FIDELITY CAPITAL MARKETS WHITE PAPER THE IMPORTANCE OF DISCLOSURE IN THE MUNICIPAL BOND MARKET HISTORY OF MUNICIPAL DISCLOSURE

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1 FIDELITY CAPITAL MARKETS WHITE PAPER JULY 2009 THE IMPORTANCE OF DISCLOSURE IN THE By Kimberly K. Edwards Vice President, Municipal Finance MUNICIPAL BOND MARKET Complete, timely and accurate information regarding the finances and operations of any borrower is vital for the market to efficiently price the debt. For many years, the municipal market has lagged behind its corporate counterpart in its disclosure practices. However, recent events in the financial markets, as well as the launch of the Electronic Municipal Market Access ( EMMA ) system this summer by the Municipal Securities Rule Making Board ( MSRB ) have created a renewed focus on continuing disclosure in the municipal securities market. The EMMA system is the result of a decades-long evolution in both the form and content of municipal disclosure, culminating in a centralized website for municipal issuers to post continuing disclosure materials and an opportunity to provide investors with timely, robust data. HISTORY OF MUNICIPAL DISCLOSURE The roots of securities disclosure trace back to the Securities Act of 1933 and the Securities and Exchange Act of 1934 (the 1933 Act and the 1934 Act, collectively, The Securities Acts ), which were enacted in response to many instances of securities fraud in the 1920 s and the stock market crash of However, both of the Securities Acts provided broad based exemptions for municipal securities. Until the 1970 s debt issued by state and local governments was widely considered to be very low-risk. The market consisted primarily of general obligation bonds, which carried a full faith and credit pledge of governmental entities. As a result, disclosure was minimal. However, these presumptions of safety began to dissipate in the 1960 s and 1970 s as new types of credit pledges and debt structures were introduced (including revenue bonds, conduit issuers, advance refundings, zero coupon bonds, and variable rate debt instruments) and disappeared altogether during New York City s (the City ) financial crisis in Although New York City never actually defaulted on its debt, the situation attracted unprecedented attention to the municipal securities market and marked the beginning of a new era in disclosure standards and oversight by the SEC. The crisis prompted an investigation by the Securities and Exchange Commission ( SEC ), which concluded that the City s disclosure did not provide the measure of disclosure mandated under the federal securities laws in

2 the interests of the investing public. 1 Subsequently, Congress amended the Securities Acts in 1975 to expand the definition of person to include issuers of municipal securities, clarifying that state and local government issuers were not exempt from the anti-fraud provisions set forth in Section 10b of the 1934 Act, promulgated as SEC Rule 10b-5. The amendments also established the MSRB, a new self-regulatory organization for municipal broker/dealers. Since municipal securities and municipalities were not subject to SEC regulation and registration, the fear was that the SEC would answer the call for better disclosure simply by requiring municipal securities to be registered, like their corporate counterparts. Many market participants hoped the willingness for effective voluntary self-regulation would fend off future efforts toward more stringent oversight. In 1976, the Municipal Finance Officers Association (now the Government Finance Officers Association GFOA ) published its first version of disclosure guidelines for municipal issuers, which it has continued to update. 2 ALTHOUGH MUNICIPALITIES HAVE CERTAIN UNIQUE ATTRIBUTES BY VIRTUE OF THEIR POLITICAL NATURE, INSOFAR AS THEY ARE ISSUERS OF SECURITIES THEY ARE SUBJECT TO THE PROSCRIPTION AGAINST FALSE AND MISLEADING DISCLOSURES. SEC STAFF REPORT ON TRANSACTIONS IN SECURITIES OF THE CITY OF NEW YORK, Unfortunately, despite the new measures to improve disclosure, there was a multi-billion dollar default in 1983 by the Washington Public Power Supply System ("WPPSS", from then on referred to as Whoops ), which led to another investigation, report and proposed rule from the SEC. Although the 1975 amendments to the Securities Acts included two provisions known as the Tower Amendments (after their author, Sen. John Tower of Texas) that specifically clarified that the SEC and MSRB did not have the authority to regulate or impose requirements upon any issuer of municipal securities, the SEC effectively forced issuers to improve disclosure by imposing requirements on the underwriters who purchased their securities. SEC Rule 15c2-12, released in 1989, required underwriters to: (1) obtain and review an official statement that was complete except for pricing information, prior to any municipal securities offering, and (2) required the issuer to obligate itself to provide an adequate number of final copies of the Official Statement, within seven days of the signing a contract to purchase. 3 Although Rule 15c2-12 did not technically require an issuer to publish an Official Statement, as a practical matter, an issuer had to publish one because an underwriter could not purchase their bonds without it. As first promulgated in 1990, Rule 15c2-12 applied only to primary offerings. Issuers were only required to provide investors with information pertinent to the repayment of the securities when the bonds were first issued. For large, frequent issuers, this generally meant that updated information was available with each new bond issue, but for the infrequent or one-time only issuer, there was no legal obligation to update the data after the issue date. With no legal requirement to provide data on the ongoing operations and financial condition of the entity, it was up to each issuer to determine what information to disseminate, and if, when, and to whom it would be distributed. In terms of disclosure, the municipal market was light years behind the corporate securities market, where the 1933 and 1934 Securities Acts required corporations to register securities offerings and file financial and operating information in a specific line-item format on a periodic basis. The market, however, did little to motivate issuers to provide such 1 (Security and Exchange Commission, Staff Report on Transactions in Securities of the City of New York, Subcommittee on Economic Stabilization of the Committee on Banking, Finance and Urban Affairs, House of Representatives, 95th Cong., 1st Sess. (Comm. Print 1977). 2 Government Finance Officers Association, Disclosure Guidelines for State and Local Government Securities, (1991 Edition). 3 Municipal Securities Disclosures (Adopting Release for Rule 15c2-12) Exchange Act Release No (June 28, 1989), 54 Fed Reg (July 10, 1989).

3 information. Although investors complained about the lack of disclosure, very few issuers faced significantly higher interest rates or were denied access to the capital markets simply due to inadequate disclosure. 4 However, in 1993 the SEC released a staff report enumerating weaknesses in both initial and secondary disclosure and concluded such weaknesses ultimately impeded the market s ability to accurately price the bonds. As a result, Rule 15c2-12 was amended in 1994 to require issuers to continue to provide updated disclosure information as long as the bonds were outstanding. The 1994 amendments to Rule 15c2-12, which took effect on July 3, 1995, were a significant milestone in municipal disclosure, both in the letter of the law and because the ensuing discussion they raised about the importance of continuing disclosure to the liquidity and transparency of the municipal market. Under the amended rule, underwriters were prohibited from purchasing bonds, with certain exemptions, unless the issuer entered into an undertaking (i.e., contract) to provide: (1) annual financial and operating data by a certain date; (2) timely notice of eleven material events and (3) notice of any failure to provide the required annual disclosure by the required dates. The rules required this information to be provided to a Nationally Recognized Municipal Securities Information Repository ( NRMSIR ), a State Information Depository ( SID ), if one existed, and material event notices could also be filed with the MSRB. 5 THE TECHNOLOGY REVOLUTION: WHEN EDGAR MET EMMA When Rule 15c2-12 was implemented in 1990, underwriters filed the official statement for municipal securities offerings with the MSRB s Municipal Securities Information Library ( MSIL ), usually in paper copy. Even at that point there was much discussion about the benefits of a single government sponsored repository versus a free market system. When Rule 15c2-12 was amended in 1994 to require more information to be filed annually, websites and web-based database technology were in nascent stages and the magnitude of maintaining a paper based system in perpetuity was overwhelming. Ironically, this was around the same time that the corporate securities market began electronic filing through the SEC s automated system, known as EDGAR (Electronic Data Gathering, Analysis, and Retrieval), which completed a three-year phase-in process in May Seven different institutions applied to be designated as a NRMSIR by the SEC. Three states, Texas, Ohio and Michigan, had organizations called Municipal Advisory Councils that had been serving as repositories since at least the 1950 s, and therefore designated these organizations as SIDs. Like the SIDs, most of the organizations designated as NRMSIRs were already collecting some or all of the data required under the amended rule as part of their ongoing business operations, and saw NRMSIR status as a way to complement their existing operations. Eventually only four firms remained NRMSIRs. However, Rule 15c2-12 also introduced the concept of a dissemination agent, i.e., a third party entity that issuers could engage to help ensure compliance with the filing requirements of the Rule, and several commercial enterprises began providing such services to municipal issuer clients. Many market participants felt that having multiple repositories was inefficient and expensive: issuers were required to file with each repository; filing could be cumbersome; filings were often not indexed to show which securities they related to; and search results could be inconsistent among repositories. The SEC, however, had to strive for a balance between the efficiency of a single repository with the appearance of federal registration and regulation of municipal securities. In January of 2001, the Muni Council, an informal group of nearly 20 organizations representing various components of the municipal market, began meeting to discuss improving municipal market 4 Pope, Robert Dean, Making Good Disclosure: The Role and Responsibilities of State and Local Officials under the Federal Securities Laws, Government Finance Officers Association, May Municipal Securities Disclosures (Adopting Release for Amendments to Rule 15c2-12) Exchange Act Release No (November 10, 1994), 59 Fed Reg (November 17, 1994). 6 (June 16, 2009).

4 continuing disclosure practices and identifying problems with the NRMSIR system. These discussions eventually led to the development of Disclosure USA, which was the Central Post Office ( CPO ) for filing disclosure documents. Disclosure USA received SEC approval in September 2004, specifying that issuers could satisfy their Rule 15c2-12 filing requirements by submitting disclosure documents on-line to the CPO, which would then transmit them to the NRMSIRs. The CPO also indexed and filed each filing by CUSIP number, which improved the consistency and usability of data. Although the CPO was merely a transmittal portal, i.e., it still sent the documents to the four separate NRMSIRs and SIDs, it laid the groundwork for the EMMA system that is now being implemented. 7 The concept of a centralized, searchable location for all municipal disclosure data evolved during a time in which the internet, websites and search engines became increasingly robust, allowing a revolution in the free flow of information and a global shift in society s mindset toward the free access and availability of information. In 2007, the SEC proposed a series of initiatives to improve municipal disclosure and accounting standards. The proposals included the concept of a free web-site, similar to its EDGAR system for corporate securities, where the public, including retail investors, could access information on municipal securities. 8 The MSRB offered to provide such a site and for the first time there was wide acceptance of the concept among most facets of the municipal bond community. 9 In December 2008 the SEC amended Rule 15c2-12 to designate the MSRB s EMMA system as the sole NRMSIR, eliminating the old system of multiple NRMSIRs and the need for the Disclosure USA Central Post Office. Furthermore, on June 11, 2009, the MSRB announced that the EMMA System will also accept and publish voluntary submissions of continuing disclosure documents other than those required by Rule 15c2-12, a further acknowledgement of the market s desire for all relevant information, not just the specific data required by the rule. WHY IS GOOD DISCLOSURE IMPORTANT TO THE MUNICIPAL MARKET? Any discussion of municipal disclosure inevitably turns to a comparison between the corporate and municipal securities market. Obviously, the two markets are vastly different in size, liquidity, price transparency, accounting standards, and government oversight and regulation. However, there are more fundamental differences that drive these distinctions. By its very nature, government operates in the open. Unlike a private corporation that might have trade secrets, virtually all information that might be relevant to a municipal investor is considered the public s information, and most states have laws guaranteeing access to that information. Government issuers, who are accustomed to conducting their daily business in a public manner, may question the need for rules requiring them to disclose specific information within a specific format on a specific timeframe. INVESTORS NEED TIMELY ROBUST INFORMATION THAT SHOWS THE TRENDS IN AN ISSUER S FINANCIAL OPERATIONS, NOT JUST A SNAPSHOT OF DATA. TOM DEMARCO, FIDELITY CAPITAL MARKETS. Governmental issuers should recognize, however, that complete, accurate and timely disclosure improves the investors ability to accurately price their bonds. This in turn enhances the marketability of municipal securities, which over time improves the liquidity and pricing of the entire market. In the absence of regulation, several industry groups representing issuers and investors have developed disclosure guidelines for municipal securities. The National Federation of Municipal Analysts (NFMA) has been on the forefront of encouraging issuers to develop comprehensive, accurate and timely disclosure. Acknowledging the vast differences in the various sectors of the 7 (June 16, 2009). 8 Disclosure and Accounting Practices in the Municipal Securities Market, SEC Staff White Paper to Congress, July 26, available at 9 SEC OKs EMMA as NRMSIR, The Bond Buyer, December 7, 2008.

5 municipal market, they have developed Recommended Best Practices in Disclosure for 17 different types of financings. 10 Corporate level disclosure may not have been necessary when the municipal market was very homogenous and the credits very simple, e.g., a full faith and credit pledge of the issuer to raise taxes to whatever level necessary to repay the debt. However, over the past two decades the municipal market experienced the same proliferation of innovation and financial engineering as the rest of the world s capital markets. Products such as interest rates swaps, taxable municipal debt, infrastructure privatization and the predominance of arbitrage accounts have caused a gradual merger of the corporate and municipal markets. Furthermore, the dislocation of the credit and liquidity markets since 2007 have underscored the need for information on underlying credits now more than any time in history. As bond insurers lost their AAA ratings and bank liquidity dried up, investors went back to the basics of evaluating the underlying credit to help determine the price. Now more than ever, investors and research analysts are relying on continuing disclosure to conduct their own investment research for municipal securities. The disappearance of AAA rated bond insurance also spurred a debate on the use of a single rating scale for corporate and municipal issuers further highlighting the difference in the level of disclosure in the two markets. For example, most municipal issuers publish financial reports 180 days after the end of each fiscal year. While some large frequent issuers update their financials quarterly and post on their websites, most municipalities do not publish quarterly financials. In comparison, corporate issuers are required to file quarterly financials 45 days after quarter end and annual financial reports within 60 days of year end. As municipal issuers attempt to broaden their investor base, particularly with taxable debt such as pension obligation bonds and the new Build America Bonds, they are reaching out to investors who are used to corporate level securities disclosure. To potentially benefit from a wider investor base, issuers must be prepared to respond to the demands of these investors for more timely information. On June 17, 2009, in response to the recent events in the credit and financial markets that led to the current global economic crisis, the U.S. Department of Treasury released proposed reforms for regulation and supervision of the financial markets. While the report does not specifically mention municipal bonds or propose specific reforms to the municipal market, it does recommend that the SEC be given expanded authority to promote transparency in disclosures to investor, including revisions in the federal securities laws. 11 Like the Securities Acts of 1933 and 1934 that ushered in a new era of financial regulation following the 1929 stock market crash and the Great Depression, these proposals, if enacted, could result in major changes in the regulatory scheme, and provide a vehicle for further regulation of the municipal market. HOW DOES EMMA WORK? Effective July 1, 2009, to satisfy the requirements of Rule 15c2-12, issuers are required to file disclosure documents electronically to EMMA, by electronically uploading a PDF file format through the EMMA website. EMMA will not accept paper documents. Issuers can submit documents directly to EMMA, or an agent or obligated person can submit continuing disclosure documents on behalf of an issuer. Many financial advisors and other third party services provide these services to issuer clients. EMMA will generally make all submitted documents available to the public within about an hour of submission. To submit a document, a user must register and create an account, which requires basic information such as name, user ID, password, address, user type, etc. The registration process for submissions will be done through the 10 See (June 16, 2009). Also see: National Federation of Municipal Analysts. White Paper on Federal Securities Law Relating to Municipal Securities. (March 2008). 11 U.S. Department of the Treasury, Financial Regulatory Reform: A New Foundation, Rebuilding Financial Supervision and Regulation. June 17, 2009.

6 MSRB s Gateway, a secure access point for all MSRB applications. Registrants must declare their user type: Issuer, Obligated Person or Agent. When a party registers as a designated agent or obligor of an issuer, the issuer will receive an from MSRB asking for confirmation that the party is authorized to act on the issuer s behalf. There is no charge to submit continuing disclosure documents to EMMA. The EMMA system can also be used for voluntary electronic submissions of continuing disclosure documents other than those specifically required by Rule 15c2-12. In addition to providing an electronic system for Continuing Disclosure for issuers, the MSRB is also requiring underwriters to use the EMMA system for disclosures in connection with primary offerings. EMMA will be used by broker/dealers to satisfy SEC and MSRB requirements for: Preliminary and Final Official Statements ( access equals delivery ); Advance Refunding documents; and Real time trading data received. Most trades are required to be reported to the MSRB and are posted on EMMA within 15 minutes of the time of trade; Information regarding municipal auction rate securities and variable rate demand obligations. The MSRB will be conducting a series of webinars to introduce municipal issuers to the new EMMA system. Additional information is available on the MSRB website: For More Information on recommended disclosure practices: We hope you find this white paper on the upcoming launch of the Electronic Municipal Market Access ( EMMA ) system timely and informative. We look forward to helping provide our clients the information they need to be successful in all aspects of their capital financing needs. Our municipal finance professionals have experience with a full spectrum of tax-exempt and taxable transactions and leveraging the resources of Fidelity Investments extensive distribution channels to underwrite and distribute your bonds effectively.

7 ABOUT FIDELITY CAPITAL MARKETS Fidelity Capital Markets, a division of National Financial Services LLC, serves as the conduit to the fixed income markets for the various distribution channels of Fidelity Investments. Fidelity Investments is one of the world's largest providers of financial services, with custodied assets of over $2.5 trillion, including managed assets of over $1.2 trillion as of March 31, Our goal is to bring the considerable market demand generated by Fidelity s retail and middle market distribution networks to municipal issuers across the nation in order to offer them access to one of the deepest pools of liquidity in the nation. Fidelity Capital Markets access to Fidelity Investments national retail distribution network is one of our core competitive strengths. We have served as a source of liquidity for issuers in the primary municipal bond market and the secondary market for decades. In 2008 we participated in 366 new issues with a par value in excess of $42 billion. In 2009 we opened municipal finance offices in New York, Illinois and Texas, which, in addition to our office in Boston, provide municipal issuers with dedicated professionals, excellent coverage and high quality execution when we support their new issues as Before investing, consider the funds investment objectives, risks, charges and expenses. Contact Fidelity for an official statement an underwriter. containing this information. Read it carefully before investing. Although To learn bonds more generally about Fidelity present less Capital short-term Markets risk please and volatility feel free than to stocks, visit our bonds website do entail or contact interest rate any risk of the (as interest members rates of rise, our municipal bond prices finance usually team fall noted and vice below: versa) and the risk of default, or the risk that an issuer will be unable to make upcoming or principal payments. Kim Edwards (512) kim.edwards@fmr.com Lourdes German (617) lourdes.german@fmr.com (212) Tim Coffin (617) timothy.coffin@fmr.com Mark Kim (312) mark.kim@fmr.com Before investing, consider the funds investment objectives, risks, charges and expenses. Contact Fidelity for an official statement containing this information. Read it carefully before investing. Although bonds generally present less short-term risk and volatility than stocks, bonds do entail interest rate risk (as interest rates rise, bond prices usually fall and vice versa) and the risk of default, or the risk that an issuer will be unable to make upcoming or principal payments. Additionally, bonds and short-term investments may entail greater inflation risk, or the risk that the return of an investment will not keep up with increases in the prices of goods and services, than stocks. Interest income generated by municipal bonds is generally expected to be exempt from federal income taxes and, if the bonds are held by an investor resident in the state of issuance, state and local income taxes. Such interest income may be subject to federal and/or state alternative minimum taxes. Investing in municipal bonds for the purpose of generating tax-exempt income may not be appropriate for investors in all tax brackets. Generally tax-exempt municipal securities are not appropriate holdings for tax-advantaged accounts such as IRAs and 401(k)s. Interest income generated by Treasury bonds and certain securities issued by U.S. territories, possessions, agencies, and instrumentalities is generally exempt from state income tax but is generally subject to federal income and alternative minimum taxes and may be subject to state alternative minimum taxes. Short- and long-term capital gains and gains characterized as market discount recognized when bonds are sold or mature are generally taxable at both the state and federal level. Short- and long-term losses recognized when bonds are sold or mature may generally offset capital gains and/or ordinary income at both the state and federal level. The content in this piece is provided for informational purposes only and any references to securities listed herein do not constitute recommendations to buy or sell. 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