. SANCHEZ:  Thank you very
11   much, Foster.  Bill.
12                 MR. FALLON:  David, thank
13   you.  Commissioner Walter, also thank you,
14   as well as the other SEC officials, Larry
15   Lavender as well, and the County
16   Commissioners who are all here.
17           First of all, just a little bit of
18   background.  As Dave mentioned, I am the
19   CEO of MBIA subsidiary National Public
20   Finance Guaranty.  We've been insuring
21   public finance bonds for over 35 years.
22   We insure over 11 thousand credits in the
23   United States, and have a portfolio that
24   is almost 5 hundred billion dollars.  In
25   listening to Foster go through some of the
0043
 1   cities that are facing real difficulty, I
 2   thought maybe he had one of my reports,
 3   because we have Vallejo in our portfolio,
 4   we have Central Falls, we have Harrisburg,
 5   Pennsylvania and the City of Bell, and
 6   we're very proud of the fact that any time
 7   that someone has run into a situation
 8   where they haven't made payments, MBIA or
 9   National has always been there to make
10   payments.  Collectively we've made 7
11   billion dollars of payments in both the
12   public finance and structure finance world
13   and never missed a payment.
14           Preparing for today on distressed
15   communities I wanted to really cover three
16   things:  One, how we think we got to where
17   we are today; two, what the outlook is;
18   and, three, what is it that cities and
19   towns can do going forward, in some cases
20   some of the action's already been taken.
21           Also, we were really focusing on
22   cities and towns, though, some of the
23   comments and some of the statistics that
24   I'll cite apply to states or come from
25   states, and given everything that's going
0044
 1   on in D.C., I think some of the issues
 2   here also apply to countries as well, so
 3   take those in that context.
 4           We believe that the financial
 5   crisis of 2008 at least cities and towns
 6   were not responsible for.  It was a
 7   housing and mortgage problem had created
 8   great stress as you all know, for many
 9   cities and towns.  It led to great
10   unemployment, it led to a significant
11   reduction in revenue, it led to in some
12   cases additional payments that those
13   localities need to make, and in many cases
14   it led to a significant reduction in the
15   pension assets of these communities, which
16   have put tremendous stress on the
17   communities.
18           However, there are some things
19   that have been going on for a long time in
20   certain towns and cities that were not
21   caused by the financial crisis, which have
22   also added to the problem.  We've seen
23   increased spending, so at the state level
24   in the years 2005 through 7, just before
25   the financial crisis, states were
0045
 1   increasing their spending at over 8
 2   percent a year, which I don't think most
 3   of us believe would be a sustainable
 4   situation.
 5           Also, many communities were not
 6   building up any type of rainy day funds,
 7   which when times have been good we would
 8   all I think recommend that they try to set
 9   aside some funds when difficulties might
10   strike.  And then there's been very little
11   transparency in many cases around the
12   pension and other post employment
13   retirement benefits, which has gotten a
14   lot of attention, and we'll talk about
15   that later.  And we also think there's
16   been really a lack of transparency in some
17   cities with regard to their accounting.
18   We think that's important.  As one of my
19   colleagues likes to say, while we do have
20   a crisis, it would be a terrible thing not
21   to take advantage of the crisis and use
22   this as an opportunity to make some
23   improvements because we find in many
24   things in the corporate world until there
25   is a crisis organizations don't change.
0046
 1   We think this is actually a great
 2   opportunity to make some changes in the
 3   way the markets work.
 4           In terms of the outlook, we start
 5   with the economy.  Much has been written
 6   in the public finance world, and there's a
 7   wide range of views in terms of defaults,
 8   the amount of defaults, and what the right
 9   actions are at this point in time.
10           Starting with the overall economy
11   in the country, we do believe that the
12   next several years will be very
13   challenging and this will effect the
14   cities and towns that we're talking about
15   today.  We think the recovery is going to
16   be slow.  We don't believe there will be a
17   double dip, though, I know many people
18   think that's a possibility.  We do think
19   it will be somewhat of an erratic
20   recovery, and I think there's even data
21   out this morning supporting that point
22   with regard to GDP growth earlier this
23   year.
24           We also think there's going to be
25   tremendous stress at the local level
0047
 1   because the Federal Government's not going
 2   to have the money to provide to the
 3   states, and the states, therefore, are
 4   also looking to get whatever funds and
 5   also reduce their expenditures, so it is
 6   going to put pressure.
 7           We also think other taxes for
 8   cities may face some reductions, property
 9   taxes being one as properties are
10   reassessed in value, and we also think, as
11   I mentioned, the retirement benefits for
12   some cities are very large.  So, again, we
13   think it's going to be challenging, and in
14   some ways for many cities the challenges
15   in the next few years will be even greater
16   than what we've seen to date.
17           However, we're more optimistic
18   than others with regard to defaults.  We
19   think defaults will not be at the levels
20   that some people have been forecasting.
21   To put it in perspective, even the first
22   half of this year we count 24 defaults for
23   7 hundred and 46 million dollars, so much,
24   much lower than the numbers that people
25   have been forecasting, where they said
0048
 1   hundreds of billions of dollars.  We think
 2   part of that -- or part of the reason for
 3   the fact that there will be less defaults
 4   goes somewhat to what Jim was mentioning,
 5   that Chapter 9 when we talk about
 6   bankruptcy it really is the last resort,
 7   it maybe appropriate in some cases.  I
 8   know there's been a lot of attention
 9   locally about that, but that really some
10   other type of restructuring is what's
11   focused on first.
12           We also think that cities and
13   other municipalities have the ability to
14   take lots of actions.  We're quite
15   encouraged by the fact that based on
16   certain results we have, almost 80 percent
17   of cities have been reducing their
18   workforce to deal with the budget
19   challenges that they face; almost 70
20   percent have either been delaying or
21   canceling capital projects; 40 percent
22   have cut services; 30 percent have
23   modified health care benefits, and while
24   these do create stress overall, at least
25   in terms of trying to get their budgets in
0049
 1   order, they're doing the right things.
 2   And at the state and city levels since the
 3   peak in 2008 there's been almost 6 hundred
 4   thousand job reductions, so, again, we do
 5   think there will be tremendous
 6   restructuring.
 7           We think the other thing that
 8   helps is increased transparency.  I know
 9   this is one of the things that the SEC is
10   focused on, and we also know that GASB is
11   focusing on it, and we think not only does
12   it help the investor, but it actually
13   helps the local politicians actually bring
14   greater focus to what their situation is,
15   and we find often that in dealing with
16   many of the cities and towns that we deal
17   with, first understanding the situation
18   and making sure that there is agreement as
19   to what the financial picture looks like
20   is very important, and, therefore,
21   bringing this focus while we are sensitive
22   to the fact that we don't want to create a
23   financial burden in what they need to
24   report, that it is one of the key steps
25   going forward.  So we are actually quite
0050
 1   optimistic that while there will be some
 2   challenges ahead, that it's not sort of
 3   the doomsday scenario that some
 4   prognosticators have put forth.  We very
 5   much again believe that this is a very
 6   important session and we thank the SEC for
 7   pulling this together, because I think it
 8   is, as I said at the beginning, an
 9   opportunity to take advantage of the
10   crisis and make things better, and like my
11   other panelists, I look forward to the
12   open discussion.  Thank you.
13                 MR. SANCHEZ:  Thank you very
14   much, Bill.  Phil.
15                 MR. DOTTS:  Thank you, Dave.
16   And let me also add my welcome and thanks
17   to Commissioner Walter for being here
18   today and Mr. Cook and the other SEC staff
19   members, one of whom I met at breakfast
20   this morning.
21           Ever since I was asked to do this
22   and was pondering what I was going to say
23   about distressed communities, I kept
24   thinking back to a 20 year old golf story
25   that I will tell on myself, I was playing
0051
 1   in a best ball tournament with Bill
 2   Easterling, the former and now deceased
 3   sports editor of the Huntsville Times,
 4   hitting the ball pretty well, but
 5   unfortunately my iron play was a little
 6   off and I was consistently finding myself
 7   in a lot of green side bunkers.  After
 8   about the 12th hole I was muttering
 9   something -- probably off-color -- about
10   my sand game and how I needed to practice
11   that more, and Easterling stopped me in
12   mid sentence and said, "Dotts, you don't
13   need to practice coming out of the sand,
14   you need to practice not hitting into the
15   sand".  And so it is with state and local
16   governments-- the key is staying out of
17   the sand.
18           Communities don't become
19   distressed overnight.  Distress is the
20   result of both internal and external
21   factors that accumulate over time--
22   sometimes rapidly due to sudden and
23   uncontrollable changes in economic
24   conditions; sometimes over many years of
25   mismanagement and internal weaknesses, and
0052
 1   consciously or unconsciously choosing to
 2   ignore reality.  I refer to it as "not
 3   knowing what they do not know".
 4           In some cases -- in some ways it's
 5   analogous to the so-called epidemic of
 6   bank failures over the past few years,
 7   which in theory were run by sophisticated
 8   financial professors -- professionals,
 9   sorry about that, Bob -- that had risen up
10   over the years based largely on their
11   ability to produce successful results.
12           Leading up to the great recession,
13   I think it's safe to say that most banks
14   did not think they were heading for
15   trouble by loading up their balance sheets
16   with concentrations in commercial real
17   estate or by continuing to make
18   residential development loans as prices
19   continued to inflate.  Just as the state
20   and local governments saw increased
21   revenues from inflated real estate values
22   and sales taxes, the banking industry saw
23   increased profits from those activities
24   until the shock waves of 2007 and the
25   recession led to declines in income and
0053
 1   sales tax receipts, they were the steepest
 2   -- in Alabama anyway -- since the Great
 3   Depression.  In Alabama both state budgets
 4   were cut by approximately 20 percent
 5   before the current administration took
 6   office, rainy day funds, which were
 7   substantial, were exhausted, and stimulus
 8   funds that were used to prop up
 9   operations, all of which were not
10   available for the 2012 budget.  Local
11   governments were effected in a similar
12   way.
13           But back to the bank analogy for a
14   minute.  In hindsight, I think it's fair
15   to say that banking regulators also failed
16   to anticipate the impact of the economic
17   collapse.  In fact, bank profitability was
18   soaring, and this after extensive annual
19   examinations and scrutiny by their
20   examiners.  To put things in context, over
21   the past three years there have been 3
22   hundred and 56 bank failures, and I know
23   we're not talking about banks today, but
24   comparing to the municipal market, with a
25   cost to the FDIC of over 80 billion
0054
 1   dollars, to say nothing of the loss of
 2   market value by shareholders and employees
 3   in the failed institutions.  If you
 4   compare that to state and local
 5   governments, their debt and its overall
 6   performance, I think you'll find that the
 7   metrics would say that perhaps things are
 8   not as bad, as Bill said, as it might be
 9   predicted.  The old adage about, lies,
10   damned lies and statistics" probably holds
11   true here as well, but nonetheless, I'm
12   going to try to add some numbers to the
13   discussion also.
14           Overall, the municipal marketplace
15   is approximately 2.9 trillion dollars.
16   There are almost 17 thousand rated credits
17   within that universe.  The record year for
18   defaults was 2008, totaling approximately
19   8.1 billion dollars, which was largely
20   fueled by a large number of "dirt bond"
21   defaults and, of course, Jefferson County.
22           For the first half of 2011,
23   defaults totaled 24 or 7 hundred and 46
24   million dollars, down from 60 and 2.29
25   billion dollars during the first six
0055
 1   months of 2010, and a hundred and 44
 2   during the first six months of 2009, which
 3   total 4.89 billion dollars.
 4           According to a recent Moody's
 5   report, the ten year cumulative default
 6   rate in the municipal market was .09
 7   percent compared to 11.06 percent for
 8   corporate debt, most of those defaults
 9   being in the health care and housing
10   sectors.
11           So I'm not trying to suggest that
12   there aren't a lot of distressed
13   communities out there.  Just about every
14   client we have has had to deal with a lot
15   of stress over the past few years and many
16   are continuing to work through the effects
17   of the recession.  In fact, all of them
18   are continuing to work through the effects
19   of the recession.  But I think the numbers
20   do suggest that defaults are rare in spite
21   of the press attention on Jefferson
22   County, Harrisburg, Meredith Whitney, and
23   elsewhere.
24           So the questions in my view are:
25   How severe is the problem of distressed
0056
 1   communities?  I think for a number of
 2   communities the answer is very severe, and
 3   in some cases almost without a solution
 4   short of a debt compromise, and perhaps
 5   even Chapter 9.  Are the problems isolated
 6   or widespread?  I think the evidence,
 7   total evidence, and the numbers suggest
 8   that the worst of the distress, that is to
 9   say the kind that leads to default, is
10   isolated and not of epidemic proportions.
11   But either way, what can or should the SEC
12   do about the problem or problems?  In my
13   view, and as a practical matter, there are
14   only a few initiatives or approaches for
15   the SEC to consider unless they are
16   suddenly given the resources to conduct
17   on-site examinations of public debt
18   issuers by a staff of highly trained
19   examiners similar to the FDIC -- something
20   I'm not recommending, by the way.
21           There are a few added roles for
22   the SEC that I do think may be worth
23   considering:  Promote the benefits of
24   disclosure and the tools that are
25   increasingly available to make the task of
0057
 1   disclosure easier.  In practice, many
 2   public issuers provide financial
 3   information on their websites on a
 4   continuing basis.  Many are certainly
 5   following all the continuing disclosure
 6   requirements and do it routinely.  On the
 7   other hand, some have not even heard of
 8   EMMA or the new voluntary disclosure
 9   options.  So issuers should be encouraged
10   to provide more voluntary information,
11   perhaps mid year commentaries.  And added
12   visibility by the SEC at GFOA meetings or
13   perhaps other government county meetings
14   might be helpful.  There really should be
15   some matters of disclosure that if
16   ignored, lead to sanctions beyond just a
17   five year notice in the POS that the
18   filings were late.  For example, there 30
19   really is no reason that I can think of
20   for annual audits not to be completed
21   within a hundred and 80 or 2 hundred and
22   70 days.
23           Next, focus oversight on municipal
24   advisors and underwriters on things that
25   matter.  I may be a rarity, an independent
0058
 1   FA that thinks added SEC and MSRB
 2   regulatory oversight is a good thing for
 3   the industry.  I also thought that it was,
 4   it is long overdue and necessary even if
 5   there had only been one event of abuse of
 6   self-dealing.  The substance of the new
 7   regulations do not alarm me at all, and I
 8   encourage the SEC and the MSRB to focus on
 9   substance and not form as the regulations
10   are finalized-- all of which should be
11   given with an assumption of fiduciary
12   duty.
13           Lastly, and perhaps most germane
14   to the discussion today, the SEC should
15   attempt to focus the states to encourage
16   better debt management policies by the
17   public issuers within their respective
18   borders.  The benefits to the issuers of
19   debt in North Carolina, for example, which
20   has a Local Government Commission are
21   obvious I think and show up in lower rates
22   and the ability to access best practices
23   for issuers that are less sophisticated.
24   States should also be encouraged to adopt
25   legislation providing them the ability to
0059
 1   intervene in some manner in distressed
 2   situations.  Some states have that, I
 3   don't think the majority do.  The states
 4   such as Pennsylvania and Michigan have
 5   those mechanisms.  Act 47 is probably I
 6   guess the most routinely cited.  Perhaps a
 7   collaborative approach with each state's
 8   Securities Commission would be a good
 9   place to start.
10           There are clear examples of bad
11   management, corruption, and significant
12   external factors; for example, national
13   economic recessions and the downgrades of
14   the monoline insurers that have led to
15   some pretty major dust-ups in the
16   municipal finance space over the last few
17   years.  Today who would have ever
18   expected, for example, that Moody's would
19   place 7 thousand issuers under review for
20   a downgrade as a result of the impasse
21   related to Federal debt negotiations.
22   Several of those issuers are right here in
23   Alabama -- a number of those issuers
24   actually.  But, in my view, and maybe it's
25   because most of our traditional public
0060
 1   finance practice is in this region, I see
 2   this as a period of transition to new
 3   economic realities, and not the beginning
 4   of a municipal apocalypse.  Lower debt
 5   issuance is a sign, is one sign of the
 6   transition, as is the right-sizing of the
 7   workforce in the public sector, a process
 8   that has clearly trailed the private
 9   sector.  All issuers will be affected by
10   national and regional economic
11   conditions-- some will muddle through
12   better than others.  I guess you can call
13   those either communities under pressure or
14   distress -- in general it's really a
15   matter of semantics, but without a doubt,
16   those with the best internal practices and
17   that value their credit standing and
18   market access will do better than those
19   that don't exhibit those characteristics
20   irrespective of external factors.  As
21   conditions improve, and they surely will,
22   some of the concern will go to the back
23   pages or to increasingly more obscure
24   blogs.  On the one hand, that is a good
25   thing, but not if it lessens the
0061
 1   objectives of better disclosure, effective
 2   oversight of municipal advisors and
 3   underwriters and having the states take a
 4   more active role in encouraging better
 5   debt and financial management practices by
 6   issuers located within their
 7   jurisdictions.  Thanks.
 8                 MR. SANCHEZ:  Thank you very
 9   much, Phil.  Bob.
10                 DR. BROOKS:  Thank you for
11   the privilege of participating in this
12   event.  It's an honor to be here.  As a
13   finance professor in the State of Alabama
14   for the past 25 years, I would like to
15   thank the SEC staff for maintaining an
16   attractive environment in which my
17   students may flourish in their various
18   finance vocations.
19           In these opening remarks I would
20   like to make five brief points.  First, it
21   is a given that the regulatory environment
22   governs how municipal finance is practiced
23   day-to-day, but what may not be obvious is
24   that it also influences who chooses to
25   enter this vocation.  If the municipal
0062
 1   finance landscape resembles a prison
 2   environment, then we should not be
 3   surprised that many highly ethical,
 4   competent, creative professionals opt for
 5   an alternative finance profession.  If the
 6   finance landscape instead encourages
 7   innovation and creativity where self-
 8   enforcement is reliable, then we will
 9   observe more highly ethical professionals
10   opting for the municipal finance
11   profession.
12           Like most communities, self-
13   enforcement is an excellent deterrent for
14   criminals (we are in Alabama where hunting
15   is very popular, giving pause to many
16   would-be intruders).  For example, if a
17   large financial institution is found to
18   have ravaged a specific municipality
19   through malicious swap advice, then
20   through industry-wide self-enforcement
21   that particular financial institution must
22   find itself unable to create demand for
23   their services.  This loss of market
24   share, coupled with severe regulatory
25   enforcement action, would provide a
0063
 1   healthy deterrent.  The municipal
 2   industry, perhaps through its professional
 3   organizations, should provide a clear
 4   message to those institutions that
 5   instigate harm on municipalities.
 6           Second, there are at least three
 7   presuppositions for well-functioning
 8   financial markets-- clear rule of law,
 9   clean property rights, and a culture of
10   trust.  Complex and ambiguous laws and
11   regulations may result in tyrannical
12   enforcement where particular regulators
13   arbitrarily bring enforcement actions.
14   Well-defined and well-protected property
15   rights are essential for efficient
16   financial transactions.  Activities, such
17   as rampant naked short-selling should
18   never have been permitted to flourish.  A
19   culture of trust cannot be legislated,
20   rather it flourishes when nurtured from
21   within.  The CFA Institute, through its
22   Code of Ethics and Standards of
23   Professional Conduct, is a great example
24   of the professional association setting a
25   very high bar within the finance
0064
 1   community-- which helps to build a
 2   stronger culture of trust.
 3           Third, the municipal finance
 4   industry historically has demanded
 5   transaction-driven financial consulting.
 6   Consider the following analogy:  Suppose
 7   I'm experiencing heart problems (say
 8   pressure from appearing at a SEC Field
 9   Hearing), and have the choice of two
10   different cardiologists.  Dr. Red Cuttem
11   only receives compensation if he conducts
12   open-heart surgery.  On the other hand,
13   consider Dr. Green Soy who is paid for
14   whatever services are provided, including
15   her time for routine office visits.  Who
16   is more likely to provide the unbiased
17   advice that diet and exercise is all that
18   is needed?  The municipal professional
19   associations should be at the forefront of
20   leading a cultural change.  The municipal
21   finance advisory providers will adapt
22   their business model to whatever their
23   customers demand.
24           Four, the optimal debt structure
25   is somewhat unique for municipalities.
0065
 1   For our purposes, it is important to note
 2   that the optimal quantity of municipal
 3   debt depends on whether you are a bond
 4   underwriter, the current elected official,
 5   or the tax-paying member of the
 6   municipality.  The incentives to borrow
 7   more than optimal exists for the
 8   underwriter and the elected official.
 9   However, somehow the interests of the
10   tax-paying member of the municipality
11   needs to be served.
12           Finally, the optimal maturity
13   structure is also unique for
14   municipalities.  Existing elected
15   officials as well as municipal bond
16   underwriters maybe tempted to push
17   principal payments into the distant
18   future.  However, the lower cost and lower
19   risk solution is likely to have shorter
20   maturities.  The municipal finance
21   community must abandon their fixation on
22   speculative, view-driven, interest rate
23   risk management.  Rather, they should
24   embrace the hedging and needs-driven
25   approach used by most financial
0066
 1   institutions (often termed asset-liability
 2   management).
 3           In summary, the municipal finance
 4   industry is regarded as dubious by many
 5   finance professionals, there appears to be
 6   little downside risk for criminals, and no
 7   real representation of the interests of
 8   the tax-paying public.  We must resolve
 9   these numerous existing structural
10   problems in municipal finance so there
11   exists an attractive environment for
12   highly ethical, innovative and creative
13   professionals to enter and serve the
14   municipal finance industry.  There are
15   many young professionals today interested
16   in public service.  We should create an
17   attractive environment for them to
18   flourish.  Thank you.
19                 MR. SANCHEZ:  Thank you,
20   Bob.
21                 COMMISSIONER WALTER:  Let me
22   start off by harking back to I think the
23   theme that both Foster and Phil raised,
24   whether you want to call it the don't be
25   led off in handcuffs or keep out of the
0067
 1   sand -- maybe we'll stick with the sand --
 2   is you asked about and you focused on, and
 3   I think appropriately so, some early
 4   warning signs, and I assume that you would
 5   agree, and that would be my first
 6   question, that it is obviously advisable
 7   to identify problems early and before they
 8   get worse.  Assuming that that's the case,
 9   what really are the leading indicators in
10   order to head off, head a community off
11   from becoming distressed?
12                 MR. CLARK:  Go ahead and
13   give it a shot --
14                 MR. DOTTS:  Well, I'll take
15   a shot and you can correct me, I guess,
16   Foster does that a lot with me.  I think
17   Foster went through a pretty good litany
18   of items that really are germane.  I think
19   that the, you know, I think one indicator
20   I think is perhaps most significant is
21   drawdowns, consistent year after year
22   drawdowns of, you know, fund balances,
23   liquidity.  I think that that speaks to a
24   whole lot of things.  It speaks to
25   structural problems with their budgets.
0068
 1   It speaks to declines in revenues.  It
 2   speaks to all of those, all of those other
 3   things.  I mean that would be the single
 4   biggest thing I think that I would look at
 5   as an outside observer.  There are -- and
 6   all the other -- and that reflects on
 7   management.  Management can't deal with,
 8   again, either external or internal events
 9   that are causing that.  Decline in tax
10   revenues news, unemployment rates going
11   up, demand on services, whatever it might
12   be, and so if internally they can't -- I
13   mean, rainy day funds are there for a
14   reason.  Most of our clients had drawdowns
15   of their reserves in 2009, in some cases
16   2008, but typically 2009 more pronounced,
17   and those that were able to adjust in 2010
18   and 2011 say they did a good job managing
19   through the process.  Those that did not,
20   obviously are perhaps still struggling
21   with it, so I think that to me is the
22   single biggest thing.
23                 MR. CLARK:  I guess the
24   simplest definition of we're talking about
25   financial stress, and nobody's really
0069
 1   defined it, but I think it's pretty
 2   obvious, it's when revenues and
 3   expenditures get out of whack.  And so
 4   you're trying to think about what the
 5   early warning signs are, obviously you
 6   want to keep your eye on both of those
 7   things.  I had a slightly longer list than
 8   I had time for earlier, but, you know,
 9   I'll run through them and maybe that will
10   create some more discussion about it--
11   budget deficits and imbalances; decreasing
12   fund balances, like Phil mentioned, or
13   extraordinary fund transfers; cuts to
14   services, departments or programs;
15   employee furloughs or layoffs;
16   implementation of an early retirement
17   program; deferred maintenance and aging
18   infrastructure; hiring or spending
19   freezes; unfunded pension liabilities that
20   we've mentioned; bumping up against legal
21   limits for debt capacity or maximum tax
22   rates can foreshadow problems; material
23   regulatory failures; health care costs;
24   burdensome long term labor contracts; a
25   failed project, such as Harrisburg that
0070
 1   required some sort of financial support
 2   for the city; spending from reserve funds;
 3   high unemployment in the service area;
 4   loss of major industries, taxpayers or
 5   employers; obviously significant tax
 6   declines; or even adverse results in
 7   material litigation.  All of those things
 8   either effect revenues or expenditures,
 9   and they're all warning signs of trouble
10   it seems to me.
11                 COMMISSIONER WALTER:  Do you
12   think that one thing the municipal finance
13   committee community could do to help might
14   be, we talk a lot in our business about
15   investor education, but perhaps to talk
16   about municipality education in terms of
17   taking the people who are often occupying
18   these roles as a second occupation and
19   educating them about what really are early
20   warning signs and the benefits of taking
21   action way early in the process before
22   there really is trouble?  Is that a role
23   that the community could play?
24                 MR. DOTTS:  My answer to
25   that would be yes.  I think that there are
0071
 1   a lot of elected officials that enter that
 2   arena without a whole lot of background in
 3   finance or other things.  I think that
 4   having that access to that kind of
 5   information would be very helpful.  It
 6   would make them ask a lot of questions
 7   that perhaps they otherwise wouldn't ask
 8   if they didn't have that background.
 9                 MR. BROOKS:  If I could just
10   interject, one of the problems I see is
11   that the industry has gotten conditioned
12   to get their education from the
13   counterparty on the other side who has a
14   severe conflict of interest, and so there
15   needs to be a cultural change where the
16   municipal officials get their unbiased
17   advice not from the person trying to sell
18   them something.
19                 MR. COOK:  Can I ask --
20                 MR. DOTTS:  I think that
21   that's kind of -- that's one of the things
22   I was trying to allude to in my remarks
23   about having a best practices center, I
24   mean that states I think can drive, I
25   really believe that that's -- I don't
0072
 1   think every state ought to adopt exactly
 2   what North Carolina does, but I do believe
 3   that there ought to be -- there should be
 4   better debt management practices at a
 5   statewide level.  There also could act as
 6   a best practices center for local
 7   governments to come get that unbiased
 8   advice, or -- but also I would say to
 9   Bob's point that I think we're independent
10   FAs, we don't sell anything, we don't buy
11   anything, but we get some of our best
12   information from the counterparty, you
13   know, we have the ability to then go get
14   other information and digest it so we can
15   understand it and see how it makes sense.
16                 MR. CLARK:  You know, the
17   other obvious point is that cities and
18   counties just come in all shapes and sizes
19   and degrees of sophistication and
20   population, and the large cities have
21   large staffs, people tend to stay there
22   and make a career out of it, they're well
23   paid, they're well-educated.  At the other
24   end of the spectrum you've got very small
25   cities, rural counties where there just
0073
 1   may not be anybody on the staff that
 2   understands securities disclosure laws or
 3   understands the kinds of early warning
 4   signals we're talking about, or if they
 5   are lucky enough to have someone, he or
 6   she doesn't stay very long, so it's
 7   constant turnover, and finally, if you
 8   find yourself being one of the "distressed
 9   communities" that we're talking about, the
10   daily pressure of responding to
11   constituents and keeping the police force
12   and the school teachers and firemen on the
13   job can be overwhelming.
14                 MR. SPIOTTO:  One of the
15   things that I think would be very helpful
16   is having, at least on a state level, the
17   availability for distressed communities to
18   talk to someone about what their options
19   are and what history has really shown.
20   One of the biggest problems is band-aids
21   versus fixes.  Sometimes we put a band-aid
22   on it thinking that that will cure it and
23   it really needs a fix.  If you look at the
24   pension problem, that has not been a
25   problem that we just discovered today.
0074
 1   That's a problem we've kicked down the
 2   road numerous times.  We know we have to
 3   do it, just like many of us with diets, we
 4   just don't stay to it, and one of the real
 5   keys is having somebody provide the
 6   supervising adult that helps the community
 7   to focus on the right things and look at a
 8   long term solution rather than a short-
 9   term band-aid.
10                 MR. FALLON:  Just on that
11   one, I do think on the accounting so many,
12   and there's many different cities and how
13   they do things, they focus on the cash
14   revenue and cash expenditures, when so
15   much of a cost that ends up being in the
16   pension is not occurring cash expense, and
17   it's created for some cities huge
18   challenges which they can't push off any
19   further.
20                 MR. COOK:  Can I ask how
21   we'd think about operationalizing that
22   idea in the sense of the challenge of so
23   many different types of issuers, so many
24   different causes for the distress, but
25   let's assume that whatever those metrics
0075
 1   are there's an indication of distress.  Is
 2   this an area where there should be a
 3   legislative fix at the state or national
 4   level or regulatory fix, or is this more
 5   of an area where it's developing best
 6   practices?  How do you address the
 7   diversity of issues that can come up in a
 8   way that addresses these issues?
 9                 MR. DOTTS:  In my view, you
10   start with best practices or perhaps have
11   some sort of a process where there's some
12   of reporting mechanism before debt's
13   issued or something, and, again, I think
14   you also run the risk of overkill, you
15   know, and you don't want to also walk in
16   the political firestorm trying, you know,
17   where cities and counties say, well, the
18   state's trying to tell us what to do, and
19   that's not really the purpose.  The idea
20   would be I think in my view best
21   practices, first of all.  The other side
22   when there is distress, I think that
23   having a mechanism where the state can,
24   where you can go to get that advice and
25   get some options and review and in some
0076
 1   cases perhaps even authorize the states to
 2   have some level of intervention authority
 3   would be a positive step as well.
 4                 MR. FALLON:  I think also I
 5   think there's a minimum amount that needs
 6   to be essentially required because there
 7   is a real burden, and I think beyond that
 8   are the best practices or a principles
 9   based approach because to the point
10   there's so many differences in the towns
11   and cities that we're talking about that
12   what you don't want is what's happened to
13   corporations where you have a 3 hundred
14   page disclosure that no one reads or can
15   understand and would be a real burden, but
16   I think each one would be different, but
17   to would give us some set of best
18   practices and principles beyond the
19   required financial, as well as I think
20   Phil mentioned a more timely disclosure
21   would be very beneficial.
22                 MR. COOK:  Just to follow up
23   on that idea, so the best practices is a
24   way to help the community get its handle
25   around the finances, but what about from
0077
 1   the investor perspective?  To what extent
 2   should this be an area where additional
 3   disclosures ought to be mandated, and do
 4   you have a sense that investors really
 5   understand what the legal framework is
 6   around the bankruptcy rime or the
 7   alternatives to bankruptcy that an issuer
 8   may be subject to?  Is that an area where
 9   there's more investor education that's
10   necessary?
11                 MR. SPIOTTO:  I think that
12   that is an area that for all parties
13   concerned more education is good and
14   encouragement of getting it out.  Over
15   half the states as a municipality you
16   generally can't file Chapter 9, so those
17   that are, and only 13 specifically
18   authorize it.  There are various types of
19   state supervisory commissions and
20   authorities that can help, and spelling
21   out which states have them or not.  Rhode
22   Island just recently passed legislation in
23   which they granted a statutory first lien
24   to their note and bondholders of all
25   municipalities on the ad valorem taxes and
0078
 1   general funds to insure access to the
 2   market.  That means that even if they do
 3   file Chapter 9, the bond debt reportedly
 4   won't be adversely effected, so that's a
 5   very interesting piece of legislation.
 6   Where do things go from there?  Is that
 7   going to be a trend?  Will that take sort
 8   of the access to the market and the cost
 9   out of the equation?  Very interesting.
10   There's some states, Rhode Island again,
11   Michigan and some others that have
12   recently passed legislation, Indiana tried
13   this last session, putting in either
14   overseers in a staged approach:  If
15   there's some problems, you have an
16   overseer.  If it gets worse, you have a
17   budget commissioner.  If it gets worse,
18   you have a receiver, and ultimately
19   possibly Chapter 9, but they put in a
20   supervising adult to help, somebody with
21   some experience and knowledge that can
22   point the way and sort of take the heat
23   also.
24                 MR. SANCHEZ:  I mean, aside
25   from investors, do you feel that the
0079
 1   professional analysts understands these
 2   differences in bankruptcy and also these
 3   other programs available?
 4                 MR. SPIOTTO:  Well, I think
 5   that sort of putting it out there and
 6   sharing it and building it will create,
 7   you know, our own sort of library of
 8   resources that people can use.  And I
 9   think we spend so much time in the good
10   time that we haven't spent time in the bad
11   time so we haven't had to develop that.
12                 COMMISSIONER WALTER:  Could
13   you just go through, perhaps give us a
14   little bit more information if the worst
15   happens and there is a Chapter 9 filing or
16   you have some close supervision, what
17   happens on a day-to-day basis both with
18   respect to investors, bondholders and with
19   respect to people in the community?
20                 MR. SPIOTTO:  There are a
21   couple of things.  You know, when you
22   meltdown it is a painful experience.  One
23   of the problems is to make sure that the
24   least sophisticated holders realize don't
25   panic.  I mean this is not going to be
0080
 1   elimination of debt.  The whole purpose of
 2   Chapter 9 is debt adjustment, to lower the
 3   debt to a level which is affordable and
 4   sustainable by the municipality.
 5   Municipal bonds, for example, have had on
 6   the whole a higher recovery than other
 7   types of debt obligations, and, therefore,
 8   if people panic and sell, all they're
 9   doing is helping the subsequent purchaser
10   to obtain a better value and they obtain a
11   loss, so, one, don't panic.
12           Two, the municipality going in,
13   and whether you talk to Vallejo or any
14   municipalities going through it, it's time
15   consuming, it's expensive, it's uncertain.
16   You tip over all of your creditor
17   relationships.  All of those that you
18   like-- suppliers, vendors, even workers
19   that you really don't want to challenge.
20   You may not have paid them up-to-date, but
21   now you have them in a rattled situation.
22           With regard to the bond debt,
23   there will be questions raised as to
24   access to the market and cost, and
25   increased cost is like the last thing that
0081
 1   a troubled municipality wants to do,
 2   because that's more taxes going to pay
 3   interest rather than other essential
 4   services, so debt paying.  We have still
 5   been trying to work out, and it happened
 6   in the '30s, what's the relationship
 7   between the federal judge in a Chapter 9
 8   and the municipality and the state.  It's
 9   that co-sovereigns dealing with each other
10   issue that has a judge with limited
11   powers, the judge can't make policy for
12   the municipality, can't overrule the
13   policy made for it, can't overrule state
14   law, so it's a lot different than Chapter
15   11, and that's a complicating factor also.
16           One other factor is the exit isn't
17   as clear as -- obviously a pre-package 9
18   sounds a whole lot better than a hard
19   crash landing 9, a Chapter 9 where you
20   have to work it out and get everybody on
21   board and figure it out.  As Vallejo
22   realized and as many other situations bear
23   it can take more time than you think, cost
24   more money, and be far more complicated.
25   And in the long run, if it cost you money
0082
 1   as far as access to the market, you may
 2   have had better alternatives before
 3   choosing, and so it's a last resort.
 4   Unfortunately, it has been taken, but we
 5   really haven't had large municipalities do
 6   it of any size.  I mean less than ten in
 7   the last ten years has been -- basically
 8   ten or less -- has been basically mantra
 9   Chapter 9s and they've been small tax
10   districts, with the exception of Vallejo.
11                 MR. CLARK:  You know, in
12   terms of secondary market disclosure,
13   which I think is what you're really asking
14   about and getting information out to
15   investors on an ongoing basis, it seems to
16   me it really divides itself into when
17   times are going okay, when the city's not
18   in trouble, then the normal rime of
19   annual reports and the, you know, material
20   event notice requirement's probably,
21   probably adequate.  When things start to
22   spiral down and things are happening every
23   week or every day, or if you get into a
24   Chapter 9 where creditors want to know
25   what's going on, then maybe there's room
0083
 1   in those situations to talk about some
 2   other kind of more frequent and more
 3   meaningful reporting.  I don't know what
 4   that is.  I have a suggestion about it,
 5   but I can understand how investors who are
 6   holding debt from a story that they're
 7   reading about across the country would
 8   want more current and more frequent
 9   information.  Right now the material event
10   notice requirements under 15c2-12 is what
11   we have.  At last count Jefferson County
12   in three years, three and a half years,
13   has filed 93 material event notices.  I
14   suspect that's a world record.
15                 MR. FALLON:  And I would
16   just add to your point on the investor's
17   side, keep in mind so many of the
18   investors in municipal debt are individual
19   investors versus the large institutions,
20   and so I think the answer to this question
21   is they don't know what happens in these
22   situations, and so for all the reasons I
23   think Jim and Foster mentioned, and on top
24   of that what they were buying were
25   investment grade bonds or insured bonds,
0084
 1   and where the defaults have happened they,
 2   to a large extent, have been things at
 3   inception were either unrated or below
 4   investment grade, so for the individual
 5   investor I think it's impossible for them
 6   to have known or to know what happens in
 7   these distressed situations.
 8                 MR. SANCHEZ:  Unfortunately,
 9   I think we're out of time, unless you have
10   anything else.
11                 COMMISSIONER WALTER:  No, I
12   just want to thank our panel, and we will
13   promptly reconvene at 10:15 for the next
14   panel.  Thank you all so much.  I stand
15   corrected, ten minutes everybody, come
16   back in ten minutes.
17   
18                 (Recess was taken.)
19   
20                 COMMISSIONER WALTER:  If
21   everyone can take their seats, we'll get
22   started again.  Thank you.  Before I turn
23   the floor over to Dave again to start our
24   panel with our second set of distinguished
25   guests, just a couple of pointers.  If
0085
 1   everyone will speak into the microphone so
 2   the transcription will be accurate.  And,
 3   also, if I can encourage our panelists to
 4   stick to sort of a three to five minute
 5   time frame for their opening statements,
 6   we'll have that much more time to pepper
 7   you with questions, which will be a
 8   delightful prospect.  Take it away, Dave.
 9                 MR. SANCHEZ:  Our second
10   panel of the day is entitled Small
11   Issuers.  In addition to considering the
12   meaning of the term small issuer, our
13   panelists will examine the ability of such
14   issuers to comply with existing disclosure
15   requirements.  They will also review how
16   other additional disclosure obligations
17   being considered in the market might
18   effect small issuers.  Panelists will also
19   explore how small issuers interact with
20   financial intermediaries.
21           I will, again, introduce the panel
22   in the order in which they will be making
23   their opening remarks, starting to my
24   immediate left.  We're very excited to
25   have a great mix of experienced market
0086
 1   professionals on this panel.  First will
 2   be Bob Scott.  Bob is the Chief Financial
 3   Officer and Assistant City Manager for the
 4   City of Carrollton, Texas, where he has
 5   responsibility for all aspects of the
 6   City's financial operations.
 7           Next is Sandy MacLennan, a partner
 8   in the Tampa office of the law firm
 9   Squire, Sanders & Dempsey, representing
10   both municipal entities and conduit
11   borrowers.
12           Hobby Presley is the founder of
13   the Birmingham law firm Presley, Burton &
14   Collier and is a former president of the
15   National Association of Bond Lawyers.
16           Scott Beardsley is the Executive
17   Managing Director of the Capital Markets
18   Group at Crews & Associates, which is a
19   full service regional investment banking
20   firm headquartered in Little Rock,
21   Arkansas.  Bill Henderson is the Managing
22   Director of Piper Jaffray providing
23   financial advisory and underwriting
24   services to governmental and non-profit
25   entities throughout the Midwest.  Bob.
0087
 1                 MR. SCOTT:  Okay.  Thanks.
 2   I don't really consider Carrollton, Texas
 3   a small issuer.  We're probably a smaller
 4   or medium size issuer.  Just to give you a
 5   little background on our city, we are an
 6   affluent north Dallas suburb of a hundred
 7   and 22 thousand with a diversified
 8   commercial base.  We grew by 95 thousand
 9   residents between 1970 and 2000, a 30 year
10   period, and I mention that because when
11   you grow rapidly then everything wears out
12   about the same time.  Most of our
13   infrastructure was built with a 25 to 30
14   year design line and so now everything is
15   wearing out, and we're estimating the
16   replacement cost of that infrastructure is
17   at right about 2 billion, so access to the
18   capital markets and being able to keep up
19   and keep ahead of the curve of our
20   deteriorating infrastructure is very, very
21   important to us.
22           Okay.  Our total outstanding debt
23   is about a hundred and 93 million, and our
24   operating budget, just to give you
25   context, is about a hundred and 70
0088
 1   million, but it's been going down in the
 2   last few years.  In 2001, trying to stay
 3   ahead of the curve, we recognized that we
 4   were approaching build out and that we
 5   weren't going to have the double digit AB
 6   growth that we had enjoyed in the past,
 7   and also that we needed really a different
 8   staff to handle being a mature city that
 9   was getting older every year versus a
10   rapidly growing city where building
11   inspections and planning and zoning was
12   much more prominent functions, and so we
13   kind of reinvented ourselves and we have
14   gone from over a thousand employees to now
15   we're well under 8 hundred with this
16   budget year, even at a time when the city
17   was continuing to grow.  And I think it's
18   important to note, too, that our finance
19   and accounting staff have less people now
20   than they had when I started when our
21   population was significantly less 20 years
22   ago.
23           So all of us at the city in the
24   finance function wear multiple hats.  We
25   all do various things.  Our treasurer,
0089
 1   who's primarily responsible for debt
 2   issuance, for example, does all the
 3   day-to-day cash management.  She does all
 4   the revenue forecasting, she does all the
 5   investing, and she's also responsible for
 6   our credit card program, which has become
 7   extremely time intensive with all the
 8   identity theft requirements that have come
 9   in place recently.  So we've done various
10   things to try to reduce that burden.
11           Just going very quickly to the
12   challenges that I see us facing, or I'll
13   skip over -- the two primary financial
14   disclosure documents, for us to get
15   everything done and do a reasonably good
16   job at it we have to double dip whenever
17   we can and use the same documents for
18   multiple purposes, and so I view our
19   financial disclosure program as really
20   revolving around two documents.  We have a
21   goal of getting our annual report out by
22   four months after year end which comes out
23   to about February 1st of each year, and we
24   also include in it all our continuing
25   disclosure documents.
0090
 1           And then about six months later,
 2   first week in August, we publish our
 3   proposed budget on the website, and so,
 4   you know, from my perspective every six
 5   months I'm providing some major financial
 6   disclosures to the markets, one is more of
 7   a historical, and then the other is more
 8   prospective, although the continuing
 9   disclosure is focused on more current data
10   than the CAFR itself.
11           So our challenges:  First of all,
12   additional requirements do not necessarily
13   mean additional resources.  I've been in
14   the business for over 20 years, I've never
15   had a single person come to a budget
16   public hearing and say what this city
17   needs is more accountants and AP clerk,
18   and we would just be so much better off.
19   It does not happen.  We're a back office
20   operation, and our elected officials are
21   going to focus on those things that the
22   citizens see, and that's as it should be.
23   So what happens is when we have additional
24   requirements, we juggle, and typically
25   something doesn't get done or it doesn't
0091
 1   have as much time spent on it as it did
 2   before.  Sometimes that works and
 3   sometimes it doesn't.
 4           One of the things that I've been
 5   very adamant about over the years is we've
 6   always prepared our own OS, and we're
 7   unusual for our size city in that, and the
 8   reason we do that is because I'm convinced
 9   that I can't really understand what I'm
10   committing to unless I help prepare the
11   document and I know what's going on.  If
12   we had many more staff cuts than what we
13   currently have, though, we would probably
14   have to give that up to the FA.
15   Misapplication of accountability is
16   another challenge.  The recent GASB
17   proposals on pension standards are going
18   to ask me to put a financial number in my
19   financial statements that I don't prepare,
20   and I have no ability to really say that
21   it's fairly stated in all material
22   respects.  That's a concern to me.  It's
23   prepared by my pension plan that is
24   totally independent from me.  And then
25   GASB standards are getting more and more
0092
 1   complex all the time.  And that's my
 2   comments.
 3                 MR. SANCHEZ:  Thank you,
 4   Bob.  Sandy.
 5                 MS. MACLENNAN:  Good
 6   morning.  First and foremost, I'd like to
 7   thank Commissioner Walter and the
 8   Commission staff for the invitation to
 9   participate in this Field Hearing.  I
10   should say, that I appear here today on my
11   own behalf and not as a representative of
12   my firm or any particular organization or
13   any particular client.
14           I've spent my entire legal
15   career-- at least the first 27 years,
16   we'll see how it goes after today-- in
17   public finance and predominantly in the
18   primary municipal market and mostly on the
19   "issuer" side of the table.  My first
20   encounter, though, with municipal bonds
21   was as a young girl accompanying my mother
22   to the bank to retrieve interest coupons
23   to submit for payment.  I don't think I
24   really knew what a municipal bond was at
25   the time, and I have to tell you I don't
0093
 1   think I knew much more when I got out of
 2   law school.  It's just not something they
 3   teach you in law school.  So I think in
 4   this business some would say you learn by
 5   doing, and I've been doing this for 25
 6   years.
 7           My practice is very diverse.  I
 8   currently work with small, medium and
 9   large issuers, some of whom are here in
10   the room, and non-profit organizations,
11   primarily in Florida.  What I have
12   observed over the last 20 years -- 27
13   years is that, at least from the issuer's
14   side, the municipal market is not a
15   homogenous market but rather a group of
16   diverse, distinct, and somewhat segregated
17   markets that reflects the diversity as to
18   the source of security and payment and the
19   type of issuer and, of course, the level
20   of perceived risk.  To a certain extent,
21   each market has its own practices, in
22   terms of primary and continuing disclosure
23   and each, I believe, has evolved over the
24   years to different points along that
25   disclosure continuum.  Does this disparate
0094
 1   approach to disclosure across market
 2   segments indicate some issuers are more
 3   forthcoming with information and others
 4   less?  I think the answer to that question
 5   is no.
 6           These practices, although diverse,
 7   have evolved separately over time in
 8   response to a number of factors, including
 9   market requirements, as well as Commission
10   published guidance, and, yes,
11   unfortunately, also Commission enforcement
12   actions.  Issuers preparing primary
13   disclosure documents typically look to the
14   financing team for advice as to what
15   investors expect and require.  You've
16   already heard from speakers in prior
17   hearings that there have been improvements
18   in the area of primary market disclosure,
19   and these improvements, I believe, have
20   been achieved in part through the combined
21   and concerted efforts of many market
22   organizations including the National
23   Association of Bond Lawyers, National
24   Federation of Municipal Analysts, the
25   Government Finance Officers Association,
0095
 1   as well as the Commission, the MSRB,
 2   SIFMA, among others.
 3           With respect to continuing
 4   disclosure and municipal secondary market
 5   generally, I believe that improvements can
 6   be achieved in the same manner, through
 7   the combined and concerted efforts of all
 8   participants in the municipal secondary
 9   market, and without necessarily additional
10   regulations of issuers.  After reading the
11   transcripts of the prior field hearings, I
12   have a greater understanding now of the
13   municipal secondary market.  I was a
14   little surprised I think at how complex
15   the secondary market is, and, honestly,
16   just how far removed from it municipal
17   issuers are.  I sometimes think that
18   municipal issuers, and, particularly,
19   smaller and less frequent issuers exist in
20   a separate but parallel universe from the
21   secondary market.  There are improvements
22   to be made on both sides, in terms of
23   investors understanding and appreciating
24   the distinct differences between municipal
25   and corporate markets and issuers
0096
 1   understanding of what investors need on an
 2   ongoing basis.
 3           I would like to say a few things
 4   about municipal bonds issued for corporate
 5   or private borrowers, the so-called
 6   "conduit bonds".  This type of debt covers
 7   a wide array of financings, including
 8   financings for affordable housing,
 9   hospitals and other health care
10   facilities, higher education facilities,
11   manufacturing facilities, electric utility
12   facilities and numerous projects for
13   non-profit organizations.  The ability of
14   a state or local government to offer
15   tax-exempt financing as an incentive for
16   local development is an important tool,
17   and, in this economy, I hope you would
18   agree that it would be a particularly
19   inopportune time to restrict the use of
20   this structure or otherwise increase the
21   cost (thereby reducing the value) of this
22   economic tool.  For smaller communities
23   especially, this may be the only financial
24   incentive available to be offered for new
25   commercial development.
0097
 1           In conclusion, I have to say I
 2   don't envy the task of the Commission.  It
 3   is somewhat of a conundrum that the
 4   municipal entities you might seek to
 5   regulate with increased disclosure or
 6   increased oversight if the Tower Amendment
 7   is repealed are the very entities you are
 8   charged with protecting to a certain
 9   extent with other regulations and laws
10   such as the municipal advisor regulations.
11   There are many facets to the municipal
12   market and many participants with diverse
13   interests.  The best I hope for is a
14   balanced approach that recognizes the
15   unique characteristics and limited
16   resources of municipal issuers and the
17   current information resources already
18   available to investors.  A good result
19   would be one that provides investors
20   access to more relevant information
21   without breaking the banks or the backs of
22   our local communities.  I do believe this
23   is achievable over time through the
24   combined and continued efforts of all
25   market participants working in concert
0098
 1   with the Commission and the MSRB.  Thank
 2   you.
 3                 MR. SANCHEZ:  Thank you very
 4   much, Sandy.  Hobby.
 5                 MR. PRESLEY:  Thank you.
 6   First, I would like to thank Commissioner
 7   Walter and the SEC staff for hosting these
 8   hearings.  A fair and effective regulation
 9   of the municipal securities market
10   requires dialogue and mutual understanding
11   by those regulated and those being --
12   those doing the regulations.  Your
13   willingness to hear from market
14   participants in general and on this panel
15   from those interested in the problems of
16   small issuers is a healthy and encouraging
17   sign that the regulation of the municipal
18   market can be achieved and the legitimate
19   interests of all issuers, small issuers
20   included, kept in mind, so, again, thank
21   you for the spirit in which these hearings
22   are held.
23           During my 30 plus years of
24   practice in the field of public finance
25   I've been active in the National
0099
 1   Association of Bond Lawyers and have been
 2   privileged to serve in leadership
 3   positions for NABL.  However, my remarks
 4   today and my participation on this panel
 5   express individual views and should not be
 6   understood as the policy or statement of
 7   NABL.  With that disclaimer in place, I
 8   will say that I'm proud, quite proud, of
 9   the role NABL has played in improving the
10   municipal securities market over these
11   many years, and on behalf of my NABL
12   colleagues I want to thank the SEC for its
13   openness and encouragement of NABL's role
14   and efforts.
15           Before making comments or
16   suggestions about the challenges facing
17   small issuers, I would like to say
18   something about the positive developments
19   in disclosure practices that effect the
20   market in general and certainly small
21   issuers as well.  First, it is certainly
22   true that disclosure practices in the
23   municipal market can and should improve,
24   but it is also true that significant
25   advances have been made in disclosure
0100
 1   practices in the municipal market in the
 2   last three decades as a result of various
 3   SEC enforcement actions, private
 4   anti-fraud actions and regulatory
 5   initiatives with respect to primary market
 6   official statements and continuing
 7   disclosure, the great majority of issuers
 8   have a very solid appreciation for their
 9   disclosure responsibilities.  That was not
10   at all true 30 years ago when this process
11   started.  There's also been improvement in
12   the attitudes and practices of those who
13   assist local government such as
14   underwriters, lawyers, financial advisors,
15   their participation has also improved.  Is
16   there room for improvement?  Of course,
17   there is, but awareness and willingness
18   have definitely improved.
19           Second, the disclosure process has
20   been greatly improved through the
21   implementation of a centralized filing
22   system, and I'll say thank you for that.
23   The EMMA system is obviously important to
24   investors, but it has some important
25   benefits for issuers as well.  Before Emma
0101
 1   state and local governments could rarely
 2   see the tangible fruits of their filing
 3   efforts.  The acronym NRMSIR was hard
 4   enough to say or use in a complete
 5   sentence, but finding an actual NRMSIR
 6   where an issuer's filings could be
 7   verified as successfully made was even
 8   harder.  Simply put, the process lacked
 9   reality for issuers.  Now, that the
10   results of continuing disclosure are
11   available for everyone and issuers can see
12   the fruits of their efforts, they will
13   more readily accept their burdens I think
14   and appreciate the process.
15           Issuers are also finding that the
16   centralized filing system is a very good
17   resource for their own disclosure.  Seeing
18   how other issuers similarly situated have
19   dealt with a particular disclosure
20   question can be important.  It's not at
21   all unusual now for an issuer to search
22   EMMA just for the purpose of determining
23   how to structure and improve their own
24   disclosure.
25           Finally, EMMA has provided much
0102
 1   improved access to pricing information.
 2   Issuers can now see a lot about what
 3   actually happened to their bonds after the
 4   initial pricing, and this information
 5   should be very helpful to issuers,
 6   particularly small issuers who wish to
 7   measure the validity or fairness of the
 8   pricing they receive, and this kind of
 9   validation can only improve the integrity
10   of the market in general.  But, the
11   pricing information is very difficult for
12   issuers to interpret accurately.  A
13   careful study of the data yields questions
14   such as are these questionable trades by
15   my underwriter or are they by some other
16   dealer who's taking advantage of the
17   situation, or what exactly does an
18   interdealer trade signify.  This is one
19   area where improvements could be made for
20   the benefit of small issuers, for all
21   issuers actually.  If the presentation and
22   terminology in the pricing data could be
23   adjusted to help issuers understand what
24   data is relevant and what data is
25   aberrational or irrelevant, it would make
0103
 1   this important tool even better.
 2           We're aware that the SEC is
 3   considering changes in the regulatory
 4   approach to the municipal securities
 5   market.  As proposals are considered there
 6   are some characteristics or realities for
 7   small issuers that deserve attention.
 8           The most frequently mentioned
 9   challenge for small issuers is that they
10   often lack the resources necessary for
11   good disclosure practices.  The time and
12   staff necessary to provide good disclosure
13   both at the initial level and on the
14   continuing disclosure level is an
15   availability issue and a cost issue.  A
16   small issuer usually cannot afford to have
17   one person with this as his or her primary
18   responsibility.  Its staff is typically
19   stretched thin by the day-to-day
20   operations of government.  Hiring new
21   staff may be beyond budget restraints, and
22   diverting the attention of existing staff
23   from their normal difficulties can be
24   difficulty -- can be difficult.
25           Infrequency of market access is
0104
 1   also a problem.  An issuer that goes to
 2   market infrequently, say once every three
 3   to five years, has to start from scratch
 4   each time.  Natural turnover from
 5   employment and election cycles may mean
 6   that a new person is responsible each
 7   time.  The learning curve for the
 8   responsible official is steep.  Experience
 9   is always a crucial element for any
10   important task, and lack of experience is
11   definitely a problem for the small issuer.
12           There is some other more subtle
13   differences that distinguish state and
14   local issuers from the issuers of
15   securities in the traditional securities
16   market.  Most important among these I
17   think is that corporate issuers of
18   securities generally can control the
19   information available about their
20   operations and financial results.  By
21   contrast, state and local governments live
22   and operate in a world of public
23   availability of information.  They
24   frequently have Sunshine or Open Meetings
25   Laws that make their agenda available for
0105
 1   all to see and their deliberations
 2   available for all to attend.  They're also
 3   subject to various laws that make public
 4   documents available for anyone who
 5   requests them, including the press, and
 6   they are frequently required to file their
 7   financial statements and their budgets
 8   with some other governmental agencies.
 9           The result of these laws is that
10   issuers customarily disseminate a great
11   deal of information to the public in the
12   normal course of business, and the local
13   press usually reports anything significant
14   or controversial that is going on with the
15   issuer.  This world of public availability
16   of information has some subtle effects.
17           First, for local officials it can
18   make disclosure of the market --
19   disclosure to the market seem unnecessary
20   or even anti-climatic.  Local officials
21   may well ask if this information is
22   already in the public domain why is it
23   necessary to repeat it or file it in yet
24   another place.
25           Second, since this information is
0106
 1   available publicly anyway, the process of
 2   determining what is relevant for an
 3   official statement or a continuing
 4   disclosure filing is in some ways more
 5   difficult to assess.  The issuer may find
 6   itself in the unsatisfying position of
 7   choosing what to disclose among
 8   information already disclosed.
 9           The problem, of course, is that
10   investors may not, may or may not be aware
11   of issues or information reported or
12   available locally, and they may or may not
13   be getting accurate or complete
14   information from local news sources.  The
15   point is that disclosure issues are
16   different for state and local officials
17   who live in a world of publicly available
18   information.  If we're going to improve
19   the disclosure rime, we've got to find a
20   way to blend public availability of
21   information with efficient, accurate
22   disclosure practices in the Federal
23   securities laws.
24           The Tower Amendment:  It's a
25   double-edged sword for issuers.  While it
0107
 1   avoids intrusion of government into the
 2   affairs of local issuers, it also means
 3   that there's a lack of clear guidance on
 4   the required content of disclosure.  This
 5   is particularly true for small issuers.
 6           Large, frequent issues have the
 7   advantage of their own established
 8   practices and frequent feedback on
 9   available information from rating agencies
10   and investors.  Small issuers do not.  The
11   lack of clear guidance or experience on
12   disclosure content makes the small
13   issuer's job even more difficult.  One of
14   the biggest challenges in the municipal
15   securities market is finding a way to
16   structure and standardize the content of
17   disclosure without burdening or
18   unnecessarily intruding upon local
19   government.
20           What can be done to help small
21   issuers overcome these problems?  Few will
22   suggest that any of these characteristics
23   or challenges of small issuers somehow
24   remove or excuse basic disclosure
25   responsibilities.  Investors need and
0108
 1   deserve information relevant to their
 2   decisions.
 3           The question is how those
 4   disclosure responsibilities can be defined
 5   and addressed in a cost-effective way that
 6   honors the realities faced by small
 7   issuers.  The hearing today is a good step
 8   in the effort to find the right balance on
 9   these questions.
10           Again, on behalf of small issuers
11   and all market participants, I would like
12   to thank the SEC for its willingness to
13   listen and learn about these challenges.
14                 MR. SANCHEZ:  Thank you very
15   much, Hobby.  Scott.
16                 MR. BEARDSLEY:  Thanks,
17   Dave.  Good morning.  My name is Scott
18   Beardsley, and I'm the head of public
19   finance for Crews & Associates based out
20   of Little Rock, Arkansas.  I've spent the
21   last 16 years working as a financial
22   advisor primarily for school districts in
23   the state, and moved up to management last
24   year.  I don't know that I would have
25   taken the promotion if I had known that
0109
 1   this was involved with the new position,
 2   this is a little intimidating, so I thank
 3   you for letting me be here today.
 4           Crews is a regional broker-dealer.
 5   It is primarily focused on small and
 6   medium size issuers.  Our sweet spot, as
 7   we like to say, is the 5 to 20 million
 8   dollar range.  We're typically working
 9   with cities and counties and school
10   districts funding their capital needs and
11   typically operating in the fixed income
12   segment.  While we like to brag on our
13   large and complex transactions, our
14   day-to-day business is working with small
15   issuers.
16           In preparing for today, I was a
17   little surprised and I was quizzing Dave,
18   you know, how does the SEC define small
19   issuer, and if I understood his e-mail
20   correctly, there is no definition for
21   small issuer, and so I think there are a
22   couple of things that are hints to us from
23   different regulatory agencies and from
24   different rules whether they're small
25   issuer exemptions that give us a hint
0110
 1   maybe to what a small issuer is.  And to
 2   pick on Thompson a little bit and steal
 3   some of their ratings, they do an annual
 4   report that many of you are familiar with
 5   of the number of bonds issued in 2010, and
 6   if I'm quoting them correctly, last year
 7   there was 4 hundred and 30 billion dollars
 8   worth of long term fixed municipal bonds,
 9   and that's 13 thousand bond issues
10   approximately.  And so if you look at that
11   segment, you'll see that of that only 25.7
12   of the 4 hundred and 30 billion were
13   issues that were 10 million dollars and
14   under, so kind of using that as a working
15   definition for small issues, but out of
16   the 13 thousand bond issues 7 thousand 5
17   hundred of those were small issues, so it
18   only makes up about six percent of the
19   principal issued in 2010, but it's 54
20   percent of the actual issues.
21           In our shop we tend to think of
22   small issuers as those entities that issue
23   less than 10 million dollars in debt at a
24   time and probably don't have more than 5
25   to 20 million dollars in total debt
0111
 1   outstanding.  They don't come to the
 2   market on an annual basis and they have
 3   limited staff in a financial area.  I
 4   know, Alicia, that I'm skipping around so
 5   I think you're keeping up with me here.
 6           To illustrate the point I have a
 7   couple of statistics from our financial
 8   advisor group that works with the small
 9   issuers.  I think it's the next one,
10   Alicia.
11           We worked with 52 different
12   Arkansas school bonds last year, the
13   average size of the transaction was 5
14   million, and of those issuers they didn't
15   -- on average they had 10 million dollars
16   in outstanding debt, so over half of our
17   clients don't have 10 million dollars in
18   debt outstanding.  It ranged from 4
19   hundred thousand to the one we really like
20   to brag on up to a hundred and 31 million
21   dollars last year, and most of those
22   issuers are coming to market every three
23   to four years, and they typically, with
24   the exception I think our five largest
25   clients have a CFO, so the other hundred
0112
 1   to a hundred and 20 school districts that
 2   we work with don't have a CFO.  Some of
 3   those have business managers, but
 4   typically it's the bookkeeper that's
 5   tasked with any type of financial
 6   reporting.
 7           Working with small issuers has its
 8   own sets of benefits and problems.  I
 9   mean, I really enjoy going to a rural high
10   school before a board meeting and you go
11   down the hallway and all the lockers don't
12   have locks on them.  I don't know if
13   they're called a locker if it doesn't have
14   a lock, but a cubicle.  You know, their
15   backpacks are in the hallway, nobody's
16   worrying about anything being stolen.
17   It's not unusual to be going to a meeting
18   this time of year and receive a phone call
19   that the meeting's been pushed back an
20   hour to two hours because the weather's
21   nice and the farmers need to stay in the
22   field, and so instead of meeting at 6:00,
23   we're going to meet at 8 or 9 o'clock.  I
24   called a superintendent last week to ask a
25   question, and he answered from the school
0113
 1   bus, and it's against the law to drive a
 2   school bus while you're on the phone so he
 3   did pull over, let me clarify that, and he
 4   was out driving the school bus to time the
 5   latest route.  And so the types of issuer
 6   officials that we work with on a daily
 7   basis, you know, what's going on with
 8   their bond is not a priority for them on a
 9   daily basis.  I don't want to say that
10   they're uneducated about the financial
11   process, but it is not their priority on a
12   day-to-day basis.
13           And just to highlight a couple of
14   things that we do with small issuers to
15   help them learn about the process is we've
16   been certified by the State Department of
17   Education in Arkansas.  All Arkansas
18   school board members are required to have
19   so many hours of continuing ed each year,
20   and so we're certified to come in and
21   teach and give four hours worth of
22   continuing education and training related
23   to financial topics, and one of the things
24   that we go over with school board members
25   is that, you know, the bond is a security,
0114
 1   that you're subject to continuing
 2   disclosure, and here are the things that
 3   you need to do from an issuer perspective
 4   that are going to impact your ability to
 5   borrow in the future.
 6           We've also drafted a model policy
 7   because school districts have policy
 8   manuals, and it's as simple as there's
 9   actually a blank that says this is the
10   person that is responsible for, and
11   there's a blank there, and we have them
12   write in the person on their staff, and
13   here are the things they're responsible
14   for.  When you issue bonds you have to
15   keep a separate folder with all the checks
16   that were written with the bond proceeds.
17   That stays with the transcript.  If the
18   school is consolidated, that goes to the
19   receiving school district.  If the
20   bookkeeper retires, you must transfer this
21   responsibility to the next person.  As
22   simple as that sounds, we have to make
23   that part of the process so that they are
24   good borrowers.
25           There are a number of other things
0115
 1   if we have time, you know, that we'll
 2   delve into later, that we do to educate
 3   our borrowers, but we just ask that as the
 4   SEC examines small issuers that, one, they
 5   look at how to define it and get a good
 6   working definition, and that consider on
 7   some rules and regulations that the
 8   benefit for the investor be weighed
 9   against the cost for the issuer and really
10   look at how can they realistically
11   implement some of those things, and as
12   long as it's a balanced perspective, then
13   I'm sure that we'll be able to follow
14   through on those regulations.
15                 MR. SANCHEZ:  Thank you very
16   much, Scott.  Bill.
17                 MR. HENDERSON:  Good
18   morning.  Thank you for the opportunity to
19   be here.  My name is Bill Henderson.  I'm
20   a Managing Director in Public Finance
21   Investment Banking with Piper Jaffray.
22   We're a middle-market investment bank and
23   asset-management firm.  Today I'm here
24   representing SIFMA, the Securities
25   Industry and Financial Markets
0116
 1   Association.
 2           I have 28 years experience
 3   providing financial advisory and
 4   underwriting services to governmental
 5   entities and not-for-profit entities,
 6   primarily in the Midwest.  My practice is
 7   not unlike what Scott was talking about,
 8   we represent a number of small entities.
 9   I oversee the activities of the Kansas
10   City, St. Louis, Milwaukee and Des Moines
11   offices of Piper Jaffray.
12           Given our limited time today, I
13   just want to highlight a couple of key
14   points related to the municipal bond
15   market, particularly small issuers.  As
16   we've discussed today, the municipal bond
17   market is broad and diverse.  It includes
18   frequent issuers who come to the capital
19   markets multiple times each year, some
20   transactions exceed a billion dollars and,
21   you know, with the BABs program last year
22   we opened up global markets.  But it also
23   includes small issuers who just issue a
24   few million bonds every few years, as well
25   as one-time issuers who never intend to
0117
 1   issue bonds after the first sale, and
 2   then, of course, everything in between.
 3           The definition of small issuer, as
 4   Scott mentioned, is not even clear.  To
 5   some, a small issuer might be somebody who
 6   issues 25 million dollars in bonds per
 7   year.  To others, it might be a school
 8   district that sells 3 million dollars
 9   every five years.  As Bob mentioned, one
10   could argue that Carrollton, Texas, with a
11   population of a hundred and 22 thousand
12   people is not a small issuer in comparison
13   to many other small communities that sell
14   bonds.
15            We believe that the SEC and other
16   regulators should take care not to impose
17   rules which would impede the ability of
18   municipal bond issuers of all sizes to
19   access the market effectively and
20   efficiently.
21            We understand that some
22   commissioners and staff may be of the
23   opinion that small issuers need greater
24   regulatory protection from dealers,
25   advisors versus large issuers.  It's
0118
 1   important that issuers of any size have
 2   the knowledge and ability to understand
 3   not only the financial terms and impacts
 4   of the transactions they undertake, but
 5   also the responsibilities that come with
 6   borrowing in the capital markets.  If an
 7   issuer does not, they can seek the
 8   assistance of an advisor that will guide
 9   them in the transaction or pursue other
10   alternatives for borrowing.  Regulations
11   should not discriminate against issuers
12   based only on size.
13           In the securities business, our
14   philosophy is that we serve clients
15   regardless of the size of the deal or the
16   issuer.  We want a state government
17   borrowing 5 hundred million dollars to
18   fund a road project or a community that's
19   borrowing 3 million dollars to fund a new
20   water tower project both to get the best
21   financing possible.  We try to ensure that
22   the issuer's needs are measured against
23   the depth and breadth of the investor
24   market, so that the financing outcome can
25   be achieved for all parties.
0119
 1           To achieve that goal, a banker
 2   needs to bring significant knowledge and
 3   expertise to the relationship.  Bankers
 4   often provide market color, suggest
 5   financing alternatives and timing for
 6   transaction pricing, provide indications
 7   of investor demand, outline refunding
 8   options and provide other value-added
 9   functions.  SIFMA has concerns with
10   several pending regulatory proposals, as I
11   think most people in the financial world
12   do.
13           We have several concerns about the
14   SEC's proposed rule related to the
15   registration of municipal advisors under
16   the Dodd-Frank Act.  The proposal appears
17   to go far beyond Congress' intent in
18   enacting Section 975 of the Dodd-Frank
19   Act:  To bring previously unregulated
20   municipal financial advisors under the
21   regulatory umbrella.
22           The proposal also seems to take an
23   overly broad approach to what activities
24   contribute to being a "municipal advisor".
25   Traditional investment banking services
0120
 1   such as responding to requests for
 2   proposals, providing deal ideas and
 3   information, structuring escrows and other
 4   funds, and other functions which form the
 5   basis of a good investment banking
 6   relationship with an issuer client should
 7   never cause a banker to become an advisor
 8   and have a fiduciary duty toward the
 9   issuer.  Unfortunately, a fiduciary
10   relationship between an underwriter and
11   issuer is unworkable once the process
12   comes to the price negotiation.
13   Effectively prohibiting underwriters from
14   providing ideas and information to issuers
15   is contrary I think in the long term to
16   the interests of the issuers.
17           SIFMA has submitted a detailed
18   comment letter on the advisor proposal and
19   we have had several follow-up meetings
20   with Commissioner Walter and the SEC staff
21   on the issue.  We are hopeful the SEC will
22   revise its proposal before it is final to
23   address our concerns.
24           So thank you again for the
25   opportunity to present our views, and I
0121
 1   look forward to opening the questions.
 2                 COMMISSIONER WALTER:  Thank
 3   you very much to all of you.  I guess I
 4   would like to start by going back to
 5   something Hobby said which, basically,
 6   related to the tension between having the
 7   intrusion of the Federal Government --
 8   let's just, we'll pick on the Federal
 9   Government now and stay away from the
10   states, but the balance between avoiding
11   unneeded intrusion and yet having a set of
12   disclosure standards in the disclosure
13   arena.  I guess I would like to get your
14   reaction to the possibility of leaving the
15   Tower Amendment in place and perhaps even
16   leaving the exemptions that currently
17   exist in place, but giving the Commission
18   authority to set minimum disclosure
19   standards, so with the standard-setting
20   authority but not a pre-review before
21   offerings and not a continual filing with
22   the Federal Government of ongoing
23   disclosures.
24                 MR. PRESLEY:  Well, I think
25   you've certainly hit on some of the key
0122
 1   points, which would be a filing -- a
 2   pre-filing system would be burdensome and
 3   almost unworkable.  I imagine you would
 4   have to increase your staff by an enormous
 5   amount just to cover that, and I think
 6   that's probably not necessary in my own
 7   view.  I do believe that standardization
 8   is an important part of good disclosure,
 9   and I think I personally would not -- I
10   would welcome guidance from the SEC, and I
11   think I say that because you're the most
12   logical player in the market to provide
13   that guidance.
14           The trick, and really the
15   challenge, of providing that guidance will
16   be to address the really different nature
17   of all the local issuers.  That's hard to
18   do.  A school board is not a water system
19   is not a city council is not a county
20   commission, and I think the fear in the
21   market is that we will end up with one-
22   size-fits-all or disclosure requirements
23   that are not truly responsive.  If we
24   could develop standards that were truly
25   responsive to the different needs of local
0123
 1   issuers, I think it would be a welcome
 2   process and it would help small issuers,
 3   and all issuers.
 4                 COMMISSIONER WALTER:  Any of
 5   the rest of you have reaction to that?
 6                 MS. MACLENNAN:  I
 7   whole-heartedly agree with what Hobby
 8   said.  I think it's easy to say that
 9   disclosure standards could be developed,
10   but I think how you would go about doing
11   that when you're looking at such a diverse
12   market, so many different types of
13   securities, so many different types of
14   issuers, so many different state laws at
15   work I think that would be very hard.
16           I think one of the main
17   difficulties I believe is that, you know,
18   I think we've had a lot of corporate
19   investors coming into the municipal market
20   and expecting those things to be -- the
21   securities to be comparable across market
22   sectors, and I think there's an
23   educational process that needs to go on
24   with investors to give investors a better
25   insight as to just how diverse and how
0124
 1   distinct some of those market segments
 2   are.  But within those distinct market
 3   segments, I do believe that disclosure
 4   standards already have been developed for
 5   the primary market, and I think can
 6   continue to be developed further.
 7                 COMMISSIONER WALTER:  If I
 8   can move on for a moment to secondary
 9   market disclosure.  I, like you, we have
10   welcomed the advent of what's happened
11   with EMMA, and EMMA has a great deal of
12   potential to do additional things.  I'd
13   like to touch a little bit more about how
14   smaller issuers use their websites.  One
15   of the ideas that we have been exploring
16   in the course of these hearings and the
17   meetings that we've had is one that grows
18   out of the fact that as was pointed out
19   municipal issuers are always coming out
20   with information, not because of mandated
21   requirements that come from the securities
22   laws, but because of who and what they
23   are.  How much do smaller issuers make use
24   of their websites to make the disclosure,
25   financial disclosures, that they do have
0125
 1   readily available?  And if that practice
 2   varies a lot, as I suspect it does, is
 3   that a valuable line of inquiry in terms
 4   of enhancing post offering interim
 5   disclosure in terms of encouraging greater
 6   and more easily accessible availability?
 7                 MR. SCOTT:  I can, at least
 8   partially, answer that.  Governments are
 9   always benchmarking against each other,
10   and one of the things we found is with
11   everything public information it's a whole
12   lot easier to put things on your website
13   than to answer individual phone calls on,
14   you know, how much do you pay this person
15   or whatever, so we have our pay plans
16   posted.  We have any variety of
17   information posted and do that just as a
18   matter of course because in many ways it
19   makes our life easier, and that includes a
20   lot of financial information.  Other
21   financial information we're required by
22   law, state law, to post our budgets and so
23   forth, so my general experience and as
24   I've implemented new standards and I've
25   wanted to find out what this city or that
0126
 1   city is doing, I've been able to find just
 2   a wealth of information from the
 3   individual government websites.
 4                 MS. MACLENNAN:  I would like
 5   to remind you, though, that not all
 6   issuers have websites.  There are going to
 7   be smaller issuers where, you know,
 8   they're just not caught up with
 9   technology.  They're not, you know, they
10   may have a website, but it's really static
11   with information, so it might include
12   nothing more than, you know, the names and
13   contact numbers for the current staff and
14   where to get information.  So, you know, I
15   think particularly with the smaller
16   issuers, you know, it's one thing to say
17   well most people have websites, most
18   people know, you know, what do you put on
19   the website, it should be pretty easy to
20   post more information, but there is a
21   segment of local governments that are not
22   there yet, and I think probably, you know,
23   as with a lot of things, smaller local
24   governments lag behind the rest of, you
25   know, the rest of the world in developing
0127
 1   those technological advances because
 2   they're putting their money to other
 3   things.
 4                 COMMISSIONER WALTER:  Sandy,
 5   do you have an idea -- one of the things,
 6   we understand that.  We're trying to get
 7   further information as to how to quantify
 8   it.  I mean what segment of the
 9   marketplace is in that kind of a
10   situation.  I would assume it shrinks.  As
11   with all things, there is progress in
12   terms of using technology, or maybe it's
13   not progress, but increased use of
14   technology, but how much of the small
15   municipal issuer community would fit into
16   that?  Is it ten percent, is it 50
17   percent?  Do you have any idea?
18                 MS. MACLENNAN:  I have no
19   idea.
20                 MR. PRESLEY:  I would say in
21   preparation for the panel, I contacted a
22   number of small issuers and it was very
23   interesting that half of them had their
24   information, their annual report already
25   on a website, and most of the other half
0128
 1   said they were in the process of revamping
 2   their annual reports to put it on the
 3   website.  But there is one problem with
 4   websites that troubles, at least the
 5   professionals who have to advise issuers,
 6   and that is some information that goes to
 7   the website has been scrubbed properly for
 8   digestion by investors.  Other material
 9   that goes on the website has not been
10   carefully thought about in terms of how
11   would this, how might this information be
12   misused or misleading to investors, so
13   there's some concern about treating the
14   website as a resource for investors since
15   some of the information is carefully
16   prepared and some is not.
17                 MR. HENDERSON:  I would say
18   just based on experience, obviously I
19   think the public finance professionals
20   from bond attorneys to financial advisors
21   to the underwriting community all are
22   working very diligently with the issuer
23   community to make sure they are complying
24   with the existing continuing disclosure
25   rules because, keep in mind, that we all
0129
 1   have incentive because, for example, if
 2   Piper Jaffray were to sell bonds to a
 3   client, the investing client they call us
 4   when the continuing disclosure is not
 5   current, so we work, you know, we work
 6   very diligently.  And I would say that in
 7   general I would agree with what Hobby --
 8   when a client puts an annual report on the
 9   website that's fine.  When they put
10   monthly financial statements, it gets a
11   little bit nerve-racking because, for
12   example, property tax receipts in many
13   entities come through in one month, so
14   there's going to be a lot of revenue that
15   month, so if an investor pulls up and
16   looks at that financial statement without
17   any context or color, they're going to
18   think an entity is doing fine.  But 11
19   months later when all of those tax
20   receipts have been spent, they might find
21   out that perhaps they weren't quite as
22   flushed with cash and things as they
23   thought that they were.
24                 MR. PRESLEY:  And to follow
25   up on your point, the same issuer if you
0130
 1   look at their monthly financial statement
 2   toward the end of the year when property
 3   tax receipts are not coming in, if you
 4   look at those in isolation, they would
 5   show severe monthly deficits because the
 6   money was collected in the first half of
 7   the year and they're now spending in the
 8   second half and so there's a mismatch, and
 9   it's of concern that investors get
10   information in the right context, so it
11   has some downside to it.
12                 MR. SCOTT:  And I will say
13   I've held off doing an investor section of
14   our website for these very reasons, and we
15   don't publish monthly financial
16   statements.  Although they're available to
17   our council, available to anyone who asks
18   for them, we don't put them on the website
19   for these very reasons because they
20   haven't been scrubbed for investors.
21                 MR. COOK:  Could you
22   describe for us a little bit of the
23   process of how small issuers engage
24   underwriters, bond counsels, advisors?  To
25   what extent is there a formalized process,
0131
 1   how much is it informal, what are some of
 2   the challenges that are worth our focusing
 3   on in that context, you know, specifically
 4   focusing, again, on the smaller issuers,
 5   and then also recognizing the point that's
 6   been raised about the need to balance
 7   appropriately the regulatory environment
 8   and the cost it may impose on the nature
 9   of the interactions and the benefits to
10   the issuer potentially and to investors
11   making sure that the way the engagement
12   comes about is done in a transparent and a
13   fair manner.
14                 MR. BEARDSLEY:  I'll start
15   and then you can clean up.  You know, for
16   us it's very market specific.  For
17   example, Arkansas school districts are
18   required to take competitive bid, are
19   required to hire a financial advisor
20   before they start the process, and so most
21   financial advisor relationships are long
22   term.  I'm actually a third generation of
23   my family working with schools in the
24   state, and so for many of those issuers
25   it's a relationship.  It doesn't go out
0132
 1   for RFP.  It is ongoing even when they are
 2   not in the process of borrowing money.
 3           For many cities and counties in
 4   our market they are not required to hire a
 5   financial advisor and so if it goes out
 6   for bid, they'll just hire an underwriter,
 7   that underwriter's doing the structuring,
 8   there's no financial advisor involved, and
 9   it's not -- it depends on the issuer on
10   how organized that process is.  We kind of
11   see it across the board from this is who
12   we used last time or this is the last
13   person that came by to see us to a very
14   detailed process of statement of
15   qualifications and proving your track
16   record to them.  It really varies for us
17   by issuer and by different market segment.
18                 MR. HENDERSON:  Yeah, I
19   would concur a hundred percent, and it's
20   true of selection of bond attorneys, FAs,
21   underwriters it's pretty much the same
22   across the board as to whether or not they
23   run a process.  Oftentimes there are
24   historical relationships that have come
25   through, you know, I will say that for
0133
 1   much of my personal client base, I would
 2   say that 99 percent of the time I was
 3   selected through some sort of formal
 4   process, but in time they don't
 5   necessarily "rebid the service" because
 6   they're satisfied with me, you know, they
 7   view me very much as part of their team
 8   like they would their bond attorney, their
 9   financial advisor, et cetera.  Sometimes
10   all three of us, you know, all three
11   public professionals, or all three
12   professionals, are still engaged for
13   multiple periods of time, so it does vary.
14   And then similarly, as a public financial
15   professional sometimes I am engaged as a
16   financial advisor, sometimes I'm engaged
17   as an underwriter depending on what the
18   preference of the client is,
19   sophistication level of the client, et
20   cetera, so it is a very broad process,
21   I'll put it that way.
22                 MR. SANCHEZ:  Sandy, you had
23   mentioned sector specific disclosure
24   guidelines.  Other than the NFMA, National
25   Federation of Municipal Analysts, are you
0134
 1   aware of any other sort of detailed sector
 2   specific disclosure guidelines?
 3                 MS. MACLENNAN:  Not
 4   necessarily published, but I do think that
 5   in some of the sectors there have been
 6   practices that have developed over time
 7   that are pretty much acceptable, accepted
 8   by the wider market, and then, for
 9   example, the health care market, I mean, I
10   think health care, in the area of health
11   care finance there are some standard
12   disclosure practices, there are, you know,
13   expected information that will be in the
14   primary disclosure document, there's also
15   expected quarterly disclosure in secondary
16   market, and with particular items,
17   including liquidity position and other
18   operating margins, so, you know, I think
19   you can develop some of those standards
20   within those market segments, but, you
21   know, it will need to be implemented over
22   time and it will take a while as the less
23   frequent issuers come to market for those
24   practices really to be put into place.
25                 COMMISSIONER WALTER:  A
0135
 1   different question.  Can any of you speak
 2   to the extent to which smaller issuers are
 3   using the private placement market and/or
 4   bank loans more than even they have in the
 5   past?  How does their use of those
 6   financing techniques compare to those of
 7   larger issuers?  And if there's a trend,
 8   what's driving it, and how does that fit
 9   into the bigger picture about public
10   offering disclosure?
11                 MR. PRESLEY:  Well,
12   financial institutions, banks, have always
13   been a critical part of borrowing for
14   small governments.  Unfortunately, the tax
15   laws have from time to time encouraged or
16   discouraged banks from buying debt of
17   small issuers.  We had a fortunate period
18   of time for a year or two when the limit
19   was up to 30 million for so-called bank
20   qualified bonds, now it's back down to
21   ten.  But for certain small issuers it's
22   just not cost-effective to get into the
23   public market, and they need access to
24   sources of capital lending where they
25   don't have to go through the drill of
0136
 1   going to the public market, and so that --
 2   finding alternatives for the smallest
 3   issuer is definitely important.
 4                 MS. MACLENNAN:  I will add,
 5   though, that one of the drawbacks of doing
 6   bank financing or bank direct lending from
 7   a bank for smaller municipalities is that
 8   banks generally aren't willing to go out
 9   as long as you might be able to go with a
10   public bond issue, so if you're looking
11   for a 30 year amortization of your debt,
12   you're not going to find that from a bank.
13   There was a point in time, I'll tell you,
14   back in the '90s, the mid '90s, where
15   banks were trying to go that long, but
16   what they were doing, you know, they were
17   offering smaller municipalities the
18   ability to hedge that debt, so there would
19   be, you know, they would put a 30 year
20   debt in place, but it was really an
21   interest rate swap which -- and that
22   created other issues as well.
23                 COMMISSIONER WALTER:  Is
24   private placement an option at all?
25                 MR. HENDERSON:  Well, it is
0137
 1   an option.
 2                 COMMISSIONER WALTER:  A
 3   viable one?
 4                 MR. HENDERSON:  You know, I
 5   think the bank lending market, I've got 28
 6   years under my belt -- that's good and bad
 7   -- but the bank lending market has come
 8   and gone five times or six times in my
 9   career.  Right now, for example, a number
10   of community banks don't need tax-exempt
11   income, so it's not necessarily a viable
12   option for a lot of the local communities
13   that we serve.  I do think -- I think
14   where I personally see the bank lending is
15   actually on larger institutions right now,
16   that you see the larger commercial banks
17   coming in and making very significant
18   purchases of debt directly through to the
19   institution, but at the local level, at
20   least in the Midwest region, I don't know
21   if it's real estate stress or whatever,
22   while there are pockets where local banks
23   are options, there's also pockets where
24   local banks are not options.
25                 MS. MACLENNAN:  I was also
0138
 1   going to add that just as there needs to
 2   be additional education on the investor
 3   side of the municipal market, a lot of
 4   local banks don't necessarily understand
 5   how to analyze a municipal credit as
 6   opposed to a corporate credit.  So while
 7   some of my smaller issuer clients, you
 8   know, in the '90s would be sending out
 9   RFPs or requests for proposals from banks,
10   the interest rates that were being quoted
11   were all over the map, so you might have
12   some that were consistent with what, you
13   know, maybe a little bit higher than what
14   you might have gotten in a long term debt
15   issuance, but some of them were, you know,
16   the equivalent of taxable borrowing rates
17   to corporate borrowers.  So, you know, a
18   lot of it is trying to find the right
19   lender in the right market, educate them
20   as to the municipal credit, and a lot of
21   it does come down to local banking
22   relationships.
23                 MR. PRESLEY:  It's also
24   important to remember that when direct
25   subsidy Build America Bonds were in vogue,
0139
 1   that opened up a whole new range of
 2   options for local borrowers; for example,
 3   pension funds don't want tax-exempt debt.
 4   They want a taxable obligation for obvious
 5   reasons, and they are a natural source of
 6   capital for small issuers in various
 7   states, all the states.  And banks, as you
 8   mentioned, their appetite seems to be
 9   driven, among other things, by their tax
10   position, and if you had taxable Build
11   America Bonds subsidy bonds, you would do
12   away with that problem with banks and they
13   could focus on it as a credit issue as
14   opposed to a tax appetite issue.
15                 COMMISSIONER WALTER:  Thank
16   you.  I think we're out of time.  I would
17   like to thank all of our panelists for
18   being with us.  This has been tremendously
19   helpful to us, and for the audience, both
20   here and the virtual audience, we are
21   going to move to the next panel without a
22   break just as long as it takes us to move
23   people and ten cards in and out.  Thank
24   you very much.
25                 MS. STARR:  I want to thank
0140
 1   you and welcome to the third panel of
 2   today's Field Hearing.  Our third panel is
 3   entitled Looking at Disclosures:  Issuer
 4   and Investor Perspectives.  We're going to
 5   explore the types of disclosures that
 6   investors, both retail and institutional,
 7   are interested in receiving about
 8   municipal securities and municipal issuers
 9   and the issuers existing in future
10   capability of making such information
11   available.  The panel will examine
12   disclosure issues in primary offerings and
13   on an ongoing basis, and also will examine
14   ways in which information is or could be
15   presented, and how such presentations
16   could be improved to further investor
17   understandings.
18            Our panelists this morning are
19   Joseph Borg, Director of the Alabama
20   Securities Commission; Charlie Duggan,
21   City Manager of Auburn, Alabama; Jennifer
22   Johnston, vice president and research
23   analyst from Franklin Templeton
24   Investments; Ned Mudd, an investor from
25   Birmingham, Alabama; Paul Nolan, Senior
0141
 1   Municipal Analyst from Asset Preservation
 2   Advisors; and Ben Watkins, Director of the
 3   Division of Bond Finance for the State of
 4   Florida.
 5           I'm going to ask each panelists,
 6   beginning with Mr. Borg, to give us their
 7   initial thoughts, and then we will ask
 8   questions of our panelists, and I would
 9   like to reiterate if we can keep it to
10   about three to five minutes, then we'll be
11   able to really get into some great
12   dialogue.  Mr. Borg.
13                 MR. BORG:  Well, thank you,
14   Amy, and on behalf of the investors in
15   Alabama and the Alabama Securities
16   Commission, I would like to thank the U.S.
17   Securities & Exchange Commission for
18   holding these hearings today.
19           I'm going to concentrate on issuer
20   and investor perspectives with regard to
21   disclosures in the markets.  Listening to
22   this morning, it's certainly not news that
23   the municipal bond market investors are
24   clamoring for more information, more
25   in-depth information, and that's the key,
0142
 1   the in-depth information, about the bonds
 2   and the issuers they're investing in.  The
 3   investors are demanding more disclosure,
 4   and we've had discussion again this
 5   morning, some have pointed out that
 6   there's a difference that the disclosures
 7   provided are not on par with corporate
 8   disclosures.  And while that might be an
 9   unfair comparison, I think there are
10   lessons that can be certainly taken from
11   the more consistent and quicker, more
12   quicker released information that goes on
13   in that segment of the market.  So
14   increasingly, investors are complaining
15   that they're not being kept up-to-date on
16   changes in the financial status of
17   issuers, and this lack of information
18   raises serious concerns that these markets
19   may have hidden dangers, especially for
20   the "Main Street" investors, the retail
21   markets.  So with significant pressures on
22   state and local government budgets, timely
23   and complete disclosure in this market is
24   now of greater concern.  Now, given the
25   historical levels of predominantly lax
0143
 1   disclosure, there's certainly room for
 2   improvement.  The decision that an
 3   investor will make on whether to invest in
 4   a municipal or governmental bond must be
 5   based on good, solid, reliable and timely
 6   information.  Disclosure is the primary
 7   component of that information.
 8           Let me take a moment to compliment
 9   the SEC for creating this separate unit in
10   its division focusing on the municipal
11   bond markets and also we applaud the more
12   aggressive actions that are being taken
13   for the protection of investors in this
14   area.  I guess in addition to the recent
15   implementation of upgrades by MSRB to the
16   EMMA disclosure system is an example of
17   valuable and needed improvement.  Even
18   with these improvements and even with the
19   greater enforcement focus, timely
20   information concerning ongoing obligations
21   is still lacking, and the need to assist
22   smaller issuers in understanding the value
23   of communicating directly with investors
24   has not yet been achieved.  We all realize
25   that the municipalities do not have
0144
 1   sufficient resources to provide continuing
 2   up-to-date disclosures on their bond
 3   offerings, it's a resource issue,
 4   especially in these distressing times, but
 5   investors, and I think investors
 6   rightfully continue to demand more
 7   accurate and timely information.
 8           Historical data demonstrates that
 9   risk to investors is generally low with
10   regard to municipal bonds, but recent SEC,
11   state regulatory and FINRA actions clearly
12   point to a growing concern regarding the
13   lack of current official filings, the lack
14   of transparency, and the lack of
15   continuing financial records of some
16   public borrowers.  Look, this is almost a
17   3 trillion dollar market, and with weak
18   disclosures this raises the anxiety levels
19   of investors where current and continuing
20   financial information is absolutely
21   necessary for investors to do what we have
22   always said in regulatory parlance, make
23   informed investment decisions.  We teach
24   that, we preach, that's what the
25   information is there designed to do.  So
0145
 1   while it appears that regulators, industry
 2   and the investors agree that state and
 3   local governments need to boost their
 4   continuing disclosure, the question now is
 5   is it going to be done voluntarily or will
 6   regulators need to continue to mandate
 7   improvements.  This is going to come from
 8   both ends.  So some issuers do provide
 9   current information, they bring up their
10   information on a regular basis, but it is
11   well known to the regulators and the
12   market participants that many issuers just
13   do not comply with continuing disclosure
14   agreements, and unfortunately the broker-
15   dealer community has not insisted on and
16   in many cases has not assisted with
17   supplying that information.
18           In their written statements, which
19   I think there are copies up here
20   somewhere, I've referred to initiatives by
21   the Government Officers Association's
22   committee on governmental debt management
23   and the Bond Dealers of America on
24   revising best practices on primary and
25   secondary market disclosures.  The
0146
 1   marketplace is well aware that regulators
 2   on all levels have taken an interest in
 3   promoting investor protection in this
 4   area.  I've already mentioned some of the
 5   SEC's actions.  I'll also note that FINRA
 6   launched a regulatory sweep of firms back
 7   in June of 2009, and by last report I saw
 8   from FINRA there was like 2 hundred plus
 9   actions for MSRB violations according to
10   those reports.  Recently there was a fine
11   of four companies for failing to deliver
12   official statements to customers, failing
13   to deliver official statements to
14   customers who purchased new municipal
15   securities required by MSRB rules.  So
16   this brings home the point that matters of
17   transparency, disclosure and timely
18   delivery of material information to
19   investors, not only rests with the
20   issuers, but with the advisors, the
21   broker-dealers and everybody connected
22   with issuance of bonds as well.
23           In the materials that I've
24   submitted, I've covered a little
25   historical timeline to show the difference
0147
 1   of what has occurred with regard to the
 2   municipal market, specifically, look, when
 3   we change from a nation of as like what we
 4   like to say, nation of savers to a nation
 5   of investors starting in the '70s and
 6   '80s, the entire sector of who was buying
 7   these products changed.  Since the '80s
 8   the public sector of individual investors
 9   and trusts has accounted for more than 50
10   percent of new issues.  That's a big
11   shift.  We have not kept up with
12   information required.  Unlike
13   institutional investors, "Main Street"
14   investors must depend on an official
15   statement as the primary source of
16   information.  Unlike institutional
17   investors who have back room operations to
18   dig into numbers, they are going to
19   require updated disclosure and financial
20   information to determine the status, the
21   value, and the current risk of their
22   investments.
23           We could talk about, you know, the
24   creation of when 15c2-12 started right
25   after the Washington Public Power Supply
0148
 1   System defaulted on 2 and a half billion
 2   dollars worth of bonds back in '83.  We've
 3   had some amendments since then that have
 4   come forward, the MSRB followed in 2008
 5   establishing the EMMA system.  Amendments
 6   to 15c2-12 made EMMA the single repository
 7   for continuing disclosure filings.  And
 8   now we've got, as of December 1, I
 9   believe, EMMA now requires certain
10   information, "reportable events" to be
11   included on the system.
12           I think Commissioner Walter said
13   it well in her speech on May 4th that to
14   achieve the significant improvements we
15   need to have this "layered approach-- the
16   legislative, regulatory and industry
17   levels working together", and I think
18   that's exactly where we need to be.
19           Now, issuers, investors and
20   dealers we understand have different
21   perspectives on disclosures.  Some are
22   producers of information, some are
23   consumers of information, so, therefore,
24   you're always going to have a difference
25   of opinion, and the disclosure initiatives
0149
 1   must weigh and balance those differences
 2   in the regulatory and industry efforts to
 3   protect investors.  But with any
 4   regulation, any proposal, any policy we've
 5   got to give careful thought to avoid
 6   unforeseen and unintended consequences,
 7   that's why a time process with detailed
 8   thought involved to make sure we don't
 9   have any of those unforeseen processes.
10   God knows we've had enough of those in the
11   last years with the financial meltdown.
12           With regard to issuers, the bottom
13   line is that they need to be careful.
14   Issuers must be certain that all material
15   information is properly discussed.  Even
16   when issuers or a municipality hires
17   outside counsel the issuer's responsible,
18   that's the position we've taken, that's
19   the position the SEC's taken, and that's
20   the position FINRA's taken, and look, no
21   matter how you slice it, bad news is
22   always material.  Questionable news is
23   material.  Good news is material, so it
24   all has to be included.  Municipalities
25   should also consider having an assigned
0150
 1   person who has primary duty and primary
 2   responsibility for making sure there's a
 3   clear list of responsibilities and a clear
 4   line of command.  And while issuers may
 5   rely on outside counsel, outside counsel
 6   has been sued, too, actually the SEC has
 7   brought those actions.  My office, for
 8   example, issues what's called a "No Stop
 9   Order" with regards to a certain type of
10   bonds, these are what we call the IDRs and
11   IDBs, I think we maybe one of the state
12   securities commissions that actually has
13   that responsibility in-house.  This No
14   Stop Order must be in place before the
15   bonds are permitted to be issued and sold.
16   During the last 24 months, last two fiscal
17   years, we've reviewed and approved about 7
18   hundred and 50 million of IDBs in Alabama.
19   Some of the questions we ask, and I think
20   other state regulators ask this as well,
21   is whether or not the issuers have asked
22   themselves why are they issuing the bonds,
23   what purpose, was it their idea, was it
24   the investment development bond idea or
25   did somebody come to you with that idea,
0151
 1   who brought it to you.  We caution them
 2   against suggesting friends such as lawyers
 3   and underwriters that can handle various
 4   phases of the issuance.  In a few cases
 5   where we have questioned that, all of a
 6   sudden the necessity of the bond went
 7   away; that tells me something.  An issuer
 8   is duty-bound to assess the need for the
 9   issuance and be certain they're getting
10   good advice, good services and are not
11   over-paying.
12           There's a lot of options
13   available.  This isn't the old days of
14   retail investors investing in stocks and
15   bonds.  That was easy back then.  But to
16   quote a colleague of mine from Illinois,
17   Tanya Solov, "In other words, when someone
18   wants bonds, they want safety and they
19   assume a municipal bond is about as safe
20   as it gets.  The duty then falls upon the
21   issuers, underwriters, advisors, stock
22   brokers and everyone else involved in
23   bonds issuance to disclose everything in
24   an easily understandable way".
25           Sales professionals need to make
0152
 1   sure they understand the risks before they
 2   recommend and sell to investors.  We don't
 3   think that's being done on a sufficient
 4   basis.  Too much information is coming
 5   down that here's the official report and
 6   we sell it.  We have found that even
 7   investors who have been in the market for
 8   decades are just not aware of the bond
 9   risks.  Arkansas had a recent
10   investigation involving bonds where not
11   only were they being sold through a
12   various network, but they were being
13   pledged to banks and a number of those
14   bonds had nothing behind them, even though
15   they looked like they were mortgages.  Had
16   anybody looked to see what they were
17   secured by, they would have seen the
18   issues.
19           Going forward, SEC, states, FINRA
20   are going to hold accountable
21   underwriters, accountants, lawyers,
22   advisors, firms and salespersons for
23   information they knew or should have known
24   was material.  So, again, let me end by
25   commending the SEC for holdings these
0153
 1   hearings and for its new initiatives.  I
 2   take the opportunity to compliment my
 3   fellow state regulators, FINRA, and the
 4   various industry groups for recognizing
 5   the importance of transparency, complete
 6   disclosure and the need for timely,
 7   ongoing information to make intelligent
 8   decisions, for investors to make
 9   intelligent decisions.  Thank you.
10                 MS. STARR:  Thank you, Joe.
11   Charlie.
12                 MR. DUGGAN:  Thank you,
13   Commissioner for having us today, and
14   thank you for giving us the opportunity to
15   give some feedback to the SEC because I
16   believe it's very important.
17           The City of Auburn is a city of 53
18   thousand people.  Our annual general fund
19   budget is about 52 million dollars, with
20   about a hundred million dollars of overall
21   budget authority.  We issue bonds in the
22   general funds for the city school system,
23   for our sewer system, our water board and
24   our industrial development board.  We've
25   moved from a Double A Minus to a Double A
0154
 1   Plus in the last five years, and we
 2   believe disclosure comes pretty easy
 3   because we have a number of professionals
 4   working constantly so that when disclosure
 5   occurs our financial information is
 6   accessible, useful, and accurate.
 7           To give you an example, today in
 8   the audience we have our finance director,
 9   our bond counsel and our investment
10   banker, that shows a team approach.  We do
11   believe the basics are very important.  We
12   follow best practices from GFOA.  We also
13   look to ICMA, the International
14   City/County Management Association, to the
15   ethics code and also trying to foster
16   professional management in cities.  I
17   believe that it's imperative that elected
18   officials are not schooled in the
19   information that they need to analyze
20   deals like this, and by hiring
21   professionals that are part of the staff
22   that gives us an opportunity to take the
23   information that bond counsel, that
24   underwriters and any other financial
25   advisors give us and assess that in a
0155
 1   light that's different than someone who
 2   came from a totally different sector but
 3   was elected to make policy decisions.
 4           We keep constant contact with our
 5   professionals to assess the risks.  We do
 6   believe in forecasting, and we do
 7   bi-annual budgeting in Auburn and so we
 8   forecast out six years.  And we look at
 9   our fund balance, our drawdowns and our
10   unreserved balance to make sure that we're
11   not having any problems out in the future.
12   Monthly reports are given to the governing
13   body and they're available to investors,
14   if requested.  A lot of the information
15   I'm talking about was discussed in the
16   last panel so I'm glad that there's a
17   consistent theme here that our information
18   has historical comparisons, but even more
19   important, I think it gives information as
20   to are we living up to our plan.
21           When we put out a budget we're
22   essentially giving out a plan of what we
23   intend to do, and as we do our CAFR and
24   our following budgets we go back and we
25   re-visit that plan and we give information
0156
 1   as to what changes took place, why they
 2   took place and the importance of those
 3   changes to try to give some confidence to
 4   investors that when we have a plan we're
 5   not going to deviate unless there's a
 6   specific reason.
 7           Ms. MacLennan in the last session
 8   talked about how if you're doing
 9   placements with local banks sometimes they
10   lack the sophistication in analyzing
11   municipal, not the sophistication but the
12   experience in analyzing municipal
13   information.  One of the things our
14   previous finance director and our current
15   finance director did was they created a
16   class and we invited our local bankers to
17   come and we spent a day going over
18   municipal disclosures, the information
19   that we provide, our bond counsel came and
20   led a number of the sessions, and I don't
21   know of another city that offers a class
22   like that.
23           Of course, we provide information
24   on EMMA.  If you look to our website,
25   you're going to see multiple years of CAFR
0157
 1   and budget information.  The night that I
 2   present the proposed budget to the city
 3   council we put it on the website and it
 4   stays there until the council adopts a
 5   budget.  The one thing I would like to say
 6   is that I know that careful consideration
 7   is given to the impacts of new
 8   regulations, but the following bears
 9   repeating, especially after several
10   members of the last panel said this, in
11   our zeal to prevent unreasonable risks, we
12   need to create -- we need not create
13   elaborate structures that cause all
14   issuers to bear too large a burden.
15           Mr. Dotts in the earlier, in the
16   first panel had a golf analogy talking
17   about instead of learning how to hit out
18   of the sand, don't hit into the sand.
19   Well, what I would submit is don't
20   penalize -- penalize those whose shots
21   stray, not those who shoot straight, and
22   so with that I would just say thank you
23   again for having us.
24                 MS. STARR:  Thank you,
25   Charlie.  Jennifer.
0158
 1                 MS. JOHNSTON:  Commissioner
 2   Walter and Commission staff, thank you
 3   very much for allowing me to speak today
 4   at the Hearing on the "State of the
 5   Municipal Securities Market" and in
 6   particular disclosure.
 7           Franklin Templeton Investments is
 8   a global investment manager with total
 9   global net assets under management of 7
10   hundred and 35 billion dollars.
11           Franklin's Municipal Bond
12   Department, where I've worked for 18
13   years, manages 34 tax-exempt municipal
14   bond funds.  Our total tax-exempt assets
15   under management, including our separate
16   accounts program, is more than 70 billion
17   dollars.  We have a research driven
18   approach to managing our municipal bond
19   funds, and we employ 17 analysts who look
20   at primary market deals, secondary market
21   opportunities and also provide ongoing
22   surveillance of our holdings.
23           For an analyst, information is
24   king.  Information is a key part of our
25   decision-making process to buy, hold or
0159
 1   sell a municipal bond.  We will not buy a
 2   bond unless we have enough information to
 3   accurately assess the credit quality of
 4   the obligor.  We believe that good
 5   disclosure benefits all market
 6   participants and results in improved
 7   marketability, better liquidity and price
 8   transparency.
 9           The economic and financial crisis
10   have created challenges to all market
11   participants and have highlighted what
12   works and what doesn't work in disclosure
13   currently.  Nearly all municipal entities
14   have had to make tough choices to balance
15   budgets while still providing essential
16   services to its citizenry.  The financial
17   crisis has significantly changed the
18   landscape for credit enhancement of
19   municipal bonds affecting issuers' market
20   access and a bond's security.  The number
21   of companies currently providing new
22   insurance policies has dropped to one.
23   According to The Bond Buyer in 2005, 57
24   percent of debt issued was insured.  In
25   2010, this dropped to 6.3 percent, so now
0160
 1   issuers don't and can't rely on insurance
 2   for market access, they have to rely on
 3   their own credit.  For outstanding bonds
 4   with insurance, most market participants
 5   no longer look to the insurance coverage
 6   and now look to the underlying credit to
 7   determine credit quality or trade on the
 8   bonds, oftentimes because that underlying
 9   credit quality is actually stronger than
10   that of the insured covering the bonds.
11   Many insured bonds never had underlying
12   ratings assigned, meaning many of these
13   bonds are now non-rated.  Without good
14   disclosure, many of these issuers now have
15   reduced market access and liquidity and
16   they probably don't even know about it.
17           The financial crisis has also
18   brought changes to the banking industry
19   affecting variable rate and auction rate
20   securities and limiting the options for
21   letters of credit.  Municipalities and
22   their economic and financial struggles
23   have been made very public in local and
24   national newspapers, television and even
25   the financial media.  Suddenly,
0161
 1   municipalities, public finance and
 2   municipal bonds are front-page news.  The
 3   public has been barraged with fears
 4   related to pension problems, budget
 5   deficits, bankruptcies and potential for
 6   massive defaults.  Some of this is true,
 7   but much of it is taken out of context,
 8   blown out of proportion, overwrought with
 9   politics, not supported by fact and
10   sometimes completely untrue.  So an
11   investor, whether retail or institutional,
12   needs timely information to be able to
13   determine whether what they're reading
14   about or seeing in the press is actually
15   true.
16           Fortunately, we've been able to
17   wade through the headline risk and find
18   those issuers who do provide timely and
19   accurate disclosure and remain committed
20   to them.  At the same time, we've been
21   dealing with the economic recession and
22   the financial crisis and headline risk,
23   two of the three rating agencies migrated
24   to a global scale rating, adding more
25   confusion to the market.  These challenges
0162
 1   have heightened the need for good
 2   disclosure.  It's now more important than
 3   ever for investors to have access to
 4   timely information.
 5           As I look at the current
 6   disclosure environment, I want to just
 7   make a few final comments.  First,
 8   technology has made creating,
 9   disseminating and accessing disclosure
10   much more easy, and I want to thank the
11   MSRB for their efforts in launching EMMA,
12   as I think this system is going to benefit
13   issuers and investors alike, both
14   institutional and retail.
15           Second, I would like to mention
16   that there are a lot of issuers who do an
17   excellent job of disclosure.  I'm joined
18   at this table by two of them.  It's
19   timely, frequent, complete, and easy to
20   access.  Unfortunately, not all issuers
21   are like this.  People need to actually
22   look to issuers such as whom I'm joined
23   with and the people who do provide good
24   disclosure as a model and to learn from.
25   Unfortunately, the market is filled with
0163
 1   these small issuers who do struggle with
 2   disclosure, and I will also add that not
 3   all large issuers are good at disclosure
 4   and not all small or infrequent issuers
 5   are bad at disclosure; it's definitely
 6   across the board.
 7           Finally, I see the problems
 8   related to disclosure falling into three
 9   categories.  First, timeliness.  In my
10   sector it's very common to have to wait 2
11   hundred and 70 days for any kind of
12   financial disclosure.  This is just too
13   long.  In fact, there's actually a number
14   of people who still can't meet that
15   deadline.  This issue could become more
16   troublesome, as was raised in the last
17   panel, if we do see municipalities
18   starting to move to bank loans because
19   there's a potential I won't know about
20   that for months and that could certainly
21   dilute my security or create additional
22   covenants that I'm unaware of.
23           The second problem I would like to
24   highlight is the frequency of disclosure.
25   I fully understand it's impossible for all
0164
 1   issuers to provide audited financial
 2   statements in 30 or 60 days following the
 3   end of a fiscal year, but does that mean
 4   it's impossible to get investors some type
 5   of recent information that can help me in
 6   making my investment decisions, and I'm
 7   afraid that some of obligors have fallen
 8   prey to I only need to provide audits,
 9   that's all I'm going to provide.  Is there
10   not unaudited year-to-date information or
11   monthly retail sales information or
12   quarterly occupancy numbers that investors
13   could be provided?  And what I'm actually
14   suggesting is that issuers look to
15   information they already provide to other
16   stakeholders and make it available to all
17   investors.  As was mentioned in the last
18   panel, most finance departments do create
19   some type of monthly or quarterly
20   disclosure for their governing board or
21   body, and I just ask that I be able to
22   have access to the same information, be it
23   EMMA or an issuer's website with the
24   appropriate disclaimers.  This shouldn't
25   require that much more additional work.
0165
 1   We're, in fact, just gaining access to
 2   information that's already public.
 3           Third, I struggle with
 4   completeness, and this actually does
 5   affect the primary market as well as the
 6   secondary market.  Many times compliance
 7   with continuing disclosure weakens over
 8   time.  Issuers will be very good at it for
 9   a couple of years, staff changes, time
10   goes on and then slowly parts of that
11   continuing disclosure stop happening.  I'm
12   also very frustrated by something that's
13   happened recently, and that's where in a
14   primary market deal rating agencies are
15   provided with information that potential
16   buyers are not.  This, in fact, just
17   happened a couple of weeks ago when an
18   issuer provided to a rating agency
19   operating results and potential investors
20   were not given this information.
21           And finally, I'll bring up road
22   shows.  I'd like to see road show
23   presentations, whether done on-line or in
24   person, made available for download.  Road
25   show documents often have information
0166
 1   found in the offering documents presented
 2   in a clear and concise way that would make
 3   my life a little easier.  And while I
 4   can't speak for Mr. Mudd, perhaps he could
 5   also benefit from having access to these
 6   documents.
 7           Finally, I'll end with this
 8   thought-- this forum is a good example of
 9   the dialogue that is going on between
10   market participants, and I would
11   recommend, and this is what I do whenever
12   I'm talking with finance directors, I
13   educate them on why I need the information
14   I'm asking for so that they understand,
15   there could be other information out there
16   that will satisfy my needs that they've
17   already created, so instead of just
18   providing what, I think it's important to
19   have a dialogue about the why.  And it's
20   been brought up a couple of times already
21   today, but I will point you to the work
22   that the National Federation of Municipal
23   Analysts have done, they've generated
24   several recommended best practices and
25   white papers relating to disclosure on a
0167
 1   number of sectors, and I think these
 2   documents, which are created with market
 3   participants other than just the analyst
 4   community, as a great example.
 5           Again, I'd like to thank the
 6   Commission for inviting me to speak here
 7   today and I look forward to answering your
 8   questions.
 9                 MS. STARR:  Thank you,
10   Jennifer.  Ned.
11                 MR. MUDD:  Commissioner
12   Walter, thanks force having me.  It's an
13   honor to be in a panel with so many
14   esteemed people.  I'm looking at their
15   titles, and I have no title.  It just says
16   investor.  It's kind of lonely being up.
17                 MR. BORG:  The most
18   important title.
19                 COMMISSIONER WALTER:  I must
20   interrupt you.
21                 MR. BORG:  Most important
22   title.
23                 COMMISSIONER WALTER:  That's
24   exactly right, you are the most important
25   person here.
0168
 1                 MR. MUDD:  Now, it's really
 2   making me nervous.  Joe mentioned
 3   something about this isn't the old days,
 4   and it is for me.  I don't have an iPhone.
 5   I don't do text messaging.  I don't watch
 6   TV.  I talk to brokers on the telephone or
 7   I meet them in person.  I've lived here
 8   almost 60 years, and I deal with brokers
 9   I've known for decades.  One of my
10   favorite brokers just retired, he was 87.
11   I've known him for probably 50 years.  He
12   went to grammar school with my father.
13   These guys I trust.  I've known them, it's
14   a family thing, and I know that probably
15   comes across as a Southern piece of our
16   culture, but truly relationship is where I
17   come from.  If you call me and you're a
18   broker and I don't know you, I probably am
19   not going to buy from you.  I need to know
20   whether I can trust the people who I deal
21   with.  That, too, is probably a Southern
22   thing, I don't know.  I notice that I'm
23   the only person up here so far with a
24   Southern accent, but to me the whole thing
25   comes down to stability in the market, and
0169
 1   it comes down to trust, and I can't do the
 2   research that people that move 7 billion
 3   dollars can do.  I don't have a staff.  My
 4   broker does and I've known him so long--
 5   and I have several --but I've known him so
 6   long that over the years you come to
 7   realize when something works you hang in
 8   there with them.  When it doesn't work,
 9   you don't deal with them.  So disclosure's
10   great, and frankly, I was raised to -- and
11   I have to divulge, this is something
12   perhaps heinous, but I'm a lawyer, and I
13   was trained both professionally and by my
14   teacher in the stock and bond market to
15   ask a lot of questions.  My brokers
16   sometime gets irritated because I'm butt-
17   headed, and I'm going to ask the same
18   stuff every time.  And I want to get to
19   the bottom of that bond.  I've heard from
20   some of my colleagues that this is not a
21   buyer beware market, but I think in my
22   case it is.  If I don't do my work, I have
23   to blame myself if I buy a bad bond, and I
24   have bought some questionable bonds and
25   stocks.  My biggest mistake was not buying
0170
 1   Apple when it was 20 dollars, by the way.
 2           So anyway, I'm an old-timey
 3   investor, I might not even represent the
 4   average investor, certainly not young
 5   investors.  I'm kind of old-timey,
 6   dinosaur and I'm careful and I'm fairly
 7   conservative.  These days if I tread
 8   water, I feel pretty grateful.
 9           So anyway, thanks for having me.
10   I don't have any erudite things to say
11   other than that.
12                 MS. STARR:  Thank you, Ned.
13   Paul.
14                 MR. NOLAN:  Good morning.
15   My name is Paul Nolan.  I am a Senior
16   Municipal Analyst with Asset Preservation
17   Advisors in Atlanta, Georgia, with 1.7
18   billion dollars in assets under
19   management, and I have the responsibility
20   of monitoring some 3 thousand municipal
21   bond issuers for investors, mostly in the
22   investment rating category.
23           I'm happy to have this opportunity
24   to share with the Securities & Exchange
25   Commission, the issuers, and those in the
0171
 1   audience my general thoughts and
 2   experiences with disclosure as a municipal
 3   bond analyst with some 14 years
 4   experience.  And just as a note, prior to
 5   APA I spent five years with McDonnell
 6   Investment Management in Illinois, another
 7   asset management firm, as well as spending
 8   a little over five years with Moody's
 9   Investors Service, both in New York and in
10   Chicago.
11           The sectors that I've covered, you
12   name it, I've covered it, from state and
13   local governments, to water/sewer, toll
14   roads, hospitals, public/private higher
15   education, community colleges and any
16   other muni sector you can pretty much
17   name.  I've also worked in the government
18   and not-for-profit sectors.
19           Today I want to discuss my
20   perspective on primary and secondary
21   disclosure.  And while this may seem
22   obvious, I think it needs to be stated up
23   front-- consistent, timely and accurate
24   information throughout the life of the
25   bonds needs to be improved, especially in
0172
 1   the secondary market, and particularly
 2   with regards to infrequent issuers.  While
 3   disclosures from issuers has become over
 4   the years through 15c2-12 and the
 5   establishment of EMMA, as well as the
 6   amendments to 15c2-12, there is always
 7   room for improvement.
 8           The disclosure documents are
 9   important to investors, the market, and,
10   of course, firms such as APA.  As a
11   registered investment advisor, APA
12   purchases municipal bonds on both the
13   primary and secondary markets.  APA
14   focuses exclusively on tax-free and
15   taxable municipal securities for high-net-
16   worth individuals.
17           Our main objective for our clients
18   is to preserve capital -- let me say that
19   again -- preserve client capital.  This is
20   accomplished through fundamental credit
21   analysis.  Fundamental credit analysis is
22   the objective examination of an issuer's
23   willingness and their ability to make
24   timely debt service payments.  These
25   underlying credit fundamentals vary by
0173
 1   sector with hospital issuers having
 2   different credit fundamentals than those
 3   of say a city or a county.
 4           Yet regardless of the sector,
 5   investors should have consistent and
 6   constant access to timely and accurate
 7   information over the duration of the
 8   outstanding bonds.  It is paramount that
 9   all interested parties have access to the
10   necessary information, hopefully free of
11   charge, so that one can develop objective
12   opinions on the willingness, and, again,
13   the ability of those investors to make
14   timely debt service payments.  This allows
15   the aforementioned interested parties to
16   compare issuers from not only an
17   underlying credit perspective, but also
18   from a relative value perspective.  Across
19   the rating spectrum and when comparing two
20   issuers with the same rating, all are not
21   equal with regards to the ability to make
22   debt service payments.  As such,
23   disclosure items are necessary,
24   particularly in the secondary market where
25   information is often outdated, incomplete
0174
 1   or oftentimes unavailable.  There also
 2   needs to be more than just audited
 3   financial statements disclosed with
 4   specific sector criteria also provided.
 5             The bottom line:  Disclosure in
 6   the primary market through information
 7   found in the official statement has
 8   improved under Rule 15c2-12, the
 9   amendments to the rule, and with the
10   establishment of EMMA.  Yet there could be
11   some items added on a more consistent
12   basis.  There also needs to be a more
13   uniform standard set of guidelines
14   established for the type of information
15   expected from issuers in an OS and in
16   terms of what items they intend to
17   disclose on an ongoing basis.  For
18   example, I have found that one piece of
19   information not found in an official
20   statement, again, on a consistent basis,
21   is up-to-date and/or more detailed
22   information on recent financial
23   performance upon issuance.  Let's say the
24   issuer's audit year ends June 30th and
25   they decide to issue bonds on December of
0175
 1   that same year, six months have passed
 2   since the last audit.  The financial
 3   position of the issuing entity could have
 4   changed either positively or negatively
 5   during that time.  It would be beneficial
 6   to have the updated information in the
 7   form of quarterly or even semi-annual
 8   reports, even if those were unaudited.
 9           It would also be helpful to have
10   other relevant information, let's say tax
11   collection rates for a GO issuer or
12   updated debt service coverage for a water
13   sewer deal, and these are just a few
14   examples of sector specific analysis that
15   we look at.
16           And I will commend the health
17   care, or the CCRC community, as a model
18   for primary disclosure, as these issuers
19   often provide quarterly financial numbers
20   along with up-to-date utilization figures.
21           And I do need to say this, and I
22   know it's been said numerous times, not
23   all issuers, as well as underwriters and
24   financial advisors, are equal when it
25   comes to disclosure.  Some provide
0176
 1   investors with copious amounts of data,
 2   while others provide the bare minimum.  In
 3   our view, a uniform set standard on the
 4   exact type of information included in an
 5   OS is necessary, as well as what
 6   additional items will be disclosed over
 7   the life of the bonds on EMMA.
 8           As far the secondary market, I
 9   will say the following:  In general the
10   information disclosed to EMMA in the
11   market as a whole is often incomplete and
12   not what was promised in the OS disclosure
13   statement; two, it is not provided in a
14   timely manner, often after the established
15   deadline; three, and in some cases is
16   unavailable as it was not submitted to
17   EMMA; four, we have also found a
18   significant delay in the filing of
19   material event notices; and, five, there
20   seems to be a lack of enforcement for
21   noncompliance.
22           And in general, once again, I
23   would say that the health care sector is
24   the model citizen for disclosure in the
25   secondary market.  Personally I have found
0177
 1   that this sector has done a distinctly
 2   better job at providing the market with
 3   up-to-date quarterly information on
 4   financial operations, key utilization
 5   data, and other fundamental information
 6   compared to other sectors.  Though, I
 7   understand, and I've heard that stated
 8   earlier in the other two panels, that
 9   running a state and local government
10   entity or not-for-profit that disclosure
11   may not be a priority, so perhaps
12   disclosure, again, are not a high
13   priority, but I have found numerous
14   examples, both frequent and infrequent
15   issuers, providing complete and timely
16   information on EMMA, most often in the
17   statistical section in the back of a
18   recent audit.  I also believe -- I've
19   always felt that if one sector of issuers
20   can do it, why can't all sectors and
21   issuers provide the information?  Maybe
22   part of the problem is that we analysts
23   have an obligation to further educate
24   issuers on the benefits of timely and
25   complete disclosure.
0178
 1           With some 50 to 60 thousand
 2   issuers and nearly 3 trillion in debt
 3   outstanding, the municipal world needs to
 4   improve disclosure, especially in the
 5   secondary market.  Investors can no longer
 6   rely on bond insurers, or, quite frankly,
 7   for that matter bond rating agencies,
 8   particularly on the secondary market, who
 9   often charge fees for services for timely
10   and complete information on the
11   surveillance of bonds for which they
12   purchased.  They must have access to the
13   data themselves to bring greater
14   transparency to the muni market.
15           This panel and others held in the
16   past are a step in the right direction,
17   and I applaud the SEC for these panels.
18   However, even with these panels,
19   recommendations made by NFMA through
20   various white papers on disclosure,
21   recommendations from the GFOA on best
22   practices, and the improved ability for
23   analysts and investors to access offering
24   statements and other information on EMMA,
25   investors can still sometimes be at a loss
0179
 1   when researching a particular bond over
 2   the life of the bonds, especially in
 3   disclosure -- especially those issuers who
 4   do not issue frequently.  Improvement in
 5   disclosure, coupled with some sort of
 6   recourse for investors if the entity fails
 7   to disclose the agreed upon documents may
 8   provide a catalyst for issuers and
 9   underwriters to improve disclosure.
10           Thank you for your time, and thank
11   you for listening and I look forward to
12   answering any questions you may have.
13                 MS. STARR:  Thank you, Paul.
14   Ben.
15                 MR. WATKINS:  I'm Ben
16   Watkins, and I do the debt for the State
17   of Florida, and although I'm happy to be
18   here, I'm disappointed we missed the
19   economic opportunity to host this forum.
20   Not to diminish the importance of the
21   hearings, but in this part of the world
22   the only SEC that matters is the
23   Southeastern Conference for the state that
24   produced the last two football national
25   champions.
0180
 1           On a more serious note, I'm here
 2   to share my view and concerns that any
 3   additional SEC regulation of municipal
 4   disclosure could be intrusive, burdensome
 5   and unwarranted if not very, very
 6   carefully considered and crafted.  My
 7   opinion is that the current regulatory
 8   rime in the muni market has by and large
 9   worked and worked very well over the last
10   30 years.  It's not coincidental that
11   we're here in Jefferson County today, but
12   what I would like to point out because it
13   was enumerated earlier the causes for
14   this.  The cause for losses to investors
15   was not a lack of disclosure.  Didn't have
16   anything to do with disclosure.  Jefferson
17   County actually had a very robust investor
18   relation program and disclosure rime, so
19   let's not get confused between disclosure
20   and unlawful practices and try to fix one
21   problem with the wrong solution.
22           The challenge, as you well know,
23   in regulating muni disclosure is,
24   basically, the composition of this market,
25   and it's been enumerated well by Hobby
0181
 1   Presley and Sandy MacLennan in the earlier
 2   panel about the disparities between size
 3   and complexion of issuers, as well as the
 4   multitude of different credits in this
 5   market, and trying to write a uniform rule
 6   that would apply in a meaningful way to
 7   this disparate group of issuers and
 8   securities, I would submit to you is not
 9   challenging, but impossible.
10           And our market is characterized
11   totally by idiosyncrasies and nuances, and
12   so, I mean, that is the essence of our
13   market, and so this notion that we can
14   compare ourselves to corporate and somehow
15   find some meaningful model in that sector,
16   I think it's misguided and doesn't exist.
17   I think the muni market has functioned
18   very effectively for decades without
19   significant losses to investors.  It is by
20   and large a sector known for safety and
21   security.  These highly publicized
22   defaults are, in fact, very, very rare
23   occurrences relative to the market
24   overall, and so to focus specifically on
25   the exception and the very, very low
0182
 1   probabilities and assuming that that is
 2   systemic to the whole market is also
 3   something that needs to be carefully
 4   considered.  So repealing power and trying
 5   to develop uniform disclosure requirements
 6   that are different from the current market
 7   practices I don't believe is warranted,
 8   and from my perspective it seems to be a
 9   solution looking for a problem.
10           There have been -- the market
11   practices in disclosure have improved
12   significantly over the last decade, 15, 20
13   years, and it has been without mandates
14   from Federal regulators.  It is really due
15   to the hard work of the stakeholders in
16   this industry through best practices,
17   Government Finance Officers Association
18   best practices are enumerable with respect
19   to the obligations for disclosure and how
20   to use CAFRs and using your website for
21   disclosure.  Also, the NFMA, National
22   Federation of Muni Analysts, is taking up
23   the mantle and writing a sector by sector
24   specific with respect to the content
25   they're looking for.  EMMA is a game-
0183
 1   changer, and I would remind everyone that
 2   it's the culmination of the Muni Council's
 3   efforts not to diminish the completion by
 4   the MSRB, but from an issuer's perspective
 5   who's doing everything that they can to
 6   push information to the marketplace, we
 7   now have an industry utility that will
 8   provide investors a single place to go
 9   rather than have multitude of different
10   places on having to search for
11   information, and that's just been
12   available since May, so I think we need to
13   let that work and let that mature because
14   I think we're going to see dramatic
15   improvements and information being made
16   available to the marketplace generally.
17           And there are ongoing initiatives
18   that address current issues in the
19   marketplace.  The Government Finance
20   Officers Association, for example, are
21   working with NFMA on updating best
22   practices on information for tax supported
23   and GO indebtedness, and included within
24   that, embedded within that is a
25   recommendation on what kind of information
0184
 1   they would like to see on an interim
 2   basis, and so using that as a template in
 3   terms of communication and education
 4   between investors and issuers is what's
 5   going to make meaningful and valuable
 6   improvements to information that's
 7   available to the marketplace.  It's worked
 8   in the past, and I believe that it will
 9   work in the future, and I think that is
10   really the better way to go is to let the
11   stakeholders in the marketplace continue
12   the evolutionary process of improving
13   disclosure available to analysts and
14   investors as we have in the past and
15   resist the temptation of imposing a one-
16   size-fits-all approach to improving
17   information available in the market, and
18   communication and education are the key.
19   I heard Jennifer say it and both Paul say
20   it, you know, the current hot topic is the
21   timeliness of information, and clearly
22   there needs to be more timely information
23   available, but now we have the technology
24   to do that, and the use of a website is
25   going to revolutionize the way information
0185
 1   is made available and also make it where
 2   it is available on a real-time basis.
 3           The criticism has been that the
 4   CAFR's stale and there's a call for
 5   quarterly financial information, and I
 6   would just say that it's not feasible
 7   because not only because of the cost, but
 8   also because of the technical requirements
 9   for producing audited financial statements
10   is not capable of being accelerated, and
11   quarterly financials, governments are not
12   set up to close their books on a quarterly
13   basis.  We have annual budgets that we
14   live by.  We produce annual financial
15   information.  That being said, tangible
16   suggestions for improvement is greater use
17   of internally prepared information,
18   exactly the thing that Jennifer is calling
19   for, and there will be industry efforts to
20   educate our membership about what
21   investors and analysts want and then using
22   our websites to make that information
23   available to investors on a real-time
24   basis, and I think that's a great solution
25   to satisfy the needs of the analysts,
0186
 1   investors and the marketplace for more
 2   timely information, and there are projects
 3   ongoing to do that.  And the SEC can
 4   provide some very meaningful encouragement
 5   in that regard by providing comfort to
 6   issuers that we won't get in trouble by
 7   providing information to the marketplace
 8   that has not been audited or otherwise
 9   reviewed or prepared by outside
10   professionals, and in that way it will
11   encourage issuers to make available to
12   investors and analysts that information
13   which has not been specially prepared or
14   scrubbed down, so those are my views on
15   the world.
16                 MS. STARR:  Thank you.
17                 COMMISSIONER WALTER:  Thank
18   you all.  I guess I would like to start
19   with making use of information that's
20   already available, and I have a couple of
21   related questions for everyone, but
22   particularly for Charlie and Ned.
23           Charlie, you mentioned you have
24   monthly reports and you give them to the
25   investors on request.  I guess I'd like to
0187
 1   understand a little bit better whether
 2   you're willing to think about or why you
 3   have chosen not to make those generally
 4   available on your website or they could be
 5   made available now through EMMA.
 6           And, Ned, I'd like to understand
 7   whether moving more issuers either
 8   voluntarily or mandatorily in that
 9   direction, not reinventing the wheel and
10   creating new requirements, but having
11   people make available the information
12   that's there placed in the proper context
13   would be useful to you.
14                 MR. DUGGAN:  Well, as far as
15   the monthly reports those are generated by
16   the finance director and the finance
17   department.  They're sent to me to check
18   them and then I send them out to the
19   governing body.  They are not in a format
20   that is typical of a CAFR or an OS or
21   anything like that, and so for someone to
22   just pick up one of ours, I think it was
23   mentioned in the last session, they
24   haven't been scrubbed for an investor.
25   They're not -- they have information that
0188
 1   probably requires a lot more explanation,
 2   and if you were to compare the information
 3   that we put in our CAFR versus a monthly
 4   report you would see that there's a great
 5   disparity in the target audience for the
 6   two documents.  We try to make the CAFR
 7   accessible to anyone that wants to read
 8   it, while the monthly reports are really
 9   to give the city council an idea of how
10   we're tracking during the year and how
11   we're going against -- we do compare
12   things to budget, we also compare things
13   to previous year.  We'd probably have to
14   have a lot more information for the casual
15   person to be able to pick it up and really
16   understand if there's a trend happening
17   that is significant or if the occasional
18   blips like the collection of ad valorem
19   tax at the beginning of the year versus
20   the rest of the year, if there's something
21   significant.  There's also timeliness of
22   revenue receipts.  Sometimes we have a
23   large remitter, they might wait an extra
24   day for some reason to remit last month's
25   receipts and that totally throws off the
0189
 1   numbers and the tracking for that year,
 2   but it catches up in the next month, and
 3   so as I'm working with our city council
 4   I'm always cautioning them that if they
 5   see something that concerns them, let's
 6   monitor it for the next two reports, and
 7   if it continues, then we can look into it
 8   deeper because in almost all cases it
 9   smooths out because of the timeliness of
10   reporting.
11                 COMMISSIONER WALTER:  I just
12   wonder if -- it seems to me that there is
13   information in those types of documents
14   that would be valuable to investors and
15   with relatively simple, I would think,
16   accompanying disclosure you could explain
17   the context, you could explain the same
18   thing to investors that there are issues
19   like the following, and if you have
20   questions call us or you should continue
21   to monitor this.  It seems a shame to me
22   that we would balance in terms of not
23   giving out the information regularly
24   rather than with I think probably not very
25   much effort providing enough information
0190
 1   to put it in context, but I don't know if
 2   you have a reaction to that.
 3                 MR. DUGGAN:  Well, I would
 4   say that most investors are going to look
 5   at the long term history of the city and
 6   how we've done over a number of years, not
 7   just from a month-to-month perspective, so
 8   while we gladly will give them that
 9   information if they would call us up and
10   ask us for it, and we'll send it to them
11   and we'll also make sure that they know
12   who to contact if they need more
13   information, I think the overall trend of
14   what we have planned to do, how well we
15   carry out that plan is more meaningful to
16   an investor than one month's receipts, and
17   so I think that's one of those
18   considerations that we put in.
19           Also, I think it was about two
20   years ago our local newspaper printed that
21   we had doubled our debt in one year's
22   time, and, of course, it was erroneous
23   information.  The columnist that wrote the
24   information looked at one page I think of
25   an official statement and didn't look at
0191
 1   the information from the preceding page
 2   that explained what was happening with
 3   that debt information.  It then took a
 4   series of meetings with the managing
 5   editor, the mayor to straighten that out,
 6   a column by the mayor, and so I think
 7   that's part of our hesitation of just
 8   making information like that generally
 9   available that doesn't have the background
10   information that would be necessary to
11   make that understandable to someone just
12   casually looking at it.
13                 COMMISSIONER WALTER:  Ned.
14                 MR. MUDD:  I think I own
15   some Auburn bonds, and I would say that
16   the long term history of the city is
17   critically important to me, and I like
18   Auburn, a good quality city, good quality
19   bond, but it's what you don't know that
20   could hurt you, so I see where you're
21   coming from with the question.  More data
22   is good.  I just discovered EMMA recently,
23   and wow, what a great service that could
24   be for all investors.  I would like to see
25   as much information as I can get under the
0192
 1   following circumstances, it has to be
 2   readable.  I have to be able to understand
 3   it.  I mean I've got a feeling that I'm
 4   one of the rare investors that might read
 5   it.  Dr. Jones who's probably going
 6   through a broker, maybe he's doing surgery
 7   right now, he's not going to read this
 8   stuff.  If it was real simple and concise
 9   and if Auburn said we might -- we have a
10   concern and here's what it is and you can
11   call us, that would be great.  I don't
12   know -- I don't know how you do this and I
13   don't want to make things -- I'm hearing
14   Ben over here, too, I don't think things
15   should be so onerous on the issuer that
16   they become, you know, hogtied by it.  If
17   hogtied is a word that anybody understands
18   anymore.
19                 COMMISSIONER WALTER:  You
20   may have to explain that to some of us
21   Northerners.
22                 MR. MUDD:  It has to do with
23   barbecue actually.  To me I am concerned
24   with regulations in a way because being an
25   old-timey investor I'm concerned that my
0193
 1   brokers might get to a point where there's
 2   so much regulation that they won't call me
 3   and offer me a small bond because it isn't
 4   worth their time, and so I think there has
 5   to be a real balance between making people
 6   do something and making sure that what
 7   they do is very useful and very simple.
 8                 MR. NOLAN:  Actually, if I
 9   could add to that.
10                 COMMISSIONER WALTER:  Sure.
11                 MR. NOLAN:  I agree that the
12   State of Florida is wonderful for
13   providing information, Auburn is as well.
14   You're already providing the information
15   in a quarterly or timely basis to the
16   rating agencies.  I came up with Moody's
17   and every committee they would ask well,
18   the audit's six months old, did they give
19   you any indication of how they're doing,
20   not on a quarterly, but let's say in the
21   last six months, so you're providing that
22   to the rating agencies, and it doesn't
23   have to be scrubbed for us analysts as
24   long as we have something.  And Jennifer
25   hit on that fact.  Where it becomes a
0194
 1   problem for us is when I get a call from
 2   the Neds that I represent and they call
 3   me, well, I read in a rating agency that
 4   their fund balance is going down by 8
 5   million dollars, we're going to have
 6   problems, why didn't you pick this up.
 7   Oh, boy, here we go.  So I have to go and
 8   I have to call the Auburn, I have to call
 9   the State of Florida, meanwhile Ned and
10   somebody else, everybody's calling us.  So
11   you do provide it and issuers do provide
12   it to the rating agency.  I don't see why
13   it can't be provided to the investors in
14   some form.
15                 MR. DUGGAN:  Also, I would
16   say that, you know, if something material
17   happens, of course, we have to disclose
18   that, but this is month to month.  It's
19   typically -- we like this information to
20   be boring.  We don't want any surprises.
21                 MS. WALTER:  Investors would
22   like that information to be boring, too.
23                 MR. DUGGAN:  Right.  And,
24   maybe that's our perspective, that in the
25   six years that I've been looking over
0195
 1   these reports on a month-to-month basis
 2   there's only a few times where I've had to
 3   go to finance and say something odd is
 4   happening here, and it's been those times
 5   where the next month it smoothed out
 6   because a large remitter, it was due on a
 7   Friday and they didn't put it in until
 8   Monday and it threw it into the next
 9   month's category of receipts, and so --
10   but if it's material, then, of course, we
11   put in that information.
12                 COMMISSIONER WALTER:  Ben,
13   hopefully this doesn't repeat a
14   conversation you and I have had before,
15   but you never know, you talked about
16   avoiding one-size-fits-all and relying on
17   voluntary efforts.  The downside I see to
18   voluntary efforts is that they work very
19   well with issuers like you and they don't
20   work as well with those people who are not
21   as much inclined to be at the top of the
22   heap.  Couldn't you have if, for example,
23   the Commission had some authority to set
24   disclosure standards, it seems to me what
25   we could do is to build up good voluntary
0196
 1   efforts.  I think we certainly would
 2   commit to not do one-size-fits-all.
 3   Hopefully we knew that before we started
 4   this endeavor; we certainly know it now.
 5   Couldn't you in a sense have your cake and
 6   eat it, too, by incorporating, and that's
 7   the name of the game in rulemaking and in
 8   setting standards, to have it be a public/
 9   private partnership where you build on the
10   good and you make sure that you
11   incorporate that?  Does that help assuage
12   some of your concern?
13                 MR. WATKINS:  I'm always a
14   big believer in letting -- in exercising
15   self help and giving the market an
16   opportunity to develop private solutions
17   and see how that evolves, and then if that
18   falls short of what's needed, then
19   intervention maybe in the form of
20   additional regulation may be warranted.
21   But my experience has been the change in
22   the market has been evolutionary, not
23   revolutionary and it takes time for the
24   larger issuers who have the resources to
25   do it right, provide leadership for those
0197
 1   mid level and smaller, less frequent
 2   issuers to give them an opportunity to
 3   come along.  And you would be amazed at
 4   the number of, for example, using the
 5   website, not only for communicating with
 6   constituencies, but also using it for
 7   disclosure.  12 years ago when we started
 8   this it was just a handful, and it was the
 9   state level issuers and the large issuers.
10   Now, virtually all size governments have
11   websites and use websites.  Okay, now
12   we've got the tool.  Now, we need to talk
13   about what kind of information is going to
14   be meaningful and valuable to Jennifer and
15   Ned and Paul and give the market an
16   opportunity to assimilate that and give
17   large issuers an opportunity to provide
18   that like we do.  We do monthlies in terms
19   of revenue collections so that the
20   analysts can have an idea of where we
21   stand against what our annual estimates
22   are, but we're -- and so that's happening
23   at the large issuer level, and you would
24   be probably surprised at the number of
25   small and mid level issuers that like to
0198
 1   display their GFOA award of excellence,
 2   for example, and they work hard to meet
 3   all the requisite requirements to have
 4   that certificate, and they put it on a
 5   frame and they hang it on the wall in city
 6   hall.  Well, if we embed within that, you
 7   know, providing information to investors,
 8   then that will encourage others to come
 9   along, so that's my only point is let's
10   not jump quickly to a regulatory solution
11   when we haven't had a chance for EMMA to
12   mature and haven't had an opportunity --
13   the interim information, for example, is a
14   relatively new, at least from my
15   perspective, I now have an understanding
16   that there's a greater need to have
17   information on a more current basis, and
18   we're providing it.  But I would say
19   that's been within the last year, so
20   that's new.
21                 MS. STARR:  I have a
22   question, one of the points I think,
23   Jennifer, you raised or, Paul, you raised
24   was the secondary market disclosures and
25   whether they were incomplete, et cetera,
0199
 1   and so if we look under 15c2-12 your
 2   primary -- in your primary offering, the
 3   official statement is supposed to provide
 4   the template for the kinds of information
 5   that's provided on an ongoing basis.  And
 6   I had two questions, one is what kind of
 7   role do investors find they're able to
 8   play in terms of being able to weigh in on
 9   what kind of information should be
10   included or they would like to see
11   included in an official statement in a
12   primary offering to assess the kind of
13   information they're looking for on a going
14   forward basis, that would be number one.
15   And I think the second part of the
16   question would be because that template
17   has been established, you know, from an
18   issuer's side what have you heard, you
19   know, Charlie and Ben, have you heard why
20   are issuers not necessarily complying with
21   those obligations?  They've, you know,
22   they've already identified what's material
23   to investors in that, you know, OS.  Why
24   are they not complying and providing that
25   information on an ongoing basis?
0200
 1                 MS. JOHNSTON:  In terms of
 2   the continuing disclosure agreement, we're
 3   extremely active in the primary market in
 4   trying to create an agreement that
 5   satisfies our needs.  We do intend to have
 6   a long term relationship with the issuer.
 7   We're traditionally a buy and hold firm,
 8   so we are extremely active.  And in the
 9   event we cannot get a continuing
10   disclosure agreement to satisfy our needs,
11   then we may not participate in the deal.
12   In terms of why people don't maintain
13   compliance with that, I don't know.  I
14   think some of it is turnover, whoever
15   agreed to it at the beginning is no longer
16   involved, time gets away from you, but one
17   of the things I think that's happened is
18   the economic crisis and the financial
19   crisis have shown that sometimes what we
20   thought we wanted back then just doesn't
21   apply anymore, and like Ben is saying,
22   it's an evolutionary process, and I
23   completely agree, and I think one of the
24   things that this crisis has shown us is
25   exactly how timely we need information to
0201
 1   be, and even if the template as outlined
 2   is met, sometimes there's additional
 3   information that crises like this are
 4   going to raise that we didn't anticipate
 5   ten years ago.
 6                 MR. NOLAN:  And I was going
 7   to follow-up and then I'll answer the
 8   question real quickly, Ned, I do agree
 9   with you that we need to let it evolve,
10   and I came from the new school where we
11   were taught statistics, what is -- you're
12   hearing anecdotal from Jennifer and I, and
13   one of the things I tried to find out is
14   who isn't compliant with disclosure, and
15   there's no real hard information of of
16   those 50 to 60 thousand municipal issuers
17   has anybody gone back and checked to see
18   if they're noncompliant.  Now, I did a
19   quick and dirty.  I took five bonds that
20   we own and found two of the five just
21   random from my traders noncompliant on
22   EMMA.  Now, I want to see it mature.  I
23   was just curious, so that's one of the
24   things I would recommend is that someone
25   go back and look and see who is
0202
 1   noncompliant with disclosure, so that's
 2   the first piece I wanted to follow-up on.
 3           Now, to answer your question what
 4   kind of role, I think it depends on
 5   sectors.  I think particularly the health
 6   care sector is really good at listening to
 7   investors through the road shows.  They
 8   have a direct input and to ask questions
 9   well, you're lowering your rate covenant,
10   you're lowering your additional bonds
11   test, why are you doing that.  We would
12   prefer to see a higher rate covenant or
13   more days cash or something, and another
14   -- the CCRC community is wonderful.  They
15   have three or four pages of disclosure in
16   their documents of what they're going to
17   provide on a timely basis, so I think it
18   depends on the sector in terms of
19   investors, and the same thing with
20   Jennifer, if we don't like what we see, we
21   just move on.
22                 MS. STARR:  On the issuer
23   side.
24                 MR. WATKINS:  There have
25   been parties and interests who have
0203
 1   produced reports to demonstrate
 2   noncompliance to sell their product, and
 3   I'm familiar with that, but I don't think
 4   we have a true test, because the NRMSIR
 5   system was simply dysfunctional and there
 6   were no performance standards, there were
 7   no audits done that they were doing what
 8   they had promised to do, but that's now
 9   been changed with the advent of EMMA, and
10   so now we can.  But we are clearly from --
11   I mean, we want -- government finance
12   officers are programmed to want to do
13   things right.  That's the whole reason we
14   work in the public sector, right, and we
15   are -- we like repetition and regimen and
16   rules, and if we have that, we will follow
17   them.  I think the -- and we're giving
18   guidance to the members, GFOA through
19   their recommended practices in 2010 has
20   just updated understanding continuing
21   disclosure requirements in direct response
22   to this notion of people were not
23   complying, and so that's an example of,
24   you know, us taking care of ourselves
25   rather than being told what to do, and so
0204
 1   it is front and center and I'll be
 2   interested to see if the noncompliance
 3   issue is as big an issue as we think it
 4   is.  And clearly the point Hobby made, we
 5   get tangible feedback now because we're
 6   responsible for putting it up on EMMA and
 7   you can put it up and then you can look
 8   and see it.  When we were filing it before
 9   we were throwing it into a black hole,
10   because we couldn't go to Bloomberg and
11   see if they posted it or go to DPC and see
12   if they posted it or any of the NRMSIRs,
13   not to pick those two, so there was no
14   tangible feedback in terms of making sure
15   that things were done and done right, so I
16   think you're going to see a marked
17   improvement, to the extent there is a
18   deficiency in noncompliance, I think
19   you'll see a marked improvement with EMMA.
20                 COMMISSIONER WALTER:  Let me
21   follow-up with one question in that area.
22   We've been told anecdotally that when
23   there is noncompliance and another
24   offering is coming up that the first thing
25   that will happen is, at least at the first
0205
 1   buy, that the underwriter will allow the
 2   issuer to catch up because the underwriter
 3   under present regulations has to have a
 4   reasonable belief that there will be
 5   forwarded with compliance.  We've already
 6   warned people that, you know, hard to know
 7   the first time, but, you know, that
 8   becomes a dicey proposition.  Do you have
 9   any reaction to that and how much of that
10   responsibility -- how hard should we be
11   pushing on the underwriting community to
12   be the enforcers of that rime?
13                 MR. WATKINS:  That is the
14   mechanism in place and that is the rule so
15   it needs to be enforced, and I think it
16   maybe wasn't enforced as diligently as it
17   should or could have been in the past, but
18   then you go back to well, maybe they filed
19   it and the NRMSIR just didn't even get it
20   up.
21                 MS. JOHNSTON:  And that,
22   quite frankly, is going to be part of the
23   analysis that I go through, and I just
24   looked at a deal a few months ago,
25   somebody hadn't produced an audit in three
0206
 1   years, and so here they are wanting to
 2   come to the market and issue debt, and
 3   that was my first question to them is you
 4   haven't published any audited financials
 5   in three years.  What's going to give me
 6   the comfort level that you're going to
 7   continue to do that going forward, and so
 8   that can be an issue that an obligor has
 9   to be deal with is if they have not
10   complied in the last several years, they
11   might be, you know, losing market access
12   that way, because I need to see proof that
13   they're going to do that going forward
14   because otherwise I don't want to have
15   exposure to them.
16                 MS. WALTER:  One, perhaps,
17   final question.  In their CAFRs what do
18   you think of, in their annual reports what
19   kind of a job do you think the issuer
20   community is doing with respect to
21   disclosure of trends, which I think from
22   the whole conversation here everybody
23   seems to be saying that's very important,
24   that you really want to look at the long
25   term, you want to look at a trend line.
0207
 1   How good a job are people doing at that?
 2                 MR. BORG:  I think it's all
 3   over the board.  A couple of really minor
 4   points, the smaller issuers are going to
 5   -- granted, the big issuers have some
 6   problems, too, but the smaller issuers I
 7   think a lot of it has to do with more we
 8   just didn't have the time to think about
 9   it anymore because that was a bond issue
10   we put out two years ago.  Frankly, it's
11   just a matter of resource and whatnot.
12   Couple of things real quick, I mean, we
13   have -- and, again, my jurisdiction, even
14   though we have authority on the big
15   issues, the IDPs and IDRs we have very
16   little failures with those in the State of
17   Alabama.  One of the things we do is
18   certainly a lot of the smaller issuers are
19   going to listen to organizations like the
20   League of Municipalities.  Granted,
21   they've got GFOA and some of the others,
22   too, but the League of Municipalities they
23   talk to them on a regular basis so now
24   we're communicating to the smaller issuers
25   on they're not complying with this or why
0208
 1   did you do it this way or why did you
 2   think about that, and we're talking to
 3   them.  The second thing is that we've
 4   actually started talked to our examiner of
 5   public accounts that are supposed to be
 6   looking at some of these counties and some
 7   of these things, not specifically for
 8   municipal bonds, but now if we communicate
 9   with them, we're getting information that
10   they have, they don't think it's relevant
11   maybe for us for our purposes, but we look
12   at it and we're looking a new IDB coming
13   in or a refunding issue that we want to
14   look and see what did the examiner do,
15   have they been to that county, have they
16   been to that board, do they have
17   compliance, and surprisingly enough a lot
18   of times we get information and go we
19   never saw that and it's not in the
20   materials, so, therefore, we want that
21   complied to as well.  So then there are
22   other areas both for education and
23   checking that can be applied as well to
24   bring the system up, and although I do
25   think there's a place for rules and
0209
 1   regulations, the evolution concept is
 2   true, EMMA -- especially with the new
 3   requirements with EMMA there ought to be
 4   some time period.  It's almost like there
 5   needs to be some set principles up above
 6   that we know what those rules are going to
 7   be and then fill in the rules with some of
 8   the industry participants that are looking
 9   at the best practices and whatnot, but I
10   think we are missing the boat if we don't
11   include some of the collateral
12   organizations like a league of
13   municipalities, every state's got one, an
14   examiner of public accounts every state's
15   got one, but we haven't really focused
16   them in to see what they can bring to the
17   table to make this process better, and
18   that's an education area and that's a
19   source of financial information area that
20   needs to be developed.
21                 MR. DUGGAN:  Is there also a
22   way to somehow achieve some sort of status
23   or certification where if you're doing
24   something, that you can more or less get
25   in the fast lane of saying that --
0210
 1                 COMMISSIONER WALTER:  The
 2   carrot instead of the stick?
 3                 MR. DUGGAN:  Yes.  Is it
 4   possible that there are some compliance
 5   things that really aren't relevant to you
 6   because you're doing the other things like
 7   a CAFR that might be a possibility to put
 8   out, to keep those entities that are
 9   trying -- that have made the investment in
10   the professionals and the knowledge to do
11   proper disclosure and not hamstring us
12   with those other things that -- I think it
13   was the first panel talked about the small
14   occurrence of municipal failures, and one
15   of the things that we always look at when
16   we're proposing a new policy, regulation,
17   ordinance is is this problem significant
18   enough for a new regulation, and so that's
19   something we want to look at, in providing
20   a solution is the solution solving a
21   problem or is the solution an evolution
22   and is the evolution wanted and necessary.
23                 COMMISSIONER WALTER:  Well,
24   I think we have to bring this very
25   interesting panel to a close, but let me
0211
 1   leave you with a thought to think about
 2   that will come up on the last panel of the
 3   day and that is a lot of the talk up till
 4   now has focused on the incidents of
 5   default, but we need to remember that this
 6   a trading market, too, and increasingly as
 7   time goes on not all investors in
 8   municipal bonds are buy and hold
 9   investors, so there is a need to think
10   about valuation and good pricing as well
11   which certainly goes beyond that, and we
12   will talk about that this afternoon.  And
13   we very much appreciate the input of
14   everyone on this panel on those issues as
15   well.  I really want to thank you for
16   being here and I wish we had more time to
17   go on because I have about 8 thousand
18   questions I need to ask you, and I may
19   call you on the phone and do that, but
20   thank you so much.  We will break for
21   lunch.
22   
23           (Lunch recess taken.)
24   
25                 COMMISSIONER WALTER:  Okay.
0212
 1   We will get started, and I'm going to turn
 2   the floor over to Amy -- the mic's not on.
 3   Okay, one more time.  Amy, you're up.
 4                 MS. STARR:  Thank you,
 5   Commissioner Walter.  We're starting this
 6   afternoon's panels.  Our first panel of
 7   the afternoon is, the title is Derivatives
 8   Use in Municipal Finance.  I know it's an
 9   area that many here are very interested
10   in, and so the panelists this afternoon
11   are going to explore issues involving
12   municipal issuers use of derivatives in
13   their financings as well as their ongoing
14   operations.  The panel will examine the
15   types of derivatives municipal entities
16   engage in, disclosure issues regarding
17   derivatives both from the standpoint of
18   disclosures to municipal issuers and
19   disclosures by municipal issuers of their
20   derivative's exposures, and the role of
21   other market participates in the municipal
22   issuer derivative transactions.
23           Our panelists this afternoon are
24   Robert Brooks, Wallace D. Malone Endowed
25   Chair of Financial Management at the
0213
 1   University of Alabama; Mary-Margaret
 2   Collier, Director of State and Local
 3   Finance, the State of Tennessee; Andrew
 4   Kalotay, Ph.D., President of Andrew
 5   Kalotay Associates; Paul McElroy, Chief
 6   Financial Officer of JEA, a community-
 7   owned utility in Jacksonville, Florida;
 8   and Steven Turner, partner at Hawkins,
 9   Delafield & Wood.  I'm going to ask again
10   each panelist beginning with Professor
11   Brooks to give us their initial thoughts
12   and then we'll ask questions of our
13   panelists.  Again, I'll reiterate if you
14   can keep it to under five minutes, that
15   would be great because it would give us
16   greater opportunity to have some back and
17   forth dialogue in Q&A.  Professor Brooks.
18                 DR. BROOKS:  Again, that you
19   for the privilege and honor of
20   participating in this event.  In these
21   opening remarks, I would like to make four
22   quick points.
23           First, I would like to repeat for
24   emphasis my first comment from the
25   Distressed Communities panel, the
0214
 1   regulatory environment influences who
 2   chooses to enter this vocation.  If the
 3   municipal finance landscape resembles a
 4   prison environment, then we should not be
 5   surprised that many highly ethical,
 6   competent, creative professionals opt for
 7   an alternative finance profession rather
 8   than be strip-searched every day, told
 9   what to eat and when they can relieve
10   themselves.  Particularly in the financial
11   derivatives space, we need highly ethical,
12   innovative and creative professionals like
13   never before.  We do not want to risk
14   stifling financial innovation where
15   solutions could be developed to mitigate
16   risk at a dramatically lower cost and with
17   increased precision and effectiveness.
18   There are young aspiring American patriots
19   who desire to invest their very lives in
20   public service to our exceptional country.
21   We should make every effort to provide a
22   municipal finance environment where they
23   can flourish and serve our country well.
24           Second, the most significant
25   problem related to derivatives use in
0215
 1   municipal finance is that derivatives are
 2   sold and they're not bought.
 3   Specifically, commission hungry and
 4   ethically questionable derivatives
 5   salespeople are not the best source of
 6   ideas for creative and innovative
 7   solutions to complex municipal problems.
 8           It should be suspect that often
 9   the very idea promoted by the financial
10   institution would never be done at that
11   same institution.  In my financial
12   derivatives classes since 1998 I have used
13   the 1997 swap transaction between
14   Jefferson County, Alabama, and JP Morgan
15   to train my students on how not to do a
16   swap transaction.  The idea was to
17   refinance an existing variable rate bond
18   with a fixed rate bond and then enter into
19   a swap transaction to create a synthetic
20   variable rate bond.  After millions of
21   dollars of transaction costs, the
22   synthetic variable rate paid by Jefferson
23   County was dramatically higher than the
24   original variable rate bond.  I'm not
25   aware of any financial institution that
0216
 1   would refinance their variable rate to a
 2   higher synthetic variable rate and take on
 3   more risks.
 4           Third, every ISDA confirmation
 5   letter that I can recall contains explicit
 6   language related to representations,
 7   specifically non-reliance, evaluation/
 8   understanding, and status of parties.  In
 9   essence, this portion of the derivatives
10   documents state that each counterparty has
11   made their own independent judgment or is
12   relying on its own advisors.  Most
13   importantly, there is an explicit denial
14   of a fiduciary relationship between the
15   two counterparties.
16           However, in reality, the
17   derivatives transaction idea emanated from
18   the financial institution.  The idea was
19   "sold" to the municipality based on some
20   sort of convincing pitch book where
21   benefits are emphasized and well-known
22   risks are omitted.  Due to other demands,
23   the municipal representatives rely on and
24   trust the financial institution.  From the
25   municipality's perspective, there is a
0217
 1   practical fiduciary relationship.  The
 2   municipal officials trusted the
 3   representations of the financial
 4   institution's professionals.  Ultimately,
 5   finance is and has always been a trust
 6   business.  Historically, banks have had
 7   the word "trust" in their corporate name.
 8   The solution may lie more in financial
 9   institutions re-embracing their ancient
10   fiduciary responsibilities, rather the
11   rule of law attempting to place layer upon
12   layer of complex and ambiguous
13   regulations.  At a minimum, financial
14   institutions should embrace transparency
15   by providing clear identification of
16   conflicts of interest, written
17   documentation of their profit margin, and
18   strongly recommend that municipalities
19   find their own independent, capable
20   advisor who is willing to act as their
21   fiduciary.
22           Finally, many concepts within
23   financial risk management are not well
24   defined and hence, not well understood.
25   Most finance practitioners have a general
0218
 1   understanding of "hedging", but it is
 2   surprisingly difficult to pin down.  For
 3   example, the 1997 Jefferson County swap
 4   transaction was promoted as a hedge of
 5   interest rate risk.  Within a year the
 6   1997 transaction was terminated.  If
 7   entering the swap was hedging, what was
 8   terminating the swap?
 9           There are two general approaches
10   to interest rate risk management,
11   view-driven and needs-driven.
12   Interestingly, financial institutions seek
13   to balance out their interest rate risk
14   using asset liability management
15   techniques (needs driven).  These
16   financial institutions do not attempt to
17   manage their interest rate risk by
18   guessing where rates are going.  These
19   same financial institutions will place a
20   derivatives salesperson on a plane to
21   pitch a view-driven derivatives
22   transaction on an unsuspecting municipal
23   official.  It seems reasonable that the
24   financial institution pitching the
25   derivatives deal should be willing to do
0219
 1   it themselves if they were facing similar
 2   circumstances.  Thank you.
 3                 MS. STARR:  Thank you very
 4   much.  Mary-Margaret.
 5                 MS. COLLIER:  Thank you,
 6   Commissioner Walter and panel for inviting
 7   me to participate in this important
 8   discussion today.
 9           My comments are limited to my
10   experiences with and observations of
11   special entities as defined in Dodd-Frank
12   to include state and local governments and
13   their authorities that have entered into
14   interest rate agreements commonly known as
15   swaps and forward purchase agreements.
16           First, let me give you a little
17   history about Tennessee.  Special entities
18   in Tennessee did not enter into swap
19   agreements prior to 1999.  In 1999 members
20   of the investment banking community
21   approached the state government officials
22   and asked them to sponsor legislation
23   specifically authorizing the use of
24   interest rate agreements.  Comptroller
25   John Morgan had two requirements:  First,
0220
 1   any such agreement must be related to a
 2   specific debt instrument; and, second,
 3   government officials had to understand the
 4   complexity and the risks of these
 5   financial transactions.  Our legislation
 6   required the state funding board to adopt
 7   guidelines for the proper training of
 8   government officials prior to executing
 9   such transactions.  It required special
10   entities that wanted to enter into these
11   transactions to develop both a debt policy
12   and a swap policy to identify the elements
13   of the transaction that should be
14   monitored and reported to elected
15   officials over the life of the
16   transaction.
17           As a result, over one hundred swap
18   transactions were executed.  Some of these
19   transactions were for one million dollars.
20   Others were for over a hundred million.
21   For a period of time most of the
22   transactions worked.  However, in
23   September 2008 when the financial markets
24   collapsed the results were disastrous for
25   many special entities.  Some elected
0221
 1   officials had changed.  Others failed to
 2   understand the transaction and its risks
 3   when the Government executed the
 4   transaction.  New officials were unaware
 5   of the risks embedded in the transactions.
 6   Special entities were faced with paying
 7   higher interest costs or terminating the
 8   swaps.  They could not understand why they
 9   must pay these costs of termination when
10   they had done nothing wrong.
11           Comptroller Justin Wilson amended
12   the guidelines in 2009.  Under the amended
13   guidelines the CEO of the special entity
14   and the governing body are jointly
15   responsible for understanding the
16   transaction.  They are responsible for
17   maintaining a competent staff to
18   administer this transaction.  State
19   administrative officials also encourage
20   local governments that enter into these
21   transactions to review and comply with the
22   GFOA advisory on the use of debt-related
23   derivatives products and the derivatives
24   checklist.  Only a few transactions have
25   occurred since that time.
0222
 1           As you consider regulating this
 2   market, I call to your attention several
 3   issues.  When debt is issued, frequently
 4   for 20 to 30 years that is the only time
 5   when one legislative body commits its
 6   future legislative bodies to pay financial
 7   obligations.  In making this decision,
 8   legislative bodies may fail to consider
 9   the long term economic cycle on its
10   ability to repay the financial obligation.
11           The level of local government
12   expertise and the financial philosophy of
13   legislative bodies is not consistent over
14   time.  Elected officials are often
15   incentivized by the need to keep tax rates
16   low today and do not always consider the
17   long term consequences of their decisions.
18           As the first swaps were executed,
19   special entities were unaware of the
20   conflicts of interests that may have been
21   hidden in this new type of transaction.
22           And finally, many local
23   governments entered into interest rate
24   agreements prior to the implementation of
25   GASB-53.  GASB-53 requires hedge
0223
 1   accounting to be implemented and to be
 2   implemented retroactively, resulting in
 3   accounting for mark to market losses that
 4   may not effect cash on hand to operate the
 5   government.  This mark to market
 6   accounting can lower net assets or
 7   increase liabilities to the special
 8   entity.
 9           As you consider the regulations I
10   would ask you to consider the following.
11   Ensure that swap advisors are
12   knowledgeable and most important free of
13   any conflicts of interest.  Require
14   special entities that enter into such
15   agreements to maintain a competent staff
16   or advisors to serve in a fiduciary role
17   not only during the transaction, but for
18   the life of the swap.  Require staff
19   members to report to the legislative body
20   the financial effectiveness of the swap
21   and any potential risks in the current
22   economic environment, at least annually.
23   And finally, require special entities to
24   publish the results of the reports on
25   websites on a regular basis and provide
0224
 1   members of the community the opportunity
 2   to ask questions about the continued
 3   financial effectiveness and the cost of
 4   the transactions in a public meeting.
 5   Thank you.
 6                 MS. STARR:  Thank you very
 7   much.  Andy.
 8                 MR. KALOTAY:  Thank you very
 9   much, Amy.  I will skip over my
10   background, except to say that my firm's
11   debt management advisory clients include
12   the Tennessee Valley Authority and the
13   Federal Farm Credit Banks, and that my
14   involvement in municipal finance goes back
15   to 1979.
16           I would like to thank Commissioner
17   Walter and the SEC for inviting me to
18   comment on the state of municipal
19   derivatives.  I believe that we stand at a
20   crossroads where the SEC can have a
21   significant impact by shining a light on
22   the inefficiencies and waste that exist in
23   municipal finance.  I am referring to what
24   I see as Wall Street's multi-billion
25   dollar hidden tax on "Main Street",
0225
 1   through poorly structured bond and swap
 2   transactions.
 3           I'm not talking about fraud per
 4   se.  The financial press understandably
 5   concentrates on the periodic blowups and
 6   perp walks arising from fiascos such as
 7   Jefferson County.  I'm referring to a much
 8   more pervasive problem that goes virtually
 9   unrecognized amidst the tales of
10   incompetence and greed.
11           I have been a vocal critic of
12   municipal finance practices for some time.
13   As I said in a Bond Buyer article
14   published earlier this year, swaps are
15   badly mispriced against the
16   municipalities.  I will illustrate this
17   with a recent transaction that I believe
18   is typical, and then extrapolate the
19   damage to a national scale.  As you see, I
20   put the blame for the current troubling
21   state of affairs squarely on the
22   municipalities' swap advisors, who are
23   hopelessly conflicted.
24           The scales are tilted in favor of
25   the banks, due to the kind of arcane
0226
 1   knowledge required to price these custom
 2   swap products.  But swap valuation is not
 3   rocket science; the market information and
 4   the analytical software are readily
 5   available.  The problem with swap advisors
 6   is not the lack of technical expertise,
 7   but how they are compensated.  The
 8   incentives are skewed:  The deal must go
 9   through in order for the swap advisors to
10   get paid.  If we cannot force them by
11   regulation to behave as true fiduciaries,
12   then clearly they should not represent
13   themselves as advisors-- agents or fixers
14   would be a more accurate appellation of
15   their role in municipal finance.
16           Let's now turn to 30 year 7
17   hundred and 50 million variable-rate bond
18   deal by Denver Public Schools in 2008,
19   which has been extensively covered in the
20   press.  Denver Public Schools swapped
21   these bonds to a fixed rate, with three
22   major banks, on identical terms.  Swaps
23   packaged with variable-rate bonds are
24   common in the municipal market.
25           As an aside, this was a taxable
0227
 1   bond deal, putting it in the same realm as
 2   corporate issues.  To my knowledge, no
 3   respectable corporation has ever done such
 4   a deal.  If this is such a good idea,
 5   wouldn't the banks use it to fund
 6   themselves?  What is truly scary is that
 7   municipal issuers such as Denver Public
 8   Schools don't seem to realize that they
 9   are unwitting guinea pigs in these dubious
10   experiments.
11           Getting back to swaps, there's a
12   key concept called "fair value" which can
13   be determined from the prevailing swap
14   curve.
15           And as you can see on the slide,
16   the difference between the bid and ask
17   spreads is very, very small.  For example,
18   in the case of the ten year swap, it's
19   two-tenths of a basis point.  And I can
20   tell you that our advisory clients
21   routinely transact within one basis point
22   of the mid-market spreads.
23           Now, this slide shows the fair
24   value of this Denver Public School swap as
25   reported in their 2010 annual report.
0228
 1   Interest rates had moved against DPS; and
 2   collectively, the three counterparties
 3   reported the fair value as approximately a
 4   hundred and 43 million dollars.  This is
 5   very close to the calculated value --
 6   value calculated by us; the difference is
 7   a mere 17 hundredths of a percent of the
 8   notional amount.  The point to take away
 9   is that when it comes to fair value, there
10   is consensus among the experts.
11           Now, let's look at the swap that
12   was executed in 2008.  Here we see that at
13   the time of entry, the value of the swap
14   was 13.6 million, nearly two percent of
15   the notional amount against the school
16   district.  This does not include the 4
17   hundred and 25 thousand dollars paid to
18   the so-called swap advisor, and another
19   hundred thousand dollars paid to the swap
20   counsel.  So the aggregate cost of the
21   swap to Denver taxpayers at the time of
22   execution was well in excess of 14 million
23   dollars.
24           I believe that in percentage
25   terms, the economics of the Denver Public
0229
 1   School swap are typical.  So let's
 2   estimate what this means on a national
 3   scale.
 4           So I conservatively assumed that
 5   one trillion municipal swap transactions
 6   occurred in the last five years, including
 7   many unwinds, where the municipalities are
 8   also overcharged.  At a two percent
 9   mark-up, the hidden cost of swaps to the
10   taxpayers on a national scale adds up to
11   20 billion dollars.
12           The banks defend -- the banks tend
13   to defend their profit margin by claiming
14   exposure to municipal credit risk.  But
15   what is the justification for a high
16   margin on unwinding, when credit risk is
17   nonexistent.
18           So what to do?  Swap valuation is
19   not in the skill set of most municipal
20   decision-makers, and swap advisors have
21   not served them well.  As Justice Louis
22   Brandeis said in his book, Other People's
23   Money, "sunlight is the best of
24   disinfectants; electric light the best
25   policeman".  In that spirit, at a minimum,
0230
 1   the banks should be required to disclose
 2   the swap curve at the time of execution.
 3   Also, any side agreement with the swap
 4   advisor should be disclosed as a matter of
 5   course.  More broadly, perhaps a Municipal
 6   Finance Protection Bureau should be set up
 7   to provide municipalities with fair values
 8   of swaps, on demand, prior to entry or
 9   exit.  It will be a step in the right
10   direction, but I would be naive to assume
11   that this would solve the whole problem.
12           I thank you for your time, and I
13   hope that some of these ideas will be of
14   use.
15                 MS. STARR:  Thank you, Andy.
16   Paul.
17                 MR. MCELROY:  Thank you.
18   And good afternoon, and I would like to
19   start by expressing my gratitude to the
20   SEC officials for organizing these
21   hearings.  I appreciate the opportunity to
22   answer questions and share our thoughts on
23   how proposed derivatives policies and
24   rules may affect our operations and cost
25   structures.
0231
 1           I'm Paul McElroy, and I'm
 2   currently the Vice President and Chief
 3   Financial Officer for JEA.  Prior to
 4   joining JEA, I accumulated over 20 years
 5   of financial experience in a number of
 6   commercial, as well as consumer
 7   businesses.
 8           JEA is a municipal utility
 9   operating in Jacksonville, Florida, and
10   parts of three adjacent counties serving
11   over 4 hundred thousand customers.  Our
12   product portfolio includes electric,
13   water, wastewater and district energy
14   services.  Today we are the largest
15   community-owned utility in Florida and the
16   eighth largest in the country, with total
17   assets of 8.6 billion and total municipal
18   debt just over 6 billion dollars.
19           JEA is a member of the Large
20   Public Power Council, the LPPC, an
21   organization comprised of the 25 largest
22   public power entities in the country.  It
23   is also a member of the American Public
24   Power Association, (APPA), an organization
25   comprised of approximately 2 thousand
0232
 1   public power utilities which are
 2   predominantly municipal electric systems.
 3   LPPC and APPA, as part of the
 4   "Not-For-Profit Electric End User
 5   Coalition" have been very active in the
 6   rulemaking processes for the
 7   implementation of Dodd-Frank financial
 8   reform legislation, particularly in regard
 9   to the derivatives section of the Act.  We
10   have filed, primarily with the CFTC,
11   hundreds of pages of comments and have met
12   with CFTC staff and commissioners.  LPPC
13   and APPA have also provided written
14   comments to the SEC regarding the new
15   process for registering municipal advisors
16   and the rule changes to improve
17   disclosures.  It's important to note that
18   public power utilities are owned by their
19   communities and have clear missions to
20   provide safe, reliable and low cost
21   utility services.  We are not-for-profit,
22   non-financial businesses, yet many of us
23   utilize financial instruments to hedge
24   commercial risk.  Done properly, with
25   appropriate regulatory oversight, as well
0233
 1   as rigorous internal policies, including
 2   clearly stated goals and objectives,
 3   efficiently hedging commercial risk leads
 4   to stable pricing for our customers.  Our
 5   primary point of concern in the context of
 6   today's hearing is the possible adverse
 7   outcome arising from proposed regulations
 8   with regard to business conduct rules on
 9   swap dealers, particularly the additional
10   restrictions related to swaps with
11   "special entities".  The business conduct
12   requirements for public power and other
13   special entities contain two key
14   provisions: (A) the advisor to a special
15   entity must act in the best interest of
16   the entity; and, (b), a swap dealer must
17   determine that the special entity has a
18   qualified independent swap advisor.
19           Although the SEC is not
20   responsible for regulating the interest
21   rate and commodities swap we use, we
22   believe it's important that the SEC and
23   the CFTC continue to coordinate efforts
24   related to business conduct rules.  The
25   SEC's proposed rules regarding
0234
 1   requirements for advisors are a marked
 2   improvement over previous regulatory
 3   proposals.  Specifically, the change to an
 4   overall facts and circumstances-based
 5   approach that permits a swap dealer and a
 6   special entity to acknowledge that the
 7   dealer is not acting as an advisor, better
 8   balances regulatory objectives and
 9   possible unintended market impacts.  Since
10   every swap dealer with a special entity
11   must involve an independent advisor, and
12   since the disclaimers of the advisor
13   status by the dealer and the special
14   entity are already typically included in
15   standard swap agreements, this approach
16   appears to be workable and would represent
17   a significant improvement.
18           The SEC's proposed rules regarding
19   the determination that a special entity
20   has a qualified independent swap advisor
21   are also an improvement, again, striking a
22   better balance.  Permitting the dealer
23   counterparty to rely on representations to
24   determine if a special entity has a
25   qualified independent swap advisor draws
0235
 1   upon reasonable and customary, commercial
 2   terms and standards, commonly employed in
 3   the market.  We also agree with the SEC's
 4   determination that an employee of a
 5   special entity qualifies as an independent
 6   for these purposes and especially for
 7   commodity derivatives.  However, we note
 8   that certain of the specific requests for
 9   comments include in the SEC's proposed
10   rules of conduct suggest the possibility
11   that the SEC might back away from these
12   aspects of the rules.  We would urge the
13   SEC not to do so, and we will submit
14   written comments in support of the current
15   construct.
16           We encourage the Commission to
17   continue to merge regulatory objectives
18   with reasonable and customary commercial
19   terms and standards that have been time
20   tested and successfully employed in our
21   market.  Thank you, and I look forward to
22   your questions.
23                 MS. STARR:  Thank you very
24   much, Paul.  Steve.
25                 MR. TURNER:  Thank you.  I
0236
 1   would like to thank the Commission and its
 2   staff for inviting me to participate on
 3   this panel.  My name is Steven Turner and
 4   I'm a partner in the law firm of Hawkins,
 5   Delafield & Wood, LLP.  The views
 6   expressed by me here are mine and don't
 7   necessarily reflect those of my firm.
 8           The areas in which I and my law
 9   firm practice are limited principally to
10   public financial and related activities.
11   Our clients include states, municipalities
12   and special districts and authorities, as
13   well as underwriters.  Hawkins celebrated
14   its 150th anniversary in 2004.
15           Over the years, we have
16   participated in numerous transactions
17   involving interest rate swaps, principally
18   as bond counsel.  Most often, the swaps
19   have been entered into in connection with
20   variable rate debt, to synthetically
21   convert variable rate exposure to a more
22   predictable and manageable fixed rate by
23   means of a variable-to-fixed rate swap
24   contract.
25           Issuing variable rate debt,
0237
 1   together with a variable-to-fixed rate
 2   swap, is intended to provide a lower fixed
 3   rate cost of borrowing than fixed interest
 4   rate debt, even after taking into account
 5   ancillary costs such as remarketing fees.
 6   Issuers enjoy the lower interest rates,
 7   and underwriters earn both the
 8   underwriting fee and continuing
 9   remarketing fees.  In theory, these swaps
10   are advantageous for both parties.
11           But there are risks.  Although we
12   are not financial advisors or municipal
13   advisors, as bond counsel we want to make
14   sure that the public officials who are
15   considering and approving the swaps are
16   aware of the known risks of the
17   transaction.  Risks that are common to
18   variable-to-fixed rate swaps include
19   counterparty credit risk (such as default
20   by the counterparty), interest rate risk
21   (such as the variable rate paid by the
22   counterparty not being sufficient to cover
23   the issuer's variable rate debt), and
24   termination risk (including as a result of
25   a material change in the credit of the
0238
 1   issuer or swap insurer).  In my
 2   experience, the nature of such risks was
 3   carefully explained to issuers, both
 4   orally and in writing, and, more
 5   important, were understood by them.
 6   However, no one foresaw the dramatic
 7   impact of the mortgage credit crisis and
 8   associated financial market turmoil on
 9   these swap instruments.  Once the
10   underlying swap insures lost their
11   triple-A (or even lower) ratings, many
12   issuers were required to post collateral
13   or face termination.  Because of the
14   dramatic drop in interest rates, the fixed
15   interest rate stream being received by the
16   swap counterparty was very valuable and
17   therefore it was very expensive to
18   terminate, and at the same time it was
19   difficult to post collateral.  In addition
20   to the termination risks associated with
21   insurer downgrades, issuers found that
22   they had bargained away their right to
23   most economically take advantage of
24   declining long-term fixed interest rates
25   to refund variable rate debt because the
0239
 1   benefits of the refunding were outweighed
 2   by the termination costs of the swap
 3   contracts.  Nonetheless, at great cost,
 4   many issuers refunded their variable rate
 5   debt and terminated swaps just to be rid
 6   of these transactions.
 7           These market events -- "black swan
 8   events" if you will -- create significant
 9   costs and risks to many issuers that
10   either were not foreseen or were thought
11   to be so unlikely that they were not
12   viewed by issuers and others as a
13   realistic concern.
14           Swaps as a hedging instrument
15   still may be a useful public finance tool
16   if prudently used in situations that are
17   appropriate to the fiscal status of the
18   public body.  But in light of the
19   financial crisis and its material
20   financial impact on issuers that had
21   executed swap contracts, going forward --
22   at least in the short term -- many public
23   officials will not be willing or able to
24   justify, as a prudent public financing
25   practice, executing a swap contract to
0240
 1   save 10, 15 or 25 basis points in light of
 2   the possible material adverse impact of
 3   another "black swan" event.  For various
 4   reasons, including stories of significant
 5   termination fees being paid by public
 6   issuers to commercial and investment banks
 7   and the loss of all triple-A municipal
 8   bond insurers, we are simply not seeing
 9   any new interest rate swap contracts being
10   done to create synthetic fixed rate
11   financings.
12           We've all heard the highly
13   publicized allegations of abuses in the
14   swap process which have cast doubt on
15   whether particular transactions in fact
16   have been prudent and appropriate.
17   Although undoubtedly the Commission will
18   find instances of abuse, we suspect that
19   they occur without the knowledge of the
20   issuer community and most other public
21   finance professionals, and are not
22   representative of the open and transparent
23   processes that were used more generally.
24           For those who are still
25   considering swaps in the face of all this,
0241
 1   we applaud and encourage the efforts of
 2   the Commission and its staff to try to
 3   ensure that swaps are entered into with
 4   due appreciation of their risks as well as
 5   benefits, are fairly priced and otherwise
 6   are prudent and appropriate.  Thank you
 7   very much.
 8                 MS. STARR:  Thank you.
 9                 COMMISSIONER WALTER:  Can
10   you comment on whether interest rate swaps
11   are really the entire name of the game for
12   municipal entities or whether there are
13   other type of derivatives activities that
14   happen with any degree of frequency?
15                 MS. COLLIER:  I'll start.  I
16   think interest rate swaps for the general
17   municipal governments are, basically, the
18   only kinds of interest rate agreements
19   that we see.  When we get into the energy
20   and the revenue authorities that issue
21   debt, this may be more prevalent, so with
22   housing -- it could be prevalent with
23   housing authorities, other large issuers
24   who are doing project finance type
25   financings rather than general municipal
0242
 1   governments that are financing general
 2   purpose capital projects.
 3           I will tell you that I have two
 4   future contracts.  They were done, issued
 5   in conjunction with the QZAB program back
 6   in the early 2004 and 2005 and it was very
 7   hard to do, to get those bonds issued at
 8   that time.  Part of those forwards were to
 9   induce the underwriter to sell the bonds
10   because of the -- they were tax credit
11   bonds and the tax credit was not high
12   enough to reward the investment banker for
13   entering into the contract.  We had local
14   governments, school systems that needed
15   that money, and because of the tax credit
16   there was a substantial savings to the
17   issuer and so to accomplish those
18   transactions we entered into the forward
19   agreements.
20           Those are the only two forwards
21   I've seen in Tennessee.  There have been
22   discussions about ceilings, floors and
23   caps but I have not -- I'm not aware of
24   any of those.  They have to come through
25   my office, and I haven't seen any in the
0243
 1   18 months that I have had my current
 2   position.
 3                 MR. MCELROY:  I would concur
 4   that from the interest rate swap activity
 5   it has really contracted dramatically as
 6   Mr. Turner pointed out, and Ms. Collier.
 7   From the energy sector we are active
 8   participants in hedging our commercial
 9   risks relative to natural gas and other
10   fuels and that is an active component and
11   part of our cost and ongoing cost of doing
12   business, and it really provides a
13   terrific benefit for our customers in
14   terms of the stability of our pricing and
15   passing through those costs.  That's
16   really one of the largest concerns we
17   have.  Now, to some extent the market has
18   sort of at least established this
19   moratorium on interest rate swaps to some
20   extent because of the issues pointed out
21   here, but we are actively and ongoing
22   engaged in terms of the commercial risks
23   with respect to energy and fuels in all of
24   our sectors.
25                 MR. TURNER:  We've also seen
0244
 1   some interest rate caps for issuers who
 2   have variable rate debt that are willing
 3   to pay to cap their potential exposure.
 4                 MR. COOK:  Just to confirm
 5   because I think one of the reasons for the
 6   question in part is that the jurisdiction
 7   over the swap markets under Dodd-Frank are
 8   divided between the SEC and the CFTC and
 9   the CFTC would have jurisdiction over
10   interest rate swaps, but so you're not
11   aware of any swaps on a single security or
12   a small group of securities being used by
13   municipalities?
14                 MR. TURNER:  I've not seen
15   any in my practice.
16                 MS. STARR:  One of the
17   things that I was hearing was that the
18   pricing of the derivatives to the
19   municipality may be significantly
20   different than the pricing of a similar
21   derivative to a corporate entity.  Do you
22   know what the reasons for this might be,
23   and do the municipal entities know that,
24   in fact, they are paying more than the
25   corporate entity would be paying?
0245
 1                 MR. KALOTAY:  First of all,
 2   I would say they know.  And as I
 3   indicated, I see a horrible problem with
 4   the swap advisors who are reluctant to
 5   stand up against investment bank and
 6   negotiate as fiduciaries.  They cannot
 7   afford it because they are the one who are
 8   recommended by the investment bank to be
 9   the advisor on this, so the whole
10   situation just has to be revisited and the
11   whole structure in my opinion has to be
12   completely changed.
13                 MR. MCELROY:  I think I
14   would comment on that.  I think that what
15   we have is at least a very significant
16   example of the various levels of
17   sophistication in the market, and to some
18   extent, depending upon the sophistication
19   and activity in the market, procedures and
20   policies in place.  I would comment I
21   think the SIFMA swap market versus the
22   LIBOR market is probably less efficient,
23   that's a given, from the SIFMA in terms of
24   the municipal market versus LIBOR, that's
25   purely a market size, and the LIBOR market
0246
 1   is substantially larger and I think more
 2   efficient due to size.  So taking that
 3   off, I think the range of sophistication,
 4   if you look at some of the issues we heard
 5   today, Mr. Brooks pointed out -- or Dr.
 6   Brooks pointed out clearly we need to
 7   attract or do a better job attracting
 8   finance professionals to the municipal
 9   sector, whether that's a matter of
10   compensation or a call to service, we need
11   to do that, and I think that part of the
12   issue here is it has been lacking, quite
13   frankly, in terms of the professional
14   expertise and knowledge on the municipal
15   side, and to some extent ripe for being
16   taken advantage of by the folks that Mr.
17   Kalotay pointed out.  I think it's
18   critical, as Ms. Collier pointed out,
19   having absolutely firm requirement for
20   policies.  I mean you have to have a debt
21   policy that clearly articulates the steps
22   and the process.  Internal experts the
23   advisor cannot be a commissioned based
24   advisor if you're going to expect a good
25   outcome.  It should be a on retainer for a
0247
 1   fixed fee to provide services for a period
 2   of time.  To engage an advisor working
 3   with a commercial bank on a commission is
 4   at least, again, and this a level of
 5   sophistication and understanding the
 6   markets, it is just asking for problems,
 7   and I concur with that.
 8                 MS. KALOTAY:  If I may just
 9   make another comment --
10                 MR. MCELROY:  And just to
11   finish real quickly.
12                 MR. KALOTAY:  Sure.
13                 MR. MCELROY:  I think also
14   having the policies to make sure and
15   require that there's not just a
16   transaction bought, but your policy should
17   clearly lay out that you go to market and
18   you bid and get three bids, and your
19   advisor gives you current price discovery
20   of the market so you can see triangulate
21   to see if you're there and the fixed fee,
22   so, I'm sorry, go ahead.
23                 MR. KALOTAY:  No, what I
24   wanted to point out is it's very
25   instructive to look at the taxable markets
0248
 1   and compare them to what's happening in
 2   the municipal and tax-exempt markets; for
 3   example, this Denver transaction was a
 4   taxable deal, it was completely -- and had
 5   all the standard corporate bonds.  Somehow
 6   municipalities have been led to believe
 7   that these variable rate bonds, swap, this
 8   is a good deal.  They've been brainwashed
 9   into this, and if you look at corporations
10   that issue tax-exempt bonds, and there are
11   many of them who do tax-exempt pollution
12   control bonds, they don't these swaps, so
13   it makes you wonder how come that they are
14   not doing tax variable-rate bond swaps,
15   but all the municipalities are doing?  Is
16   it something that all the municipalities
17   know that nobody else knows or is it the
18   other way around?
19                 MS. STARR:  I was going to
20   say relating that to the disclosures where
21   there's come up the thought that municipal
22   entities may not necessarily understand or
23   fully comprehend the implications of
24   entering into the swaps and what effect
25   that will have on them in the future, I
0249
 1   think, you know, there are two questions
 2   related:  One is historically have
 3   municipal entities ever received any type
 4   of sensitivity analyses that would show
 5   the performance of the swap based on
 6   changing interest rates; and, second, and
 7   related to that, is to the extent that the
 8   municipal entity has not gotten that and
 9   does not necessarily understand how their
10   swap transaction works, how, and, Steve,
11   you may be able to weigh in on that, how
12   have municipal entities been able to
13   provide disclosure to their investors with
14   regard to their municipal securities as to
15   what their potential liabilities might be
16   under the swap transactions?
17   Mary-Margaret.
18                 MS. COLLIER:  I'd like to
19   say one thing about municipal entities,
20   traditional -- traditionally municipal
21   entities have entered into fixed rate
22   debt.  That process includes a financial
23   advisor who comes in and serves as
24   financial advisor until the deal is
25   closed.  That financial advisor may not be
0250
 1   seen again until the next deal is on the
 2   table.  What we're talking about here is a
 3   financial advisor who needs to be with the
 4   entity potentially for the life of the
 5   swap.  We need to have financial swap
 6   advisors who can feel comfortable saying
 7   "no, this is not the deal for you", and to
 8   be paid by the transaction is not going to
 9   get us to a point where the financial
10   advisor can say "no, this is not the deal
11   for you".  He's not incentivized to say
12   "no, this is not the deal for you".  So I
13   think when we were talking about retainers
14   and keeping financial advisors on board
15   for various duties is a help because we
16   can then say with confidence that the
17   financial advisor can say "no, this is not
18   the deal for you".  There are a lot of
19   financial advisors -- I mean, finance
20   directors in the municipal market who wear
21   multiple hats.  They are preparing the
22   budget, doing the debt, investing the
23   money, managing the pension fund, and the
24   list goes on and on, so how can they in
25   their -- with this respective duty be able
0251
 1   to manage and think about a swap for 20 or
 2   30 years?
 3                 MR. KALOTAY:  May I just
 4   make one comment?
 5                 MS. STARR:  Yes, yes.
 6                 MR. KALOTAY:  As you heard
 7   from Steve, you have to look at these
 8   swaps, most of these swaps in the context
 9   of a deal that involves a bond, it's a
10   variable rate bond swapped into presumably
11   a fixed rate, so you can't just look at
12   the swap in isolation, and so what happens
13   logistically is that the municipality
14   somehow sold this idea that oh, we should
15   do this structured deal and let's get the
16   wheels in motion, and then by the way they
17   say, oh, you need a swap advisor, so they
18   bring you the swap advisor as an
19   after-thought after it was decided to do
20   the whole structured deal, and the whole
21   thing should have been started way much
22   earlier and somebody should have --
23   financial advisor should have said, you
24   know, this is not such a good idea, let's
25   do a plain, vanilla fixed rate bond but it
0252
 1   doesn't happen because --
 2                 COMMISSIONER WALTER:  But
 3   when it's happening what disclosure is
 4   provided to the municipality about the
 5   swap?  What is the standard analysis or
 6   disclosure?  What facts are presented?
 7                 MS. COLLIER:  My fear here
 8   is that when someone comes in and presents
 9   the idea of a swap the first thing that is
10   said is "that this is going to save you
11   money on your tax rate today".  Once the
12   elected governing officials hear "it's
13   going to save you money on your tax rate
14   today" there's often selective hearing
15   about the risks that come after "this is
16   going to save you money today".  They
17   don't think about the long term economic
18   cycle and that this particular issue was
19   going to be in effect for 20 or 30 years,
20   that there are going to be multiple
21   legislative bodies that are going to be
22   looking at this transaction, that there
23   are going to be multiple finance directors
24   who have to manage this transaction.  That
25   doesn't include all of the risks that this
0253
 1   transaction takes into place.  Often, also
 2   in public meetings when we're talking
 3   about debt issues, you would hope that
 4   there's going to be 20 or 30 minutes spent
 5   in discussion for a simple fixed rate
 6   deal.  When we're talking about a swap
 7   deal you probably need a longer discussion
 8   about all of those risks.  When city
 9   councils or county commissions or
10   authorities are in this process and in the
11   public meeting they just don't take that
12   much time to understand the swap
13   transaction.  If they are meeting in a
14   workshop, that's not in the Sunshine, so
15   we need to be able to hear these comments,
16   these risks in the Sunshine and to take
17   more time with them.
18                 MR. TURNER:  What the
19   issuers typically see is really varies --
20   it really varies quite a lot depending on
21   the size and sophistication of the issuer
22   and the transaction.  We've had sometimes
23   where the perspective counterparty has
24   come and made a presentation to the board
25   of directors or governing board of the
0254
 1   public body, including presentations to
 2   the risks and benefits involved in the
 3   transaction, including as Mary-Margaret
 4   says the savings to the transaction, very
 5   important element for them, but there is
 6   some discussion of risks.  We have seen
 7   other transactions where this function has
 8   been performed by an independent swap
 9   advisor, somebody who is not even
10   necessarily involved in the business of
11   writing or being a counterparty to swaps.
12   The presentation there oftentimes is much
13   the same, sometimes it's more extensive.
14   This may not be the case in all
15   transactions.  It, in my experience
16   anyway, has not been uncommon.  We've also
17   seen extensive statistical sensitivity
18   analyses, particularly for the much larger
19   issuers who are contemplating
20   multi-million dollar swaps with multiple
21   counterparties and the like, so I think it
22   really does range from maybe people not
23   providing adequate disclosure to people
24   really providing disclosure that's about
25   as, you know, maybe as good as you're
0255
 1   going to get under the circumstances
 2   without accounting for this unanticipated
 3   market of people --
 4                 MS. STARR:  But, Steve, do
 5   you think that the level of information
 6   that may be provided to a municipal entity
 7   is going to depend of the sophistication
 8   of the municipal entity itself, so if, for
 9   example, you know, somebody was selling a
10   swap to New York City rather than selling
11   a swap to, you know, Little Town, USA,
12   (a), you know, is the information provided
13   going to be different; (b) is the pricing
14   going to be different because I would
15   assume that New York City is going to be
16   able to do their own digging to make sure
17   that they're getting the right pricing on
18   their swap because they have, you know,
19   many people are significantly experienced
20   in that area, is that an accurate --
21                 MR. TURNER:  They're also
22   very likely -- I mean, they've got the
23   money to hire an independent advisor,
24   they're often very likely to do that to
25   provide some back-up to the legislative
0256
 1   decision to enter into the transaction.  A
 2   smaller swap participant is unlikely to
 3   have the money to hire the advisor and may
 4   not even realize that they need the
 5   additional comfort.
 6                 MR. COOK:  Could you discuss
 7   a little bit more the conflicts of
 8   interest that you see in this area?  You
 9   referred to some already, and obviously
10   having an independent advisor versus
11   getting the disclosures from the
12   counterparty, but what -- and some of the
13   compensation issues.  What do you see as
14   the key conflict of interest, number one;
15   and, number two, are they the types of
16   conflicts that can be corrected through
17   disclosure, or are there certain conflicts
18   that ought to just be prohibited
19   altogether?
20                 MR. TURNER:  From my point
21   of view I have to agree to some extent
22   with Dr. Kalotay, somebody who is
23   proposing a transaction for its own
24   financial benefit has got something of a
25   conflict of interest in terms of laying
0257
 1   out the pluses and minuses.  Whether they
 2   are conscientious in doing that and
 3   whether you've got a good deal of trust in
 4   them is a separate issue, but there's
 5   certainly an inherent plus and minus
 6   involved.
 7                 MS. COLLIER:  I've seen
 8   conflicts of interest where a party is
 9   coming in, proposing to issue the variable
10   rate debt, a bank that they are affiliated
11   with is providing the liquidity, a trustee
12   that they are affiliated with is providing
13   the trustee's services, and they are also
14   recommending the swap counterpart, so I
15   see that as a conflict of interest.  It's
16   disclosed, but no one understands the
17   conflict of interest that's going on
18   there.
19                 MR. KALOTAY:  If I may, if
20   you've ever seen a report, and some of you
21   obviously have by a swap advisor and you
22   look at these, sometimes you would think
23   by reading it that it was written by
24   somebody who's working for the investment
25   bank, not for the client.  They are so
0258
 1   much gung-ho about doing this particular
 2   deal with the swap and talk about the
 3   benefits of doing the variable rate, the
 4   swap, and so on and so forth.  There's
 5   nothing to defend the client.  That's what
 6   I see anyway.
 7                 MS. COLLIER:  And the client
 8   is paying higher fees to get all of this
 9   done.
10                 MR. KALOTAY:  Of course.
11                 DR. BROOKS:  Just as a
12   university professor for 25 years in the
13   financial derivatives area, it's
14   interesting to me that almost none, I
15   think one went into the municipal finance
16   space and there's such a frustration that
17   to me I know of no other place where you
18   can bring such value to the municipal
19   finance space because the issues are
20   complicated.  There's a great opportunity
21   to provide some quality service here, but
22   it's -- and I'm not sure this is the right
23   way to say it, but if you're not
24   affiliated with the right political party,
25   you're sat on the bench until that
0259
 1   political party comes back, and so I don't
 2   know how you get around that.  I don't ask
 3   my cardiologist what political
 4   affiliations they have.  I ask are they
 5   board certified, and I mean that's one
 6   frustration I've heard in the past, is
 7   well, we've done great work for this
 8   community but now there's a different
 9   political party in office and now,
10   therefore, we're completely out of the
11   business.  And I don't know about you, but
12   that's not a line of work I want to get
13   into if you're going to be put on the
14   bench for a while.
15                 MS. STARR:  One of, you
16   know, the other issues I think, you know,
17   that you have raised a lot is we're
18   talking about swap advisors and we're
19   talking about underwriters.  The entities
20   then who, if you can talk a little bit
21   more about who really arranges the
22   municipal derivative?  Is it the
23   underwriter, is it the swap advisor, is it
24   the person that's packaging the whole deal
25   together?
0260
 1                 MS. KALOTAY:  Typically the
 2   underwriter wants to be -- the underwriter
 3   is the major bank and they want to be the
 4   swap counterparty, and, in fact, they are
 5   recommending -- in my opinion they
 6   recommend these structure transactions not
 7   to underwrite the bonds but to get into
 8   the swap because they're making much more
 9   money on the swap than they could ever
10   make in underwriting.  Doing a swap
11   involves a couple of people and that's it,
12   and you walk away from it and then you
13   have locked in two points.  You underwrite
14   the deal and you get five-eighths of a
15   point and then you have to start
16   distributing it to the salespeople.  This
17   is an incredibly profitable deal and I'm
18   convinced that the sole reason investment
19   banks are used to be promoting these
20   structured deals is to get into the swap.
21                 DR. BROOKS:  When I present
22   the '97 Jefferson County swap to my class,
23   and I've done it every year since 1998, I
24   get two responses, number one -- and I did
25   this a long time ago, the student would
0261
 1   ask who's going to jail when they saw the
 2   materials.  The other group of students
 3   would say how can I get in this business.
 4                 MS. STARR:  Connected to all
 5   of that, I think, you know, it was as a
 6   follow-in to one of my earlier questions,
 7   and, you know, maybe if we can talk a
 8   little bit more about it, that would be
 9   helpful, I'm not sure if we can or not,
10   but, you know, if there's a possibility
11   that the municipal entities may not fully
12   understand or comprehend the totality of
13   their obligations under the swap
14   transactions, what kinds of improvements
15   do we think we really need to get in the
16   disclosures that the municipal entities
17   are making about their potential
18   liabilities under the swap transactions?
19   So, for example, you know, the potential
20   for a termination payment in the event
21   there's a desired, you know, refinancing,
22   the potential for posting of collateral if
23   interest rates go against them.  You know,
24   I think one of the key questions we always
25   are looking at is, you know, do they
0262
 1   understand what they have so that they can
 2   appropriately make disclosures to the
 3   marketplace and to their investors?
 4                 MS. COLLIER:  Are you
 5   talking about in the official statement,
 6   in the continuing disclosure, or in the
 7   CAFR?
 8                 MS. STARR:  Well, I think, I
 9   think I would say all three.  Because I
10   think as we're hearing, we have
11   implications going in, and we have
12   implications through the life, and, you
13   know, until the deal is paid off and the
14   swap is no longer there, you know, you
15   need to know what's going on because it
16   will impact potentially either your
17   current financial position or it's a trend
18   or potential contingency in the future
19   that could impact your future financial
20   condition.
21                 MS. COLLIER:  I'll tell you
22   this, that in GASB-53 it is very specific
23   about what you are supposed to disclose,
24   and you do not -- and GASB-55 just came
25   out which is on the discussion of
0263
 1   termination payments, and I was talking to
 2   a member of the GASB board last week and I
 3   said now, are we talking about disclosing
 4   in the GASB statements in our CAFRs --
 5   pursuant to the GASB are we talking about
 6   telling each year what the termination
 7   payment maybe, and this person said no,
 8   it's only when the termination event
 9   occurs, so we aren't disclosing there and
10   that's not required by the GASB.  15c2-12
11   continuing disclosure I think would be an
12   appropriate place, and perhaps in our
13   official statements once a transaction has
14   been entered into, talking about potential
15   risks to a transaction that has already
16   occurred I think the rating agencies like
17   that, we certainly like that as part of
18   our disclosure, but most definitely as you
19   are moving through that transaction in the
20   15c2-12 disclosure it should be there.
21                 MR. MCELROY:  I think maybe
22   we do disclose through the combination of
23   GASB/FASB in our reporting so in terms of
24   on the annual basis the mark and that's
25   fully disclosed to the readers of our
0264
 1   statements, but I think maybe one thing
 2   that might improve the disclosure is the
 3   risk of the liquidity support provider in
 4   the underlying variable interest rate
 5   debt, and to me that's probably one area
 6   that we haven't really talked about as
 7   being the trigger for all of the issues
 8   that come out in terms of having to
 9   refinance the swap or terminate the swaps,
10   so what happened in this marketplace was
11   that the underlying variable rate debt was
12   supported by liquidity provider, sometimes
13   unfortunately one of the same investment
14   banks that was in the mix here, and those
15   banks withdrew from the market
16   substantially in terms of the credit
17   support and you've got to have that in
18   order to make sure that the bonds can stay
19   out, and, therefore, you're forced to
20   refinance in the market to take advantage
21   in terms of the swap differential.  So I
22   think in terms of the risks of both the
23   ongoing availability of credit support and
24   also the pricing, because at the same time
25   many of these transactions were entered
0265
 1   into in the 2006, seven and maybe eight
 2   time frame liquidity support was 15 basis
 3   points, and going to market now that same
 4   liquidity support you're upwards of a
 5   hundred basis points, so even if you were
 6   able to keep your transaction glued
 7   together, you now have given up the
 8   economics that you thought you had, even
 9   though you haven't had to go ahead and do
10   the termination swap and fix out, so I
11   think two areas of disclosure might be the
12   liquidity support provider both in terms
13   of duration and in terms of the
14   variability of fee and how that might
15   effect the transaction.
16                 MS. COLLIER:  Also the
17   credit quality of the counterparty should
18   be disclosed, too, because there was one
19   counterparty that had a triple-A rating
20   for a lot of the swaps in Tennessee who
21   dropped significantly in their rating
22   which also effected the swap.
23                 MR. MCELROY:  I would agree.
24   That's a good point.
25                 MS. STARR:  I have one last
0266
 1   question which you may or may not be able
 2   to answer.  Do you know about the
 3   prevalence or lack of prevalence of CDS
 4   involving municipal entities?  Credit
 5   default swaps.
 6                 MR. KALOTAY:  What about
 7   them exactly?
 8                 MS. STARR:  Well, whether or
 9   not, you know, is there a market in credit
10   default swaps on municipals --
11                 MS. KALOTAY:  Not too much,
12   very little, very little.
13                 COMMISSIONER WALTER:  Well,
14   I think we've come to the end of the time.
15   I want to thank you all for coming, and,
16   Dr. Brooks for doing double duty, and
17   thank you very much for your
18   participation.  We are going to again
19   switch panels but not take a break, and I
20   encourage all of you to stick around with
21   us for the last panel.  We promise great
22   drama.  I don't know of what sort, but we
23   promise it anyway.
24           (Off the record.)
25   
0267
 1                 COMMISSIONER WALTER:  We're
 2   going to get going.  Alicia, go ahead.
 3                 MS. GOLDIN:  The last panel
 4   of the day is entitled Pre-trade Price
 5   Transparency.  Investors lack confidence
 6   that they are receiving fair pricing when
 7   they go to buy and particularly when they
 8   go to sell municipal bonds.  This panel
 9   will examine the current landscape of the
10   market in terms of information that is
11   available today and will explore potential
12   ways to foster greater price transparency,
13   whether through incremental steps or
14   through broader initiatives which may
15   include changes to market structure
16   related to fixed income.
17           I'm very honored to be moderating
18   a panel of such distinguished individuals.
19   Ernie Lanza is Deputy Executive Director
20   and General Counsel of the Municipal
21   Securities Rulemaking Board.  Jon Barasch
22   from Interactive Data Pricing and
23   Reference Data, one of the pricing
24   services, is a senior manager responsible
25   for overseeing municipal evaluations and
0268
 1   municipal credit analysis.  Jack Lynch is
 2   Executive Vice President and Chief
 3   Operating Officer of Hartfield, Titus &
 4   Donnelly, a major municipal securities
 5   broker's broker.  Rick Roberts is a
 6   principal at a regulatory and legislative
 7   consulting firm, Roberts, Raheb and
 8   Gradler.  He's also former SEC
 9   Commissioner, having served in that role
10   from 1990 to 1995.  Finally, Johnny
11   Lessley is a Managing Director of
12   Municipal Trading at Memphis based
13   Duncan-Williams, which happens to be one
14   of the largest female owned investment
15   banking firms in the country.  Thank you
16   all for participating.  Ernie, would you
17   like to start things off?
18                 MR. LANZA:  Sure.  Thank
19   you, Commissioner Walter, Director Cook,
20   Alicia and the rest of the Commission
21   staff.  I appreciate being able to be with
22   you here today on behalf of the Municipal
23   Securities Rulemaking Board.  The MSRB
24   views today's venue particularly apt given
25   what the citizens of Jefferson County have
0269
 1   been going through.  Last year Congress
 2   expanded the MSRB's mission beyond our
 3   historic investor protection focus to also
 4   include the protection of state and local
 5   government and other municipal entities.
 6   We're committed to working with the
 7   Commission to address through the MSRB's
 8   rulemaking and with financial
 9   professionals in our market data and
10   disclosure services some of the problems
11   brought out by the Jefferson County
12   situation and other issues facing the
13   municipal securities market.
14           This final panel of the day is
15   focused on transparency in the municipal
16   securities market, specifically pre-trade
17   price transparency; that is, public
18   availability of prices at which market
19   participants are willing to buy or sell
20   bonds, the prices at which they're
21   actually sold and the size and number of
22   trades.  This information is most helpful
23   to the investor if he or she has it before
24   buying or selling the bond so the data can
25   be used in making a well-informed pricing
0270
 1   decision.
 2           Commissioner Walter and others at
 3   the Commission have suggested that the
 4   municipal securities market might benefit
 5   from greater pre-trade transparency.  I'll
 6   talk for just a few minutes about this
 7   topic in general terms.  Our written
 8   statement we submitted to the hearing goes
 9   in much more detail.
10           As you've already heard earlier
11   today, the municipal securities market is
12   large and extremely diverse with
13   approximately 1.5 million different
14   municipal securities outstanding with a
15   value of well over 3 trillion in our
16   estimation.  Munis represent a wide
17   variety of credit structures, call
18   features, put options and other terms and
19   conditions.  This contrast sharply with
20   the stock market where about 57 hundred
21   equity securities trade on U.S. exchanges
22   as well as with the treasury market where
23   there are only about 2 hundred and 50
24   different securities.  Over 99 percent of
25   municipal securities do not trade in a
0271
 1   given day and over 90 percent typically do
 2   not trade in a given month.  What that
 3   means is that today using round numbers
 4   about 14 thousand different municipal
 5   securities may trade, but that actually
 6   means that the other 1 million 4 hundred
 7   and 86 thousand municipal securities will
 8   not have traded today and in a whole month
 9   still 1 million 3 hundred and 50 thousand
10   municipal securities will not have traded
11   throughout the entire month.
12           On top of that, which of those 1.5
13   million municipal securities may trade
14   each day changes as new issues come to
15   market, are traded for a short period of
16   time and eventually are purchased by
17   investors who hold those as long term
18   investments, the so-called buy and hold
19   investors.  As a general matter, municipal
20   securities trade most heavily within the
21   first 30 days after issuance and
22   thereafter trade significantly less often
23   until they finally mature.  Except for a
24   relatively short period of time before and
25   into the Great Depression municipal
0272
 1   securities have not successfully been
 2   traded on exchanges, but instead are
 3   traded on what is called over-the-counter
 4   market, with broker-dealers and banks
 5   across the county handling the buying and
 6   selling of municipal securities.  Several
 7   hundred firms buy and sell municipal
 8   securities on a daily basis, but given the
 9   breadth of the municipal market and the
10   frequency of trading in the vast majority
11   of bonds is perhaps not surprising that
12   only a small fraction of outstanding munis
13   have broker-dealers or banks that are in a
14   position to establish firm two-sided
15   quotations.
16           This background illustrates the
17   difficulty in finding a solution for the
18   question of greater price transparency.
19   The MSRB laid down the first key building
20   block with the launch our real-time
21   transaction reporting system back in 2005.
22   This system provides public disclosure of
23   trade price, amounts sold and type of
24   trade on virtually every trade in the muni
25   market, with the vast majority available
0273
 1   15 minutes after trade, and usually much
 2   more quickly.   Every indication is that
 3   this real-time data has reduced
 4   information asymmetries, improved pricing
 5   and helped to broaden the investor base.
 6           Beginning in 2008 this real-time
 7   trade data became free to the public
 8   through the MSRB's Electronic Municipal
 9   Market Access website, or EMMA.  The EMMA
10   website integrates this trade price data
11   with interest rate data and related
12   documents for variable rate securities as
13   well as with new issue, offering documents
14   and continuing disclosure documents.  EMMA
15   serves as a free, user-friendly platform
16   that brought retail investors for the
17   first time onto a more even playing field
18   with market professionals.  The MSRB has
19   taken on the question of what more can be
20   done to improve the flow of trade data to
21   investors so they can make informed,
22   well-priced investment decisions.  As we
23   previously announced, the MSRB is working
24   with Professor Erik Sirri, former SEC
25   Chief Economist and a predecessor to
0274
 1   Director Cook, on a study of market
 2   structure.  Professor Sirri is currently
 3   sifting through eight years of trading
 4   data reaching back to the days of next-day
 5   trade reporting limited to frequently
 6   traded securities to the current real-time
 7   system for all muni trades.  He's looking
 8   to gain a comprehensive understanding of
 9   the trading characteristics of this market
10   to replace what until now has generally
11   been merely anecdotal understandings of
12   current muni market trading behavior.
13   He's looking to assess the empirical
14   effects of real-time post-trade
15   transparency on transaction costs and
16   other trade characteristics.  He's also
17   considering the nature, extent and causes
18   of price dispersion across different
19   categories of market participants,
20   focusing specifically on retail investors.
21   Perhaps his most challenging task is to
22   develop a preliminary assessment of the
23   impact of current forms of pre-trade
24   transparency such as through alternative
25   trading systems or other market mechanisms
0275
 1   in light of the private nature of these
 2   venues and a limited dissemination of
 3   information from them to the broader
 4   markets.
 5           The overriding focus of our work
 6   will be on transparency as it relates to
 7   investor protection, particularly in the
 8   retail market.  After all, a retail
 9   investor can face challenges in
10   understanding the value of his or her
11   security when trying to sell a relatively
12   small lot of a security that may not have
13   traded any time recently.  Of course,
14   whatever difficulties the customer may
15   have in determining the fair value of his
16   or her bond, the dealer will always be on
17   the hook for obtaining a fair and
18   reasonable price for the investor under
19   MSRB Rule G30.  Given the complexity of
20   the marketplace and the issues being
21   considered, our expectation is that any
22   initial findings will not be the end, but
23   only the beginning of a process that will
24   inevitably lead to significant
25   transparency improvements spanning
0276
 1   pre-trade, concurrent and post-trade
 2   information flows.  There is much more
 3   work to be done before we have interim
 4   findings to release publicly as an MSRB
 5   concept release or other notice comments.
 6   The MSRB will be keeping the Commission
 7   apprised of our progress, and we look
 8   forward to working with you to identify
 9   and implement any appropriate actions
10   called for from our findings.  Thank you
11   again for inviting me and I look forward
12   to your questions.
13                 MS. GOLDIN:  Thank you,
14   Ernie.  Jon.
15                 MR. BARASCH:  Thank you.  I
16   would like to thank Commission Walter and
17   the staff of the SEC for inviting me to
18   participate in today's field hearing.  I'd
19   especially like to thank Alicia for
20   organizing this panel.
21           My name is Jon Barasch and I'm the
22   Senior Manager of the Municipal Evaluation
23   Group at Interactive Data.  Interactive
24   Data provides daily evaluated prices for
25   more than 2.8 million global securities
0277
 1   across various asset types and
 2   structures-- including 1.3 million
 3   municipal bonds.  Pre-trade price
 4   transparency likely means different things
 5   to different parties.  To me this means
 6   what is a bond worth today-- and absent
 7   recent trade data --this could be a
 8   difficult question to answer.  Bid and
 9   offering levels, credit information, and
10   comparable bonds are all key factors to
11   consider when making a pre-trade decision.
12   Interactive Data collects, analyzes, and
13   incorporates this data into our daily
14   evaluating prices.
15           We are an independent source of
16   evaluated prices.  An evaluation
17   represents our good faith opinion, based
18   on information available to us at the
19   time, as to what a buyer in the
20   marketplace would pay for a security
21   (typically in an institutional round lot
22   position) in a current sale.
23           Given that, on average, less than
24   one percent of the outstanding U.S.
25   dollar debt trades on any given day, we
0278
 1   generally draw parallels from current
 2   market activity to generate evaluations
 3   for the majority of issues that have not
 4   traded.
 5           Interactive Data serves major
 6   financial institutions and corporations
 7   worldwide.  Our clients include more than
 8   5 thousand global organizations in more
 9   than 50 countries.  Our pricing,
10   evaluations and reference data clients
11   include government entities, central
12   banks, broker-dealers, clearing and
13   custody firms, mutual funds, banks,
14   insurance companies, investment managers,
15   and hedge funds.
16           As I mentioned earlier,
17   Interactive Data prices 1.3 million
18   municipal issues using a model-based
19   evaluation process.  We have a staff of 22
20   evaluators organized by market sector.  We
21   have a trading desk structure divided
22   among high grade, high yield, and taxable
23   markets.  Our staff averages 11 years of
24   evaluation experience and over 26 years of
25   total securities industry experience.  We
0279
 1   also have a separate municipal credit
 2   analyst group which supports our
 3   evaluators and that includes a staff of
 4   seven comprised of five senior analysts
 5   and two support personnel, and their
 6   function is to provide fundamental credit
 7   analysis and review of material event
 8   notices.  The three main drivers that go
 9   into an evaluation are, number one,
10   transaction activity-- primary market new
11   issues and secondary market, MSRB trade
12   data; second is market color-- bids,
13   offers, two-sided markets; and, third, is
14   credit information-- audited financial
15   statements, default and material events
16   notices, and rating actions.  Thank you.
17   
18           (Off the record.)
19   
20                 MS. GOLDIN:  Jack.
21                 MR. LYNCH:  Sure.
22   Commissioner Walter, thank you very much
23   for the invitation to participate, I and
24   the owners of Hartfield, Titus and
25   Donnelly, which makes me very happy, are
0280
 1   very pleased and honored to be asked to
 2   participate.
 3           Now, as far as thanking the staff,
 4   I'm not sure.  I was going to until you
 5   said this going to be an exciting panel,
 6   and then I noticed that Alicia has
 7   triangulated Johnny and I between all of
 8   our regulators-- FINRA, the SEC and MSRB,
 9   so if there's a target floating around up
10   here some place, I can't see it, but just
11   in case.
12                 MR. COOK:  It's on your
13   back.
14                 MR. LYNCH:  It's on my back.
15   That's what I figured.  It's been there
16   many times.  Hartfield, Titus and Donnelly
17   is particularly positioned in the market
18   to provide information flow of pre-market
19   transparency to the interdealer secondary
20   market community.  Now, some of what I'm
21   going to be saying may sound like a
22   commercial and some of it is a commercial.
23   However, my intention is that by
24   explaining, partly explaining the way we
25   operate I will provide a good insight into
0281
 1   the inner-workings of the interdealer
 2   secondary market.
 3           HTD operates as a broker's broker,
 4   not a customer's broker, a dealer's
 5   broker, and we do that in municipal and
 6   government securities.  We're also
 7   registered with the Securities & Exchange
 8   Commission as an alternative trading
 9   system.  We execute transactions primarily
10   with registered broker-dealers.  We do
11   have some transactions with sophisticated
12   municipal market participants, but that
13   represents less than one percent of what
14   we do, so we truly are part of the
15   interdealer secondary market.
16           What's important to know about a
17   broker's broker and sets us apart from a
18   dealer is we do not maintain any
19   securities in our proprietary positions,
20   we do not participate in underwritings,
21   nor do we hold any funds or securities of
22   those we broker with.  Our compensation
23   comes from commission on a trade as
24   opposed to a mark-up on a transaction.
25   Now, I emphasis trade because I think the
0282
 1   general concept the public and regulators
 2   maybe feel a trade and transaction is
 3   interchangeable, but for us as a broker's
 4   broker it absolutely is not.  We do trades
 5   and we have multiple transactions in the
 6   trade.  So I may have a trade in which
 7   there's one or more buys and one or more
 8   sales, but the key is at the end of the
 9   day we don't position, so everything we
10   bought is sold and everything we sold is
11   bought.
12           What service do we provide to the
13   dealers in the interdealer market?  We
14   provide liquidity, anonymity,
15   communications, and this is that
16   transparency information flow, and order
17   matching.  We also do and provide extended
18   distribution for sometimes in a new issue
19   dealers and underwriters have leftover
20   bonds and we'll act as their arms in the
21   street to distribute that.
22           How do we provide the service?
23   Very, very simply stated we provide the
24   service in two ways, Alicia and Dave, I
25   don't know if Amy was on the phone call,
0283
 1   but we went over this on the website.
 2   There are just two ways that we provide
 3   the service.  We solicit from buyers, one,
 4   for securities that a dealer gives us that
 5   has a price, we solicit buyers for them.
 6   The second thing we do with buyers is the
 7   securities that a dealer gives us that
 8   does not have a price we solicit bids for
 9   them, so in reality there's only two
10   functions that we perform, one's called
11   offerings-- that's when there's a price,
12   and the other one's called bid wanted--
13   that's when we're looking for a price.
14           In the effort to move forward with
15   everything, I have taken out two
16   paragraphs that go further into offerings
17   and bid wanted, and I'm very happy to do
18   that when we get into questions, if it's
19   of interest.
20           Why do dealers use us?  In
21   particular I'm talking about HTD.  We are
22   an alternative trading system just like
23   BondDesk and Market Access we have a
24   platform-- plug, HTDonline.com.  However,
25   where we differentiate ourselves from
0284
 1   those other platforms is in addition to
 2   the platform, we supplement the limited
 3   exposure for offerings and bid wanted by
 4   an extensive network of employees around
 5   the country.  We divide the country into
 6   seven regions and we cover those regions
 7   out of San Francisco, California; Dallas,
 8   Texas; Chicago, Illinois; Oak Lawn,
 9   Illinois; Roswell, Georgia just outside of
10   Atlanta; and our main office Jersey City,
11   New Jersey.  It allows us we feel to
12   provide a superior method for distributing
13   the offerings and also soliciting bids.
14   Plug number two-- what we like to think is
15   our reach is national but our touch is
16   local.
17           Pre-trade transparency.  There are
18   two points to this and I'll make them
19   quick.  One has to do with statistics and
20   the other has to do with something that
21   Alicia and Dave and I talked on the phone
22   about the other day.  Statistics, we've
23   all heard about the statistics, and Ernie
24   went over them today.  The only thing I
25   would change with Ernie's one million and
0285
 1   a half issues is that an awful lot of them
 2   trade once in 20 years.  Now, the second
 3   statistic is a statistic that we at HTD
 4   did specifically for this hearing.  We are
 5   an alternative trading system so we report
 6   every quarter our statistics on our trade
 7   volume.  In the two year period, 2009 and
 8   2010, during that period we brokered--
 9   remember as a trade, brokered-- we
10   brokered 77 thousand different issues.  In
11   two years 77 thousand different municipal
12   securities as opposed to only maybe 5
13   thousand in the corporate equity market.
14   Of that 77 thousand, 55 thousand were
15   brokered only once, that's 72 percent of
16   them were brokered only once.  Another 11
17   thousand were brokered only twice, so that
18   means that during that period 87 percent
19   of the different municipal securities that
20   we brokered traded two or fewer times.
21   And the last statistic, and during that
22   period about 9 hundred or approximately
23   one percent of all the securities we
24   brokered traded ten times or more, and as
25   Ernie said earlier, that ten times or more
0286
 1   maybe we had one that traded 2 hundred
 2   times, but that comes about during the new
 3   issue period where a lot of activity takes
 4   place.  The second part of this as a final
 5   thought, Alicia had asked for thoughts
 6   about possible ways to improve pre-trade
 7   price transparency, and I thought of two
 8   ways of doing this.  In addition to plain
 9   price transparency, she talked about the
10   ability to have a retail investor show
11   their securities, maybe with a limit price
12   or retail investors see what other
13   investors might want to sell their
14   securities at, so I think it can be done.
15   I think we can do -- I don't want to say
16   it in a way that's degrading, but an eBay
17   type.  We can come up with some way to
18   have investors show their securities.  And
19   I think we can also do a way to show
20   investors a pre-trade price.  But in the
21   sense of brevity, I'll stop there, wait
22   for the questions, and, again, I thank you
23   for inviting me and look forward to
24   working with you and the Commission in the
25   future.
0287
 1                 MS. GOLDIN:  Thank you.
 2   Rick.
 3                 MR. ROBERTS:  I appreciate
 4   the opportunity to be here for a couple of
 5   reasons.  First of all, after this is over
 6   with, I'm going to see my 87 year old
 7   mother, and she's always expressed a
 8   couple of concerns to me.  One, she never
 9   quite figured out what the SEC was; two,
10   she never understood why she paid all this
11   money for me to go to law school and then
12   work in government most of my life; and,
13   three, she never, ever understood why I
14   moved to Washington, so later today I look
15   forward to the opportunity to introduce
16   her to some other SEC folks and maybe my
17   standing in life will finally go up.
18             There's another reason I
19   appreciate the opportunity to be here,
20   Chairman Bachus in particular has been
21   very concerned for many years about the
22   quality of disclosures as well as certain
23   practices that have occurred in the
24   municipal securities market, so I think
25   it's timely and important that this
0288
 1   hearing is being held here in Jefferson
 2   County at this time.
 3           Secondly, in particular Chairman
 4   Schapiro and Commissioner Walter in
 5   different roles, and, again, this was some
 6   20 years ago have been very, very
 7   interested in municipal securities public
 8   policy issues.  I want to say for the
 9   record that they were 16 when they first
10   started working for the SEC, and so I want
11   to commend them for their leadership in
12   holding not only the hearing here, but the
13   other field hearings in San Francisco and
14   D.C., and I think it's important and
15   timely for that reason as well.
16           My own view is the Commission has
17   made a number of improvements in municipal
18   securities market disclosure over the past
19   25 years.  Most of that has occurred while
20   working with the MSRB, FINRA, other folks
21   in the private sector and it's been
22   coupled with improvements in technology
23   and other sort of communications
24   technology and other technological
25   improvements, but most of that has been
0289
 1   accomplished on the back of the dealer
 2   industry.  That needs to change, and I
 3   hope it does.  I've said that for some 20
 4   years now.  Unfortunately, it's like
 5   Ground Hog Day every day in muni world,
 6   but if Congress would ever get around to
 7   looking at the SEC's authority, I know
 8   it's impolitic to say this given
 9   Dodd-Frank and all the current controversy
10   surrounding it, and, look, it's no
11   understatement to say I'm no Dodd-Frank
12   fan, but the Commission needs broader
13   jurisdiction in the area.  I don't know
14   where that would lead, but I do encourage
15   Congress to take a look at that.  For sure
16   it seems to me that conduit issuers should
17   be treated like corporate borrowers, that
18   governmental issuers should be subject to
19   the same set of -- required to satisfy the
20   same set of accounting standard, 2 hundred
21   and 70 days way too long to produce
22   financial statements, and I personally
23   think the municipal industry needs one
24   SRO, and sorry, Mac, but I think it should
25   be MSRB, but that's just my view.
0290
 1           But with respect to the issue more
 2   pertinent to this panel with respect to
 3   trade price transparency, I've heard of a
 4   number of suggestions in the past, I
 5   learned some new ones today, which I need
 6   to think about a little bit, but some that
 7   I've heard are, and I think everything's
 8   worth considering certainly to try to
 9   create some sort of limit order system for
10   the municipal securities market.  I
11   personally think that would be kind of an
12   expensive way to go and, you know, just
13   from a cost benefit standpoint, I'm not
14   trying to hit anybody's weak spots, but I
15   just don't think that makes a lot of sense
16   to me.  Another suggestion that I've heard
17   is that look at what kind of information
18   is available to interdealer brokers and
19   try to make more of that -- some of that's
20   made available now to retail or individual
21   investors and maybe there's some
22   information that's relevant that they
23   would be interested in that would be
24   helpful to them.  There is a dichotomy
25   between institutional and individual
0291
 1   marketplace, but I think you would want to
 2   be very careful with respect to any more
 3   requirements that are imposed on the
 4   broker-dealer industry personally.
 5   Another suggestion I've heard -- first of
 6   all, let me diverge for just a minute.  I
 7   think EMMA's been a great success when it
 8   was created, I'm not quite sure, a few
 9   years ago.  I was glad to see it.  It's
10   been a real improvement in terms of
11   availability of information to individual
12   investors in my judgment.  I think the
13   last sale information is very important.
14   One suggestion that's been made to me and
15   that I hope is taken seriously in that
16   regard is to have someone sort of compile
17   an index from the last sale information
18   that's available and EMMA is close to
19   real-time.  I know there's at least one
20   index out there.  I don't know much about
21   it.  I'm not sure how it's created, maybe
22   it's good, I'm not in a position to judge,
23   but it would be nice if an index from the
24   last sale information was compiled and
25   published from EMMA, maybe it should be
0292
 1   the MSRB, maybe it should be open to other
 2   platforms, and somehow or another put some
 3   sort of encouragement for them to make
 4   that available to the investor community,
 5   and I think that's a very good suggestion.
 6           Another suggestion I've heard is
 7   for the brokers to publish the marks they
 8   mark and secure their inventory up at
 9   night, for capital reasons, I don't know
10   how good -- I don't know how -- I don't
11   know about the quality of that information
12   from an investor standpoint.  Those are
13   estimates.  I guess they're pretty good if
14   the securities are traded frequently.  I
15   think there's other information out there
16   that's probably better.  My own view is
17   that that's probably not all that useful,
18   so I don't think that highly of that.  I'm
19   hoping there will be some other
20   suggestions flowing from the study that
21   Dr. Sirri has undertaken on behalf of the
22   MSRB, and I look forward to reading that
23   study when the report's completed.
24           Over the last couple -- since I've
25   been at the SEC retail investors have
0293
 1   become a very self-reliant bunch.  There's
 2   a lot more information available to them
 3   and they'll exercise the effort to go get
 4   it.  There's been another -- a number of
 5   important steps, like I mentioned, that
 6   the SEC and MSRB and others have taken,
 7   and all this has been very helpful.  I
 8   think more needs to be done.  I think the
 9   SEC does need some additional authority to
10   really complete reform of the municipal
11   securities market.  Investors need to be
12   able to count on accurate, timely and
13   complete information in making decisions
14   on what to buy, what to hold, and what to
15   sell, and that information can be pretty
16   opaque today.  It cannot be very timely.
17   I think it's very difficult when an
18   investor wants to sell a bond, for
19   example.  It's better now than it was 20
20   years ago, but it's still difficult today,
21   and I think we need to figure out some
22   solutions to that.  I look forward to
23   hearing the comments from panelists on the
24   discussion we've heard so far today.  I am
25   hopeful that through the combination of
0294
 1   heightened regulatory attention, and,
 2   again, market forces that continue to work
 3   that we'll have at the end of the day a
 4   clearer, easily accessible and comparable
 5   information in the municipal market, not
 6   just to institutional investors but to all
 7   investors.
 8                 MS. GOLDIN:  Thank you,
 9   Rick.  Johnny.
10                 MR. LESSLEY:  I would like
11   to start by saying the views I'm about to
12   express are mine and not necessarily --
13   actually I'm just kidding.  That's what
14   all the lawyers have been saying so I
15   figured I would start that way as well.
16   First and foremost, I would like to say I
17   am honored as well to be here to be joined
18   on this panel of municipal transparency,
19   and in particularly pre-trade price
20   transparency.
21           When I was first asked to be here
22   my first thoughts were how much the
23   municipal market has transformed in the 18
24   years of my working in the municipal
25   trading arena.  In the early years of my
0295
 1   career we did not have the available
 2   resources that we have today.  Platforms
 3   such as the Bloomberg municipal offerings,
 4   Internet sites like Muni Center and
 5   BondDesk did not exist.  Our only sources
 6   of secondary municipal offerings were,
 7   first, whatever we carried on inventory;
 8   and, secondly, whatever was listed in the
 9   Blue List, a daily printed municipal
10   offering booklet that was delivered each
11   morning prior to the start of business by
12   mail.  Basis points books were used to
13   calculate dollar prices and yields,
14   eventually being replaced by a shoebox
15   size Monroe calculator which enabled you
16   to calculate other variables such as yield
17   to call, current yield and principal and
18   interest dollar amounts.  Resources for
19   individuals were practically nonexistent.
20   Customers relied on their broker or sales
21   advisor as the sole source of knowledge
22   for guidance on any municipal
23   transactions.  This is no longer the case.
24   With today's technological advances, you
25   can find websites or links on investment
0296
 1   pages that were developed by financial
 2   industry regulatory organizations for the
 3   sole purpose of educating and helping
 4   investors become familiar with municipal
 5   bonds.  A few examples, SIMFA has created
 6   an Investor's Guide to Municipal Bonds, a
 7   simple brochure to learn about investing.
 8   Muni bond checklists were created by FINRA
 9   to help investors avoid common mistakes in
10   municipal investing.  MSRB provides
11   investors with questions and points of
12   interest that should be brought up with
13   their brokers or investment advisors prior
14   to investing, and more recently and
15   perhaps one of the most important
16   resources of information which a number of
17   our panelists have already spoken about,
18   EMMA, Electronic Municipal Market Access
19   was developed by MSRB.  This electronic
20   Internet-based system provides public
21   access to disclosure statements, real-time
22   trade price data and another educational
23   tools.  These are the same very sites that
24   we as dealers use to gain information as
25   well.
0297
 1             But even with all the resources
 2   offered by the financial industry,
 3   investing in municipal bonds and
 4   understanding their underlying value has
 5   become even more complex.  In the years
 6   past a majority issuance was wrapped in an
 7   insurance policy of one type or another.
 8   This would enable similar type bonds to be
 9   treated in parity and price.  Municipal
10   insurers provided a sense of comfort for
11   retail investors.  Investors understood
12   that these insurers guaranteed timely
13   payment of principal and interest in the
14   event the underlying municipal credit
15   could not live up to its obligation.
16   Unfortunately, the majority of these
17   issuers no longer exist in their past
18   form.  This brings us back to today's
19   world, a world in which financial
20   institutions rely on MMD, MMA and other
21   subjective benchmark scales to measure the
22   market direction in the municipal world,
23   but the actual knowledge and understanding
24   of municipal credits and their markets are
25   even more relevant today than ever.  This
0298
 1   is my primary role in the position of
 2   municipal trader, understanding the many
 3   intricate variables that in turn effect
 4   municipal bonds, their markets and their
 5   pricings.  Once again, I'm honored to
 6   represent Duncan-Williams and all the
 7   investment firms.  I hope any insight I
 8   can offer in the question and answer
 9   session will help in your goal to gain a
10   better understanding of trading
11   characteristics in the municipal markets.
12   Thank you.
13                 COMMISSIONER WALTER:  Thank
14   you all very much for your opening
15   statements.  I wonder if perhaps we could
16   start, and Johnny, you maybe the right
17   person to do this with the basics so we
18   get sort of levels at what we're talking
19   about and talk about what the facts are
20   today.  Say I had 25 of, you know, XYZ
21   muni bonds and I wanted to sell them, can
22   you walk us through what I would do, what
23   would happen, what sources would be
24   checked, how the broker-dealer I go to to
25   make sure that I'm getting a fair price
0299
 1   and how much of that is transparent to me
 2   today?
 3                 MR. LESSLEY:  This is for
 4   me?
 5                 COMMISSIONER WALTER:
 6   Please.
 7                 MR. LESSLEY:  First of all,
 8   you'd be going through your broker's
 9   broker -- or your broker, and the broker
10   would come to me and say I need a bid on
11   20 thousand -- customer has a want to sell
12   20 thousand dollars worth of bonds.  I
13   would look at the bond itself, first of
14   all, and look at the underlying credit.
15   As we spoke about, a lot of bonds used to
16   be insured, but that's no longer in
17   existence today, even though they are
18   still wrapped.  You have to find the
19   underlying value of the bond.  You take
20   that information and to be able to price
21   it in today's market every day you have to
22   go back and look and see what new issuance
23   is coming out, what kind of supply is out
24   there secondarily, how the markets have
25   reacted in the last couple of weeks, what
0300
 1   paper is being moved and then compare
 2   those transactions with the bond that you
 3   have today and try to put that in parallel
 4   in a situation to find out whether or not
 5   similar bonds are moving at certain
 6   prices.  You have MSRB which indicates if
 7   there's been any transactions in the last
 8   six months.  You have
 9   investinginbonds.com, another website
10   which you can go back to the very
11   beginning of existence on most municipal
12   bonds and find out if they've traded in
13   the past.  And then you have other
14   information, resources like Jack here at
15   Hartfield Titus that if we're not familiar
16   with the bond -- if I'm not familiar with
17   the bond myself, if it's a bond I do not
18   normal transactions with I can do two
19   things.  I can call other broker-dealers,
20   maybe the underwriter of the issue and ask
21   him if he knows the product, if he's
22   familiar with it secondarily.  I can look
23   in new issuance and find out other
24   underwriters in the same state, same
25   credit call them as well and ask them to
0301
 1   provide a bid for it.  And then, like I
 2   said, go to Jack at Hartfield, Titus and
 3   Donnelly and ask them what kind of history
 4   they've had on it recently, have they had
 5   the bonds out for sale, out for bid
 6   recently, if they did, how many bidders
 7   were there and so forth, and he can use
 8   his contacts to provide a bid as well.
 9                 MR. COOK:  How long is that
10   likely to take?  And just to tie it back
11   to some of the earlier statistics with the
12   very limited liquidity in some issues, how
13   long does it take for those trades to
14   happen?  I mean, and if we're really
15   talking about what is primarily a buy and
16   hold market, then how long -- does
17   Commissioner Walter need to wait to find
18   another investor who actually wants to buy
19   it and hold it, or are there -- how much
20   positioning does occur in this market?
21                 MR. LESSLEY:  Well, we act
22   both as a broker selling between
23   customers, and we're also proprietary
24   which we will buy bonds in inventory as
25   well, so the actual bid process is a one
0302
 1   day process.  It could be as quick as 20
 2   seconds if it's a highly-trafficked bond
 3   who trades frequently, say a double-A one
 4   rated Nashville, Tennessee bond,
 5   immediately I can tell you that bond
 6   trades anywhere from plus 18 to plus 20 on
 7   spread.  I can price that quarterly by
 8   looking at the scales and so forth.  I can
 9   get back to you in 30 seconds on that bid.
10   If it's a bond that is not highly-
11   trafficked, it does not have the history
12   of trades, once again, you've got to go
13   back to that step work and find out like
14   bonds, how they're trading, if they're not
15   trading very well, the different positions
16   that are out there that are against your
17   position, and then, like I said, use the
18   other resources as well.  So that process
19   could take anywhere from a couple of hours
20   to perhaps half a day, but it could be as
21   quick as 10 or 15 minutes as well.
22                 MR. LYNCH:  If you notice to
23   me the distinguishing point that Johnny
24   just made was in the municipal market you
25   just can't say well, any municipal 25
0303
 1   bonds how long will it take, you really
 2   have to be specific because the statistics
 3   I mentioned to me are horrendous.  When
 4   you think these municipal bonds don't
 5   trade that often, that there is a distinct
 6   difference the Tennessee's Johnny talked
 7   about or the New York City's which you can
 8   get rid of very quickly also.  So it does
 9   make a difference to be very specific, and
10   that's what I think investors run into is
11   their bonds could be something that would
12   take all day or longer to get a bid on,
13   and others can be very quickly bid on.
14                 MR. ROBERTS:  Robert and
15   Commissioner Walter, what's confusing to
16   me as sort of a ex-regulator observer is I
17   hear the steps that Johnny and John are
18   talking about, and I don't really
19   understand all the sources of the
20   information, and, you know, that to me
21   looks like that would be a key.  Where is
22   this information coming from, is it
23   repetitive, can it be centralized, can it
24   be made available, and that's kind of
25   where I come from.
0304
 1                 MR. LESSLEY:  It is
 2   available -- the majority of it is
 3   available for everybody.  My job as a
 4   trader, in essence, starts at 7 o'clock in
 5   the morning and ends at 4:45, 5 o'clock in
 6   the afternoon in which I get there and
 7   start and literally do not leave my sit
 8   for nine and a half, ten hours watching
 9   the markets and looking and seeing how the
10   transactions are taking place in the
11   marketplace.  So the information is
12   available.  You can read to see how new
13   issues come and how the new pricings are
14   coming and so forth to get a benchmark or
15   a basis mark on what you own and how those
16   things should be priced.  But being in the
17   seat that I am, obviously I'm in a
18   position to see the flow, natural flow of
19   a daily activity that individuals would
20   not be able to see, so I do have that.
21                 COMMISSIONER WALTER:  And
22   also there are -- I mean unlike equities
23   where there usually is a market that is
24   out there that somebody can look at and
25   say oh, I do see that there is a fairly
0305
 1   contemporaneous last rating, same things,
 2   there are judgments involved about what is
 3   comparable, what you're comparing it to,
 4   what the spread is between different
 5   things, and I guess I have two levels of
 6   concern.  One is on a trade-by-trade basis
 7   how can the little guy be assured they're
 8   getting a fair price; and, second, which
 9   is sort of you aggregate all of those,
10   that's a question, how is an investor
11   supposed to have confidence in the
12   workings of this market so it has both
13   sort of a trade-by-trade impact, but then
14   I think it makes the retail investing
15   public uneasy, and some of that is
16   inherent in the structure of the
17   marketplace and the diversity of it, but I
18   think it's up to all of us on both the
19   business and the issuer and the regulator
20   side to squeeze out everything that's not.
21                 MR. LESSLEY:  Yeah, you are
22   correct, it's not a quoted market as the
23   stock market is.  There's not always a bid
24   and ask for every security.  There may be
25   a bid and ask for like securities.  As the
0306
 1   Birmingham investor Mr. Mudd had
 2   referenced earlier, he has multiple
 3   brokers that he uses, brokers that he
 4   trusts.  Some of the institutional
 5   panelists that we had earlier, Mr. Watkins
 6   from the State of Florida and Mr. Nolan
 7   from APA when they have bonds that they
 8   need a bid on how do they assure that they
 9   have the best bid that's out there in the
10   street, they use multiple brokers and they
11   probably have in their platform in their
12   parameters that they're not allowed to
13   trade that bond unless they have five
14   bidders, at least five bids on a
15   particular bond, that's a common thing for
16   them to have.  And so when I'm bidding on
17   a bond institutionally I may be in
18   competition with 54, 55, 60 dealers.  If
19   I'm bidding it in the street with Jack and
20   his platform I maybe against 10, 15 other
21   brokers that are bidding it as well, so my
22   suggestion, what we tell our customers,
23   have multiple brokers, you know, go to
24   them, ask for bids as well.  It's not
25   always an in-house bid.  As a trader you
0307
 1   branch out yourself to go to other dealers
 2   for bids as well, so because I'm providing
 3   one number does not necessarily mean
 4   that's the number -- only bid that I'm
 5   providing you.  It may be the highest of a
 6   multiple bid list.
 7                 COMMISSIONER WALTER:  One of
 8   the other questions I have again from a
 9   retail investor standpoint is many of the
10   suggestions that we've gotten that we're
11   thinking very hard about whether to
12   mandate or to encourage involve passing
13   along pricing that's done by various
14   pricing services either for marking your
15   inventory or information that's passed
16   onto the various platforms.  As I
17   understand it, and please correct me if
18   I'm wrong, that pricing is institutional
19   pricing, not retail pricing, and so if we
20   were to get that information easily passed
21   onto the retail investing public, they're
22   left with a question, that price is out
23   there, I can't get that price and maybe
24   intellectually they can get their arms
25   around the fact that it's not a retail
0308
 1   price, but how are they ever going to know
 2   whether the extent to which they're
 3   offered that price is fair or not?
 4                 MR. LESSLEY:  I guess it's
 5   coming back to me.
 6                 COMMISSIONER WALTER:  I
 7   don't know.  It doesn't have to.
 8                 MR. LYNCH:  There's another
 9   Jon over here.  We can let Jon answer that
10   one.
11                 MR. BARASCH:  We only supply
12   one price per customer so whether you're a
13   mom and pop with 20 bonds or you're --
14                 COMMISSIONER WALTER:  So you
15   don't differentiate that way?
16                 MR. BARASCH:  We don't.  I
17   mean we do at an issue level.  There could
18   be a 70 thousand maturity issue that
19   obviously is more of a retail oriented
20   piece than a 50 million dollar issue which
21   is more institutionally oriented.
22                 MR. LESSLEY:  And as Jon
23   indicated earlier today his pricing is
24   based on block size, blocks of trade,
25   that's what influences that trade.
0309
 1                 MR. LANZA:  One of the
 2   things I think you've got to be very
 3   careful about when using not actually
 4   transaction prices or not using actual
 5   live bid and offer is the question of, you
 6   know, to what extent does someone feel
 7   they're on the hook to get the price right
 8   versus something where the price is well
 9   kind of right and that was one of the
10   concerns you had about the daily mark is
11   whether it's actually, you know, a
12   definitive good valuation or not, and so
13   that's something we have to think about
14   carefully in terms of what kind of
15   non-actual transaction or non-actual firm
16   quotations your bids would be appropriate
17   for that kind of dissemination.  One thing
18   I also wanted to mention is that in
19   running parallel with Dr. Sirri's study
20   the MSRB announced also is in the process
21   of looking at creating a five year plan on
22   EMMA overall, including trade pricing, and
23   that's something we actually spent a good
24   deal of time this week talking about at
25   our board meeting to try to figure out,
0310
 1   you know, where do we go next with EMMA
 2   2.0, and although we haven't yet kind of
 3   nailed down a five year plan specifics,
 4   the one consensus I think that we find on
 5   the board table was that, you know, EMMA
 6   is the site for retail to go to, where
 7   they don't have intermediation of other
 8   parties to kind of flow the information
 9   through, and I think it's through that
10   perspective we're going to look at what
11   kind of additional information, what kind
12   of ways to package the information, what
13   kind of tools that would be helpful to
14   retail, we can potentially put on the EMMA
15   system including things about how to make
16   comparators more easy to look at on the
17   website as far as trade prices are
18   concerned.
19                 MS. GOLDIN:  One thing that
20   seems to be a defining factor in this
21   market is the size of it and the
22   fragmentation of it and one way that comes
23   out, Johnny, you mentioned a few times you
24   pick up the phone and call, and, Jack, you
25   talked about one of the strengths of your
0311
 1   business model being the regional
 2   locations, and I wonder if that is sort of
 3   something that is permanent that obviously
 4   with the fragmentation and the large size
 5   that you really do need the person-to-
 6   person contact in this market in order to
 7   get --
 8                 MR. LESSLEY:  I definitely
 9   think so.  I think it will always be a
10   part of the market.  As we discussed
11   earlier, municipal bonds they're all
12   different.  An A-rated municipal bond
13   central service in the state of Alabama is
14   going to price different from an A-rated
15   central service in Wisconsin.  Depending
16   on where you are, a non-rated bond in the
17   state of Mississippi may trade like a
18   triple-A rated bond in Chicago.  A lot of
19   the factors are out there, supply and
20   demand or knowing the product, knowing the
21   bond, knowing the municipality obviously,
22   so, it will be geographic.  I think it is
23   important to have contacts and to work the
24   regions to find that liquidity.
25                 MR. LYNCH:  That's exactly
0312
 1   the reason we did that.  We've been doing
 2   this for about 30 years throughout the
 3   regions, and just like somebody coming
 4   from Rhode Island, I would buy a Rhode
 5   Island bond.  Somebody coming from
 6   California buys a California bond, so the
 7   dealers in those areas know their paper,
 8   and for us to take a California paper to
 9   somebody in New York I'm going to have to
10   be in the state of California.  Anything
11   else you have to go to the region to
12   really get the good coverage and people
13   who know the paper.
14                 MR. BARASCH:  And while we
15   operate out of just one location, we've
16   developed extensive relationships with the
17   smaller regional firms as well as the big
18   wirehouses that are based in New York
19   because for a certain regional paper
20   typically they're the most knowledgeable
21   and they have the best market information.
22                 MS. GOLDIN:  I guess one
23   question is whether greater centralization
24   would be beneficial to investors, and then
25   is this sort of inherent quality of this
0313
 1   market a hindrance to the ability to
 2   achieve better centralization?
 3                 MR. LYNCH:  The best thing
 4   that we have in centralization is what
 5   Ernie and the board have put together in
 6   EMMA, and as we said earlier today the
 7   same item, and I think EMMA 2 is probably
 8   going to do more, particularly if it comes
 9   up with some cheat sheets that will allow
10   an investor to go in and look at the
11   highlights, and then if there's some major
12   changes the highlights are the major
13   changes.  The problem will be taking the
14   pdfs and converting them for word search,
15   but that's a good thing for the board to
16   work on, keep them busy for a while, since
17   we're paying them so much money.
18                 MR. ROBERTS:  Would it be
19   helpful to advance -- what you're trying
20   to do is advance some sort of
21   standardization.  Is there some way to
22   break things down by region and then
23   publish things on a regional basis?  Would
24   you end up with a more standardized
25   product through that mechanism?
0314
 1                 MR. LESSLEY:  Well,
 2   nationally bid wanted the bonds are
 3   offered regionally and there are regional
 4   brokers as well specializing in that area.
 5   Most investment firms have traders that
 6   specialize not only in maturities or types
 7   of municipal bonds, but also regions as
 8   well so obviously somebody in the Midwest
 9   would not be bidding -- in our firm --
10   would not be bidding a southeastern bond
11   because they may not know those credits so
12   it is -- it is divided regionally.  Now,
13   and the offering platform divided
14   regionally, there are numerous sites out
15   there offering bonds at prices divided by
16   regions as well, so am I answering you?
17                 MR. ROBERTS:  Yeah, sort of,
18   but, I mean, I know you can tie all of
19   these diverse elements together and put
20   some judgment on it and come up with a
21   reasonable kind of price, but if you're in
22   my case, I can only speak individually, if
23   you're flopping around for some sort of
24   solution to be able to centralize things,
25   break it down so investors would have a
0315
 1   greater since of confidence when they're
 2   trying to sell a bond and that's what I'm
 3   getting at, trying to break the factors
 4   down, group them together and see if
 5   there's some way to put some high points
 6   together that would provide the public
 7   with higher quality, not quantity
 8   necessarily, but higher quality pricing
 9   information than they have today, that,
10   you know, that you can go through without
11   having to spend a day doing it.
12                 MR. LESSLEY:  The product is
13   unique in the fact that, as we stated,
14   everything -- each bond is unique.  Now,
15   there are matrix out there, and Jon has
16   pricing platforms.  There are, as I
17   mentioned earlier, MMD and MMA provide
18   yield curves which we use as tools to help
19   price new issuance and secondary markets,
20   but they're subjective, it's not a quoted
21   market, the markets themselves -- the
22   scales don't move based on buying and
23   selling.  Treasuries go up when people are
24   buying.  Treasuries go down when people
25   are selling so that's the benchmark that
0316
 1   is used by agencies and corporates and
 2   other taxable products.  The benchmarks
 3   that we use on the municipal side are very
 4   subjective in which there are phone calls,
 5   in which there are people like Jon calling
 6   to make a phone call trying to see how
 7   things trade, getting that information
 8   from other dealers saying a ten year
 9   sector moved two basis points, you know,
10   richer or two basis points cheaper, so
11   there are platforms out there, there are
12   scales that we use and they should be
13   available to individuals as well.
14                 MR. BARASCH:  Typically
15   they're not --
16                 MR. LESSLEY:  Well, it's a
17   fee basis --
18                 MR. BARASCH:  They're
19   available to use, but those generic
20   triple-A scales, benchmark scales are not.
21                 COMMISSIONER WALTER:  One of
22   the complaints that we've heard directly,
23   and somewhat indirectly, from retail
24   investors is you get an account statement
25   at the end of the month, value's placed on
0317
 1   your bonds, then you go to sell the bond
 2   you can't get that price.  How do we fix
 3   that?  You know, we understand that --
 4   it's simply not just the timing.  You
 5   know, it's the 31st as opposed to the 15th
 6   of the next month, but there's a real
 7   issue with respect to that.  And is there
 8   a way something that can be done to get
 9   better information into account statements
10   so you don't have someone feeling that
11   they've just been cheated when that is
12   not, in fact, the case?
13                 MR. LESSLEY:  If you can
14   pull that data from MSRB that would be the
15   only -- you know, it's usually a matrix
16   pricing for safe-keeping statements which
17   pulls from evaluation systems, and the
18   evaluations are all based on matrix and on
19   how trades have happened institutionally,
20   but for every bond that you say that you
21   can't get that price there maybe another
22   bond that you're getting much higher than
23   that price as well, so it may not be
24   consistent where if a bond is evaluated at
25   hundred cents on the dollar par and the
0318
 1   actual bid side is 97, as many times as
 2   that happens there's also the bid side at
 3   103.
 4                 MR. LYNCH:  There is a way
 5   of -- there is a way, but if you think
 6   about the heterogeneity -- if that's a
 7   proper word -- of a million point five
 8   municipal securities, you would have to
 9   have a tremendous staff at IDC who would
10   be able to inquire for each security each
11   month as to what a price was, and what we
12   fall back to is having to do a matrix
13   pricing just because of the size, and
14   unfortunately because some bonds are
15   unique, either on the good side or the bad
16   side, it's impossible except without a
17   tremendous increase in staffing to look at
18   them individually, and as the Commissioner
19   said earlier, equities is a problem, even
20   in the pink sheets you can get often
21   quotes, so it's not a problem but in our
22   market you just can't -- and, again, as
23   Ernie said earlier a million and a half
24   issues.
25                 MR. COOK:  In light of that
0319
 1   practical issue, is part of the answer
 2   here disclosure/education so that we make
 3   sure investors understand the liquidity of
 4   the market they're buying into and also
 5   the limitations of the pricing they're
 6   getting on account statements?  And just
 7   to tie it back to the very first question
 8   that Commissioner Walter asked, if she's
 9   looking to sell bond XYZ and you can give
10   her a price right away, maybe you could
11   give her a better price a little bit later
12   when you didn't have to take it onto your
13   own books, and is that kind of pricing
14   issue transparent to customers, the fact
15   that you have to pay for immediate
16   liquidity in an ill-liquid market because
17   someone's going to have to put up capital
18   until another investor can be found on the
19   other side?  Is that an area where there's
20   adequate disclosure to investors about the
21   nature of the pricing they're getting?
22                 MR. BARASCH:  I won't
23   comment on the timing issue, but there's
24   clearly wider spreads for smaller, what's
25   known as odd lots.  In fact, we did a
0320
 1   white paper study of both trades for
 2   corporate bonds and MSRB for municipals,
 3   and found that trading costs are higher
 4   for smaller trades and for lower quality
 5   bonds, credit bonds, and also for longer
 6   duration bonds.  And typically the
 7   evaluations which go onto the statements
 8   represent the bid side of the market which
 9   isn't necessarily what your broker charged
10   you when you bought the bonds.
11                 MR. LYNCH:  Investor
12   education is very, very key to what we're
13   talking about.  I don't mean to pick on
14   the board, but right now Ernie and the
15   board are putting themselves out front
16   more and more, and maybe as that proceeds
17   we'll be able to discuss Professor Sivic's
18   work?
19                 MR. LANZA:  Sirri.
20                 MR. LYNCH:  Sirri, and his
21   work we may take the statistics that I
22   talked, the 77 thousand, and he can
23   demonstrate to an individual it's much,
24   much worse than that, so maybe the
25   understanding of the necessary part of the
0321
 1   opaque market would make a difference and
 2   might come from the board in the future.
 3                 COMMISSIONER WALTER:  Well,
 4   I think we unfortunately, because it's a
 5   topic near and dear to my heart that I
 6   wish we could talk about it for much
 7   longer, but we've come to the end of our
 8   time, and I want to thank all of you and
 9   all of our panelists again.
10           Each of you has played a role in
11   shedding light on the issues that we've
12   covered, and you've given us a lot to
13   think about, take back and figure out how
14   it feeds into the overall picture of what
15   our staff is going to recommend.
16           For example, we've been reminded
17   today of the importance of municipalities
18   of not getting into the sand and not just
19   getting out of the sand.  We have to
20   concentrate on earlier warning, and since
21   I'm not the golfer in my family, I vaguely
22   understand what that means.
23           Additionally, we heard about a
24   range of early warning signs of financial
25   distress from frequent drawdowns on fund
0322
 1   balances, to cuts of services and
 2   community programs, to the loss of major
 3   industries, employers or taxpayers, and
 4   it's important to develop ways to make
 5   sure that type of information is
 6   disseminated to and understood by market
 7   participants.
 8           On our second panel we were asked
 9   to bear in mind practical limitations that
10   would impact the ability of certain small
11   issuers to meet increased disclosure
12   obligations; for example, the municipal
13   official charged with managing the
14   issuer's bond program could conceivably
15   even be charged with driving a school bus
16   to time the local school bus route, among
17   other numerous duties.
18           We've also heard about the need
19   for training, and I think this was very
20   important and something I don't think we
21   focused on before, the need for training
22   of municipal officials regarding their
23   disclosure obligations.
24           Next, we heard about the robust
25   disclosure practices of many issuers and
0323
 1   were asked to penalize those who shoot
 2   stray, not those who shoot straight,
 3   coming back to golf again.  At the same
 4   time, investors and analysts emphasize the
 5   benefits of frequent, timely and accurate
 6   disclosure, and it was suggested that the
 7   analyst community should step up its
 8   efforts to educate issuer officials of the
 9   benefits of improved disclosure, and we
10   certainly applaud industry based
11   initiatives of this type as we consider
12   perhaps more sort of regulatory based
13   solutions.
14           We also heard that municipal
15   issuers and investors are beginning to
16   work together to identify the types of
17   interim information that's desirable and
18   able to be provided.  We would very much
19   encourage this type of dialogue and would
20   be happy to try to facilitate it through
21   the regulatory community.
22           During our derivatives panel we
23   heard that there are some significant
24   conflicts of interest that effect pricing
25   and appropriateness of swaps, particularly
0324
 1   interest rates drops entered into with
 2   municipal entities, and it was suggested
 3   that municipal officials may not
 4   understand fully swap transactions and the
 5   risks relating to swaps.
 6           Finally, from all of you, on our
 7   pre-trade price transparency, we've been
 8   hearing about the vast numbers of separate
 9   municipal securities outstanding, the
10   large number of CUSIPs and the very
11   limited amount of trading in mini bonds
12   with some rather astounding statistics
13   following the initial trading period
14   immediately after the bond's issuance.  We
15   also heard about how municipal securities
16   are priced today in light of the need to
17   price the underlying bond due to the loss
18   of the municipal bond insurers, the role
19   of interdealer brokers and pricing
20   services and the need to have multiple
21   brokers.  We've heard some ideas for
22   improving pre-trade price transparency
23   which will be a focal point for our
24   analysis when we go back home, including
25   wider availability of interdealer pricing
0325
 1   and broker marks, a limit order system
 2   possibly and an eBay approach for retail
 3   investors.
 4           I must say we have gathered a lot
 5   of information today, and certainly my
 6   expectations have been exceeded in terms
 7   of how much food for thought I've been
 8   given, and I want to thank all of our
 9   panelists again and all of the other
10   market participants who, although not
11   appearing in one of our hearings, have
12   been willing to meet with us or talk with
13   us on the phone and have given us
14   important input on municipal securities
15   markets issues.
16           We at the Commission continue to
17   believe, and I certainly believe very,
18   very strongly that this is a market that
19   is critical to the infrastructure of our
20   country, it is critical to the vitality of
21   our securities markets as a whole, and we
22   are hopeful that our staff will be able to
23   produce a report that in a pragmatic and
24   practical kind of way comes up with a
25   variety of alternative suggestions for
0326
 1   improving this marketplace for the benefit
 2   of investors, and I think if we do that,
 3   for the benefit of municipalities as well.
 4           So once again, I want to thank
 5   you, I want to thank the entire State of
 6   Alabama for being gracious and
 7   particularly the cities of Birmingham and
 8   Homewood for hosting us and making this
 9   day so easy for all of us.  Thank you
10   again.  Thank you for coming.
11           (Whereupon, the field hearing
12    concluded.)
13                  * * * * *
14   
15   
16   
17   
18   
19   
20   
21   
22   
23   
24   
25   
0327
 1             PROOFREADER'S CERTIFICATE
 2   
 3   In the Matter of:   FIELD HEARING ON THE STATE OF
 4                       THE MUNICIPAL SECURITIES MARKET
 5   ADMINISTRATIVE PROCEEDING
 6   File Number:        OC-0729
 7   Date:               Friday, July 29, 2011
 8   Location:           Homewood, Alabama
 9   
10   
11   
12        This is to certify that I, Susan Davis, 
13   (the undersigned), do hereby swear and affirm 
14   that the attached proceedings before the U.S. 
15   Securities and Exchange Commission were held 
16   according to the record and that this is the 
17   original, complete, true and accurate transcript 
18   that has been compared to the reporting or recording 
19   accomplished at the hearing.
20   
21   
22   
23   ____________________     ____________________
24   Susan Davis              Date
25   
0328
 1   
 2           C E R T I F I C A T E
 3   
 4   STATE OF ALABAMA    )
 5   TUSCALOOSA COUNTY   )
 6   
 7   I, Nancy Pannell, court reporter, hereby
 8   certify that the above and foregoing
 9   proceeding was taken down by me in
10   stenotype, and the questions and answers
11   thereto were produced in transcript form
12   by computer-aided transcript under my
13   supervision, and that the foregoing
14   represents a true and correct transcript
15   of the proceedings occurring on said date
16   at said time.
17   I further certify that I am neither of
18   counsel nor of kin to the parties to the
19   action, nor am I in anywise interested in
20   the results of said cause.
21   
22   _______________________________
23   COURT REPORTER AND COMMISSIONER
24   ACCR#30-EXPIRES 9/30/11
25   
0329
 1   
 2   
 3   Diversified Reporting Services, Inc.
 4   1101 Sixteenth Street, N.W.
 5   2nd Floor
 6   Washington, DC  20036
 7   
 8   
 9   In the Matter of:   FIELD HEARING ON THE STATE OF
10                       THE MUNICIPAL SECURITIES MARKET
11   ADMINISTRATIVE PROCEEDING
12   File Number:        OC-0729
13   Date:               Friday, July 29, 2011
14   Location:           Homewood, Alabama
15   
16   This is a letter to inform you that we do not
17   release our tapes and notes.  I do maintain
18   them for a period of one (1) year.
19   
20   Sincerely,
21                       _________________________
22                       Nancy Pannell
23   
24   
25