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A Brief History of Municipal Regulation

Recently, Advisors Asset Management released a new product called the Municipal Disclosure Email Notification System in which every advisor or registered rep that works with AAM receives an email outlining material facts and disclosures pertaining to the municipal security that they or their client is about to purchase. Whereas this product is simply one more tool in a plethora of financial services and support for advisors and broker dealers, in this particular case there have been a lot of questions as to why we did this now and the reasons behind it. Well, it all started back in the 30’s…

Some tough times occurred in the 1930's: the Great Depression, the Hindenburg, the Dust Bowl. Some good books: Gone With the Wind, The Grapes of Wrath, Of Mice and Men. And some amazing accomplishments: the Empire State Building, the first clinical use of Penicillin, and Albert Einstein quoted, "The most beautiful thing we can experience is the mysterious. It is the source of all true art and science."

What also came out of the 30's was Congress passing the Securities Act of 1933 and creation of the Securities and Exchange Commission (SEC) in 1934. The purpose of the Securities Act was to provide full disclosure of material facts about securities being offered and sold to investors. Then of course with the Securities Exchange Act of 1934, the SEC was the new authority over most of the securities industry.

What's interesting about these two acts is the huge number of exemptions that were given to municipal securities. States wanted little to do with interference from federal government and the federal government didn't want to rub the states wrong. So other than maybe Rule 10b-5, which covers anti-fraud provisions along with some disclosure and material facts obligations, there wasn't a lot to go on for municipal bonds. And in the spirit of ambiguous uncertainty (have you read any of these regulations?), the acts provided little detail on what needed to be done in terms of disclosure or enforcement. However, at the time it wasn't such a big deal since municipal bonds were typically sold institutionally.

In the decades that followed, most municipal issues were Government Obligations (or G.O.'s) backed by the taxation authority of the municipality. They were simple, clean, and easy to understand. In the 60's things started turning; well, let’s just say they got groovy. In the spirit of the decade, issuers got much more creative. New types of municipal bonds were formulated such as housing bonds, advance refunding and variable rates. In addition, revenue bonds started to become more popular among issuers. Things became more complicated than simply “coupon and maturity”.

Ford to veto any bail-out

But still, everything was fine. For all intents and purposes, any investment in municipal bonds was at the time considered "risk-free" by many market participants because, for the most part, it was. That is until New York defaulted in 1975. New York's mayor begged the White House for a bailout and President Ford's response made the headline "FORD TO CITY: DROP DEAD." So, the State of New York created the Municipal Assistance Corp which sold $10 billion in bonds, and bailed out its namesake city in what was the largest bailout of anything at that time. It would remain one of the largest bailouts ever until the Savings and Loan debacle in 1989. (See a History of U.S. Gov’t Bailouts)

Coincidentally, this was the same year that the MSRB was created by Congress and the SEC. The purpose of the MSRB was, "to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, and processing information with respect to, and facilitating transactions in municipal securities, to remove impediments to and perfect the mechanism of a free and open market in municipal securities, and, in general, to protect investors and the public interest."

Surprisingly, there was little response to the New York incident in terms of regulation for close to 15 years. Again, these were mostly institutions affected and in general the public has little sympathy for corporations. However, in the decades that followed the retail public started investing more and more into municipals and issuers were becoming more and more creative. In fact, it was in 1982 that EF Hutton issued the first municipal zero-coupon bond. AAM’s own Jim Costas was on the EF Hutton trading desk at the time and he tells me that it was one day later that the first person asked the question: “What is the coupon on this thing and how often does it pay?”

A year later, the next meltdown occurred at $2.45 billion by the Washington Public Power Supply System (WPPS – better knows as “WhooPPS”). This time, registered voters started getting upset, which in turn meant government intervention. Congress asked the SEC to take action. The SEC spent 5 years investigating and two more years finalizing Rule 15c2-12 which went into effect on January 1, 1990. Basically, the rule requires investors to receive a copy of the official statement of any new issue municipal they purchase.

This did little for secondary market municipals, where most of the action is. In 1994, the SEC amended 15c2-12 to restrict broker dealers from participating in the secondary markets of municipals unless the issuer was providing ongoing material event disclosures, including updated financials. This was an interesting maneuver by the SEC; since they couldn’t regulate the municipalities and require that they provide disclosures so they simply told broker dealers (which they do regulate) that they couldn’t trade them unless they received the information. This information now resides at EMMA, a great resource for anyone that participates in municipal bond markets.

Since then, there have been several more SEC and FINRA notices regarding municipal sales practice and due diligence obligations. The MSRB has also done a lot of work to this end as you can see in this list of MSRB Milestones. Basically, everyone wants full disclosure – it’s best for all parties in the transaction to know exactly what they are transacting. It prevents investors from saying “I didn’t know what I was buying,” and it keeps advisors and broker dealers from having to deal with the repercussions. With the recent FINRA 10-41 Notice, they quote the following rules and notices: Exchange Act Rule 15c2-12, FINRA Regulatory Notice 09-35, MSRB Rules G-15, G-17, G-19, G-27, G-30, G-32, MSRB Notices 2004-3, 2005-01, 2007-17, 2009-41, 2009-42. That’s a lot of regulation to try and identify “what is the best way to provide the best information in a transaction.”

Whew, so there you have it. As the municipal bond market became more complex, as investors became savvier, and as regulators placed more accountability on advisors and registered reps, the need for additional disclosure became vital. However, regulations don’t have to mean that it’s more difficult for you to do what you do best. AAM provides investment solutions to advisors, including our Municipal Disclosure Email Notification System.

If you are interested in learning more about this notification system or any of AAM’s other financial services for advisors and broker dealers, please don’t hesitate contact us. Cheers, Bart.

Important: This blog post is not intended to promote an investment in municipal bonds, nor is it intended to fulfill any due diligence obligations. An investment in municipal bonds is subject to a variety of risks and you should consult your financial professional before making any investment decision.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit



Effective, June 10, 2016, please note that Gene Peroni left Advisors Asset Management (AAM) to become President of Peroni Portfolio Advisors, Inc. Peroni Portfolio Advisors, Inc. ("PPA") is an investment advisor independent of AAM.