Magazine article Government Finance Review

GFOA Joins Effort to Improve Bondholder Communications

Magazine article Government Finance Review

GFOA Joins Effort to Improve Bondholder Communications

Article excerpt

Since 1994, the Government Finance Officers Association (GFOA) and other organizations have been studying problems associated with the transmission of information notices to holders of municipal securities.(1) The existence of problems came to light when lawyers, representing issuers whose bonds were affected by the insolvency of a life insurance company in Los Angeles, had problems reaching the beneficial owners of the securities. Now these organizations have issued a report entitled "Joint Recommendations for Communicating with the Beneficial Owners of Defaulted Municipal Securities," which identifies uniform practices that are intended to assist issuers and their representatives in contacting owners of defaulted securities to send important and time-sensitive information.

The transmission problems occurred, ironically, because of municipal market reforms and innovations. In 1982, a federal tax code change was enacted requiring that municipal bonds be issued in registered form to maintain their tax-exempt status. This resulted in the effective elimination of bearer municipal bonds and promoted reliance on the use of immobilized certificates. A book-entry system of bond registration now provides for an entire issue to be registered in the name of a single nominee for a depository.(2) The depository, in turn, maintains records of the participants for whom it holds the securities that are registered in the name of its nominee. These participants typically hold most of their positions as nominees for others, including both other firms (which may hold as nominees for still others) and individual account customers of the participants. Thus, extensive chains of title may exist for securities.

While these changes have occurred, most indentures and resolutions relating to municipal securities still contain elaborate provisions - relating to the registration of ownership of securities, the transfer of ownership, giving notice to registered securities holders, and voting by registered holders - that do not take into account in any meaningful way the existence of book-entry registration systems. Under most legal documents related to securities, notices are only required to be given to the registered holder of a security, and the registrar and issuer are permitted to treat the registered holder as the legal owner of the securities for most purposes. Problems associated with these provisions have resulted in some voluntary changes, such as provisions in some resolutions and indentures permitting beneficial owners to request that notices be sent directly to them.

General Recommendations

With the intricate chains of title that exist for some securities, the lack of extensive experience in dealing with the book-entry system, and the absence of customs and practices dictating the proper actions to be taken by market participants to assure that important notices reach beneficial - or the true - owners of securities, it was not unusual that there were bottlenecks in the flow of important information about defaulted securities.

The recommended practices developed by GFOA and the other organizations attempt to remedy these problems by setting forth specific procedures. They are not, however, intended to create any new substantive disclosure obligations, nor are they intended to create new obligations for nominees to review, disclose, or transmit any notices which they may receive through a nationally recognized municipal securities information repository (NRMSIR), a state information depository (SID), or the Depository Trust Corporation (DTC)'s computerized Legal Notice System (LENS).

The new procedures provide for issuer control of the communications process and make recommendations about the format of notices, the payment of reasonable expenses by the issuer (as is the practice in the private sector), and the provision of notices by the issuer for retransmission. Also included are recommendations that market participants who serve as nominees respond to issuer requests for information about bondholders or retransmit information from issuers to beneficial owners in a timely fashion. …

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