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Until the mid-1970s, the municipal bond market was essentially unregulated. The market was the private preserve of a narrow circle of underwriters and lawyers who specialized in the field and the commercial banks, insurance companies and wealthy individuals who invested in the bonds.
That all changed with the near default of New York City in the mid-1970s and the actual default a decade later of the Washington Public Power Supply System. The New York situation, in particular, was a rude awakening for the market. Observers wondered how a participant as important as the nation’s largest city could reach the brink of bankruptcy without attracting much attention.
New York avoided fiscal collapse, but Congress felt a need to act. It did not, however, act decisively. It rejected the idea of simply eliminating the exemption that municipal bonds had from the Securities Act of 1933, which would have compelled government issuers to adhere to the same rules as corporate issuers. Instead, Congress settled on a compromise. It created a body called the Municipal Securities Rulemaking Board (MSRB) to establish a set of fair practices for the underwriting and trading of municipal bonds. As part of this system, brokers and dealers handling such securities had to register with the Securities and Exchange Commission (SEC). Yet government issuers were not required to follow any pre-issuance filing requirements like those in place for corporate stocks and bonds. Moreover, neither the SEC nor the MSRB was given significant authority over the actual content of post-issuance filings. Investors were basically forced to rely on good-faith voluntary disclosure.
In other words, the new regulatory system related mainly to brokers and dealers, not to the government entities issuing the bonds. The provisions in the law that determined this one-sided regulatory approach were referred to as the Tower Amendment, since their implementation in 1975 was led by Senator John Tower, Republican of Texas.
The MSRB, established in accordance with the Securities Act Amendments of 1975, was not a government agency, but rather an industry self-regulating body like the New York Stock Exchange or the National Association of Securities Dealers (NASD) that is subject to oversight by the SEC. Yet its powers were defined by Congress and its rules had the force of law, though enforcement was to be carried out by the SEC, which has delegated some of that function to the NASD and to bank regulators.
By statute, the Board is made up of 15 members: five representatives of investment banking firms (which underwrite and trade munis), five representatives of commercial banks that deal in munis and five representatives of the public. At least one public member must represent issuers and one must represent investors.
Among the key rules established by the MSRB were the following:
  • G-2: Brokers and dealers must meet standards of professional qualification set by the Board;
  • G- 8: Brokers and dealers must adhere to detailed recordkeeping requirements;
  • G-12: Brokers and dealers must adhere to certain rules in the execution of transactions; and
  • G-17:  Brokers and dealers must not engage in “deceptive, dishonest or unfair practices.”


The default on more than $2 billion in bonds by the Washington Public Power Supply System (WPPSS, known informally as Whoops) in 1983 made it clear that the modest regulatory framework put in place by the MSRB was not sufficient. In 1989, following an investigation of the WPPSS fiasco, the SEC adopted Rule 15c2-12 in an effort to regulate primary offerings of municipals. Given the restrictions of the Tower Amendment, the SEC had to go about this indirectly. Rather than imposing rules on government entities, the Commission put the onus on underwriters to obtain a prospectus from public issuers in offerings of $1 million or more and to distribute those documents (called Official Statements) to potential purchasers. Offerings that were being sold to groups of 35 or fewer “sophisticated investors” were exempt from the rule.
The SEC did not require the underwriters or the issuers to file the Official Statements with the Commission. Instead, it set up a system under which the documents were filed with private entities that were designated as Nationally Recognized Municipal Securities Information Repositories (NRMSIRs). Under Rule G-36, copies were also to be sent to the MSRB.
When the SEC created its EDGAR system for free, online dissemination of corporate filings in the 1990s, muni bond Official Statements were not included. Instead, these documents had to be obtained from an underwriter or from one of the NRMSIRs, which charged a fee for each Official Statement. MSRB set up a reading room at its headquarters in Alexandria, Virginia for on-site viewing of Official Statements.
Once the NRMSIR system was in place, the SEC and the MSRB turned their attention to disclosure issues regarding the secondary market, where investors typically knew little about the current finances of the government entities whose securities they were buying. In 1994 the SEC, again imposing rules on government issuers indirectly, amended Rule 15c2-12 so that underwriters were barred from handling securities from issuers that did not agree to provide annual reports with updated financial information as well as timely reports of certain material events. The annual reports were to be distributed through the NRMSIRs and also submitted to a state information depository, if one existed. Reports of material events (akin the to 8-K filings of corporations) were to be sent either to the NRMSIRs or to the MSRB and state information depositories.


The next regulatory initiative involving munis was prompted by a series of corruption scandals in the early 1990s, beginning with one involving New Jersey Turnpike Authority bonds. At the center of the scandals was the system under which underwriters were expected to make substantial campaign contributions to public officials in order to be chosen for negotiated offerings. The system, known as “pay to play,” was also highlighted in the gubernatorial race in California in 1993 when Pete Wilson complained about the big contributions that his opponent, state treasurer Kathleen Brown, had received from municipal bond firms that did business with the state. Ironically, Wilson later petitioned the MSRB for an exemption from the rule when he ran for President, but the request was denied.
Former SEC Chairman Arthur Levitt waged an intensive campaign against “pay to play.” MSRB and Congress also expressed public outrage over the practice, but the real impetus for reform came when a group of major investment banks decided in 1993 to prohibit campaign contributions. This move made it feasible for the MSRB to issue a rule (G-37) that barred underwriters from doing business with a government agency for two years after a firm or one of its employees gave a campaign contribution to a public official connected with that agency. In 1994 the SEC approved the rule, which allows contributions of up to $250 by employees of underwriting firms to officials for which they personally can vote. Rule G-37 survived a number of legal challenges based on the argument that it was an infringement of free speech. In 2003 the MSRB issued a warning to dealers about arranging for contributions to be made by spouses and using other means of circumventing G-37.
The MSRB later moved to open more aspects of underwriting to public scrutiny by requiring firms to disclose the names of consultants (including lobbyists) they used to solicit business from government entities as well as the amount paid to those consultants. Rule G-38 also requires the consultant to disclose any campaign contributions made personally, or by his or her firm, or by a political action committee associated with the firm. In February 2004 the MSRB, concerned about a sharp rise in spending on consultants-- Citigroup alone spent $8.6 million on consultants in 2002--said it was planning to issue a rule that would ban the use of consultants. The Board also warned dealers that they would be sanctioned for omissions in their G-37 and G-38 filings. 
An archive of the quarterly filings made over the past decade by underwriters to fulfill the requirements of Rules G-37 and G-38 can be viewed on the MSRB website. Since 2003 underwriters have been able to submit the forms electronically.

In July 2003 the SEC approved MSRB’s Rule G-41, which required muni brokers and dealers to establish anti-money laundering compliance programs. The MSRB said it promulgated the rule in response to the passage of the USA PATRIOT Act.

The most recent disclosure initiative of the MSRB concerns the dissemination of bond prices—information that has traditionally been closely guarded by industry insiders. In early 2002 the Board and the Bond Market Association introduced a service on the website that was called the closest thing to a real-time “ticker tape” for bond prices. Information on frequently traded bonds had a lag time of a day, while for other bonds the lag was two weeks.
That was a step forward, but still a far cry from the kind of real-time reporting that exists in the stock markets. In 2003 the MSRB told the SEC that it wanted to move toward same-day reporting by the Fall of 2004, but the Board delayed the implementation until 2005.
The need for improved price reporting was made more urgent in light of reports in early 2004 that the SEC and the NASD were investigating unusual trading patterns that may have resulted in unusually large spreads between the prices at which investors buy and sell the same bonds. A study by two SEC economists released in February 2004 found that it was much more expensive for individual investors to trade muni bonds than stocks. The MSRB responded by reminding dealers of their fair-pricing obligations.
After being relatively dormant for about a decade, it appears that municipal bond regulation may be headed for another period of increased activity.

Updated: June 2004

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