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Emerging Issues in the Municipal Securities Market

Emerging Issues in the Municipal Securities Market. Presented to International Municipal Lawyers Association 2008 Annual Conference September 15, 2008 By Robert W. Doty AGFS Sacramento. OVERVIEW. Bond Insurer Downgrades & Impacts on Issuers Dual vs. Single Rating Scales

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Emerging Issues in the Municipal Securities Market

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  1. Emerging Issues in the Municipal Securities Market Presented to International Municipal Lawyers Association 2008 Annual Conference September 15, 2008 By Robert W. DotyAGFS Sacramento

  2. OVERVIEW • Bond Insurer Downgrades & Impacts on Issuers • Dual vs. Single Rating Scales • Collapse of ARS Bonds (Related Enforcement); Underwriter Conflicts • Jefferson County Defaults; Pending Bankruptcy • SEC Action Against Former San Diego Officials • Materiality • SEC Limitations on Reliance on Counsel/Professionals AGFS

  3. BOND INSURER DOWNGRADES & IMPACTS ON ISSUERS AGFS

  4. NUMEROUS INSURER RATING DOWNGRADES • All But Two Insurers Downgraded, Some Repeatedly • Negatives for Remaining Two • Some Now Below Investment Grade • Had Declined to Certify Completeness of Information AGFS

  5. ISSUER BOND DOWNGRADES Affects Outstanding Bonds, Not New Issues Requires Material Event Notice Filings Sometimes Repeatedly AGFS

  6. DUAL vs. SINGLE RATING SCALES AGFS

  7. DIFFERENTIALS IN DEFAULT RATES Municipal Market Advisors, Says, e.g.— AGFS

  8. ISSUER CHALLENGES TO RATING SCALES California Treasurer Bill Lockyer— “Under the current system, the agencies hold governmental issuers to a higher standard. The result is lower bond ratings that force taxpayers to shoulder substantial, unwarranted costs in the form of higher interest payments and insurance premiums.” AGFS

  9. PROPOSED FEDERAL ACTION Regulatory—Several New Requirements for Rating Agency Disclosure & Conflicts Regulation Legislative (Rep. Frank)—Restrict Rating Focus to Default Litigation—Connecticut AG (Rating Agencies); New Orleans, Los Angeles, Stockton ( Bond Insurers) AGFS

  10. STANDARD & POOR’S— “[S&P] uses the same rating scale across the [various] sectors” “conducting an ongoing review … with goal of further promoting the comparability of our rating opinions” AGFS

  11. MOODY’S— “we are proposing to transition our public finance ratings to our global scale” AGFS

  12. FITCH— Indications Are a Move to Single “Global” Scale AGFS

  13. COLLAPSE OF ARS BONDS (RELATED ENFORCEMENT); UNDERWRITER CONFLICTS AGFS

  14. AUCTION RATE SECURITIES • Long-Term Securities • Rates Change Periodically (e.g., 7, 28, 35 Days) • High Insured Ratings • Periodic Auctions • No Liquidity Agent • Marketed as Highly Rated, Highly Liquid Securities AGFS

  15. AUCTION RATE SECURITIES Actually, Auction Agents (Underwriters) Supported Market Support Levels Not Disclosed As Bond Insurers Downgraded, ARS Became Illiquid Underwriters Built Enormous Inventories Damning Emails AGFS

  16. AUCTION RATE SECURITIES Alleged That Certain Firms— Discussions of Withdrawing Support for Market Simultaneous Inventory Sales to Investor Clients(Including Local Governments) Investors Found Illiquidity When Support Withdrawn AGFS

  17. AUCTION RATE SECURITIES Alleged That Certain Firms— Issuers Experienced High Interest Rates under Interest Formulae Motivated to Reduce Interest Costs Underwriters “Assisted Issuers” in Refinancings to Other Structures “Dream” World for Fees Underwriters Were Large Investors Through Inventories AGFS

  18. AUCTION RATE SECURITIES State Legal Actions • New York • Massachusetts • Texas • New Hampshire (for Student Loan Issuer) • New Orleans (VRDOs) • Missouri (Reported Pending) • More Reported Pending AGFS

  19. AUCTION RATE SECURITIES State Legal Actions • Several Settlements • Buyouts of Retail Customers ($20B) • Refunds of Restructuring Underwriting Fees to • Some Issuers • Significant Fines AGFS

  20. JEFFERSON COUNTY (AL) ARS & VRDO DEFAULTS; PENDING BANKRUPTCY AGFS

  21. JEFFERSON COUNTY Looming Enormous Municipal Default Potential Investor Losses AGFS

  22. JEFFERSON COUNTY Approximately $3B in Bond Issues in 2003/2004 Also Substantial Interest Rate Swaps Bond Insurer Downgrades Led to Auction Failures Interest Rate Increases Swap Terminations AGFS

  23. JEFFERSON COUNTY Interest Rates Burdensome Swap Termination Fees High County Forbearance Agreements Various Restructuring Proposals “End Game” Approaching AGFS

  24. SEC ACTION AGAINST FORMER SAN DIEGO OFFICIALS AGFS

  25. SAN DIEGO ENFORCEMENT ACTIONS OPEB DISCLOSURE ISSUES • City • City Auditor & Individual Principal • Former City Officials AGFS

  26. SAN DIEGO ENFORCEMENT ACTIONS OPEB DISCLOSURE ISSUES • OS Disclosure—Both Text & Financial Statement Notes • Continuing (Annual) Disclosure—Financial Statement Notes Again • Rating Agency Presentations—Indirect Disclosure to Investors & Market AGFS

  27. SAN DIEGO ENFORCEMENT ACTIONS CITY SETTLED • Cease & Desist Order • Agreed to Employ Independent Consultant to Review & Recommend Improvements in Practices • Extremely Expensive Internal Review • Many Years Later, Maybe Ready to Re-Enter Market AGFS

  28. SAN DIEGO ENFORCEMENT ACTIONS AUDITOR SETTLED • Permanent Injunctions • Individual Paid $15,000 Civil Penalty • SEC Challenged Auditor’s Qualifications, Investigation & Knowledge of City DON’T EMPLOY AUDITORS ON FEES ALONE! AGFS

  29. SAN DIEGO ENFORCEMENT ACTIONS FORMER CITY OFFICIALS (Pending) • City Manager • City Auditor-Comptroller • Deputy City Manager for Finance • Assistant City Auditor-Comptroller • City Treasurer AGFS

  30. SAN DIEGO ENFORCEMENT ACTIONS FORMER CITY OFFICIALS Penalties Sought Against Individuals • Declaratory Relief • Permanent Injunctions • Monetary Civil Penalties City Recently Denied Legal Fees AGFS

  31. SAN DIEGO ENFORCEMENT ACTIONS FORMER CITY OFFICIALS Changing & Stale Information 2002 Financial Statements Reported$39.2 MM NPO But City Knew 2003 Would Be $51.9 MM AGFS

  32. SAN DIEGO ENFORCEMENT ACTIONS FORMER CITY OFFICIALS Undisclosed Estimate Estimated PV of Retiree Health Care Liability$1.1 Billion AGFS

  33. SAN DIEGO ENFORCEMENT ACTIONS FORMER CITY OFFICIALS Predictive or Probability Information “City was aware that the CERS funded ratio would likely fallbelow [82.3% funded ratio] trigger level” [Trigger in Manager’s Proposal 1 Required Additional City Contributions] AGFS

  34. SAN DIEGO ENFORCEMENT ACTIONS FORMER CITY OFFICIALS Expectation for Future Event Retiree Health Care Paid in Past from “Surplus Earnings” in Pension Fund Would Have To Be Paid in Future from Direct City Payments AGFS

  35. SAN DIEGO ENFORCEMENT ACTIONS FORMER CITY OFFICIALS Expectation for Future Event City’s “Looming Financial Crisis” Unfunded Liability Expected To Increase Dramaticallyfrom $720 MM in 2003 to $2B in 2009 EstimatedAnnual Pension Contribution Would Growfrom $51 MM in 2002 to $248 MM in 2009 AGFS

  36. SAN DIEGO ENFORCEMENT ACTIONS FORMER CITY OFFICIALS NOTE— In Each Case, SEC Asks for Disclosure of Present State of Knowledge Estimates, Expectations, Probabilities Uncertainties Also Should Be Disclosed Requires Care to Frame Information AGFS

  37. MATERIALITY AGFS

  38. MATERIALITY • DC COURT OF APPEALS • Each “reasonable” investor • Many types of “reasonable” investors • Singular, idiosyncratic preference for balancing risk & return in unique portfolio • Different investors make very different decisions AGFS

  39. THE NAKED ISSUER SEC LIMITATIONS ON RELIANCE ON COUNSEL/PROFESSIONALS AGFS

  40. RELIANCE ON PROFESSIONALS SEC’S FORMULA • Complete Disclosure to Professional • Seek Advice as to Appropriateness of Challenged Action • Receive Advice Conduct Is Appropriate • Rely on Advice in Good Faith AGFS

  41. RELIANCE ON PROFESSIONALS (Good Faith) Neshannock Township School District— Actually Asked & Received Informal Letter Did Not Read OS or Understand Tax Certificate Dolphin & Bradbury— Bond Counsel Fairness Opinion Underwriter Counsel Opinion “Must Have Known” AGFS

  42. RELIANCE ON PROFESSIONALS • Formal Written Opinion(Not Mere Participation in Transaction) • Qualified Professional(Not Least Expensive) • Make Complete Disclosure • Review Carefully • Certifications of Experts • Good Faith Reliance AGFS

  43. RELIANCE ON PROFESSIONALS • Use Your Own Counsel/Professional • Not Underwriter Counsel • (Contrast Disclosure Counsel) • Not Underwriter (Adverse) • Not Developer’s Appraiser/Feasibility Consultant AGFS

  44. RELIANCE ON PROFESSIONALS • Bond Counsel—Limited Engagement • Fairness Opinion—Limited in Scope • Disclosure Counsel—Exceptions; Limited Review AGFS

  45. GUESS WHO IS LEFT AGFS

  46. IMLA’SFINANCING PROCEDURES CHECKLISTS AGFS

  47. THE END AGFS

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