On August 20, 2018, the SEC adopted amendments to Rule 15c2-12 to expand the list of events requiring an event notice filing on EMMA. Our initial post describing the amendments is available here. This follow-up post provides additional detail about the amendments and considerations for municipal issuers facing this new regulatory requirement.
Most municipal issuers and nonprofit borrowers are familiar with the existing list of 14 events requiring a special notice filing in current continuing disclosure undertakings. The existing list includes infrequent events, such as bankruptcy, receivership or payment defaults, and more common events including bond calls and rating changes. The two new events will require issuers to file a notice to bondholders for (i) the incurrence of certain debt obligations and (ii) certain events reflecting financial difficulties.
The Adopting Release described the SEC’s concern that municipal issuers have been incurring bank debt which might impact existing bondholders without providing notice of the bank debt to bondholders. Accordingly, issuers that incur bank debt, state loans or federal loans will likely be impacted by the new requirements.
The amendments will not change any existing continuing disclosure obligations, but all continuing disclosure undertakings for publicly-sold bonds issued after February 27, 2019 should include these two events. Accordingly, municipal issuers, particularly those who anticipate issuing publicly-offered debt in 2019, are advised to assess the impact of the changes as soon as possible.
Incurrence of a Material Financial Obligation or Terms Impacting Security Holders
Under the amendments, a notice will be required for:
the incurrence of a financial obligation, if material, or agreement to covenants, events of default, remedies, priority rights, or other similar terms of a financial obligation of the obligated person, any of which affect security holders, if material.
A financial obligation is defined as a (i) debt obligation; (ii) derivative instrument entered into in connection with, or pledged as security or source of payment for, an existing or planned debt obligation; or (iii) guarantee of (i) or (ii). A municipal security for which a final official statement has been posted on EMMA in accordance with the Rule will not be considered a “financial obligation,” as bondholders will be able to easily access such information. The term is intended to include privately-placed debt, whether with a bank, state (such as a state environmental agency), the federal government (such as USDA) or other lender.
It is important to note that the terms used for continuing disclosure compliance do not always align with accounting terms or state law definitions of debt. Accordingly, while an instrument may not be considered debt for accounting or state law purposes, it may be considered a debt obligation, and therefore a “financial obligation,” for purposes of compliance with a continuing disclosure undertaking.
Although the amendments do not include the term “lease,” the Adopting Release provides that leases operating as vehicles to borrow money, such as equipment leases and certificates of participation, are considered to be “debt obligations” that may require a notice filing when incurred. Certain leases, however, are not considered “vehicles to borrow money,” such as commercial office building leases, airline and concessionaire leases at airport facilities and copy machine leases. Notices ordinarily will not need to be filed for such obligations.
In addition, ordinary financial and operating liabilities incurred in the normal course of business and court-ordered judgments, or similar obligations, are not considered to be “financial obligations” for purposes of the amendments.
The SEC also addressed when a financial obligation is considered “incurred” for purposes of the new events. A financial obligation is incurred and the 10-business-day clock for submitting a notice begins to run when the obligation is legally enforceable against the obligated person. For example, a material taxable draw-down loan would require a notice within 10 business days of the execution of the loan documents, even if no draw has been made on the loan.
The phrase “material” in this context has the meaning developed under the Antifraud Rules of the federal securities laws. To determine the materiality of a financial obligation or agreement, an issuer and its counsel will need to assess the obligation, the issuer’s business, debt structure, and other important factors. An event is material under federal securities laws if a reasonable investor would consider it important in making an investment decision.
Materiality can be affected by a variety of factors, including the size of a financial obligation compared to the overall balance sheet or existing obligations, par amount, security pledged, rights available to holders, seniority position, covenants, events of default, or remedies. The same analysis employed when considering whether to disclose an event in an official statement should be applied to determine whether a notice should be filed under the new amendments. It is important to note, however, that not every single fact included in an official statement is material. For example, although an issuer may have included information about a small bank loan in an official statement, the incurrence of that bank loan may not have risen to the level of materiality requiring an event notice.
Content of Notice
A notice for the incurrence of a material financial obligation or other agreement will need to include either a summary of the material terms of the financial obligation or attach the instrument itself with certain permissible redactions.
Default, Acceleration, Termination, Modification or Similar Event Reflecting Financial Difficulties
Municipal issuers will also be required to file a notice for:
a default, event of acceleration, termination event, modification of terms, or other similar events under the terms of a financial obligation of the obligated person, any of which reflect financial difficulties.
In adopting the second new event, the SEC is focused on events that impact a municipal issuer’s liquidity, overall creditworthiness and existing security holder’s rights. The SEC indicated that the term “default” should be read broadly to include noncompliance with covenants and other defaults which might not technically constitute an “Event of Default” as defined under the transaction documents. The SEC noted that the same concept of “reflecting financial difficulties” is already included in existing continuing disclosure undertakings with other events requiring a notice, including unscheduled draws on reserve funds or credit enhancements. Prior guidance from the SEC indicates that “financial difficulties” occur when a municipal issuer’s financial condition has deteriorated and there is, potentially, an increased risk of a payment default or, in some cases, premature redemption.
Impact on Existing Obligations
The SEC clarified that for the incurrence of a material financial obligation, an issuer will be required to file notices only with respect to financial obligations incurred after the issuer has entered into a continuing disclosure undertaking incorporating these new provisions, for bonds issued after February 27, 2019.
For defaults, accelerations, modifications or other similar events reflecting financial difficulties, this notice requirement may impact financial obligations outstanding prior to the date of an issuer’s first continuing disclosure undertaking entered into after February 27, 2019. For example, a modification in 2020 due to financial difficulties of a bank loan originally incurred in 2017, may require an event notice if the issuer entered into a continuing disclosure undertaking in March 2019 in connection with the issuance of bonds payable from the same revenues as and on a parity with the bank loan.
Preparing for the New Events
Similar to the industry’s response to continuing disclosure compliance and related disclosures in the wake of the SEC’s 2014 Municipalities Continuing Disclosure Cooperation, or MCDC, initiative, the new amendments are widely expected to spark additional changes. As guidance is provided from trade professionals, groups and regulatory authorities, industry standards are likely to develop and be refined. Issuers should consider the following in the upcoming months:
- Issuers with written policies and procedures should review the procedures in light of the amendments and make necessary adjustments well in advance of a new publicly-sold bond issue.
- Issuers expecting a public offering of bonds in 2019 should consider which financial obligations may be material in order to monitor the related documentation and prepare for notices in connection with any new material financial obligations.
- In connection with a new public offering, underwriting firms may require municipal issuers to identify material financial obligations, standards for materiality, and other practices that will be entirely new to municipal issuers.