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GFOA joins effort to improve bondholder communications.

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.

In promulgating these recommendations for defaulted securities, the groups recognized that some of the recommendations might not be practical to implement if the defaulted securities were issued under documents that were amended or originally prepared prior to the development of the recommendations. Nevertheless, market participants are encouraged to attempt to follow the suggestions to facilitate the handling of notices.

Notice Format

As a first step, the groups recommend that any default notice should prominently include the following information in its title:

* the complete title of the securities;

* the complete name of the issuer and of any conduit borrower;

* the entire nine-digit CUSIP number for each affected maturity;

* the record date, if any, for the notice; and

* a title or reference line of no longer than 500 characters that provides a comprehensive summary of the subject of the notice, including a statement that the notice relates to defaulted municipal securities.

It also is suggested that bond documents should specify the notice address for DTC, and issuers are strongly encouraged to provide machine-readable (i.e., filed to a diskette in ACSII format) as well as paper copies to DTC's Proxy Department in order to facilitate retransmission of notices? Finally, the groups recommend that such notices should be filed with NRMSIRs or the relevant SID, if any exists, even if filing of the notice is not required under Securities and Exchange Commission Rule 15c2-12.

Issuer Practices

In dealing with municipal securities held exclusively through the book-entry system, the market groups recommend that issuers include provisions in their bond documents that direct the registrar, acting as agent for the issuer, to:

* request as promptly as possible from the DTC's Proxy Department a securities position listing (SPL), which includes the names of DTC participants who hold the affected securities, as of the record date for mailing the security holder notice;

* mail copies of the notice to each DTC participant listed on the SPL and to each other nominee identified to the issuer;

* request from each nominee other than DTC either an undertaking to retransmit the notice to all persons for which it serves as nominee, including nonobjecting beneficial owners,(4) or a similar undertaking with respect to objecting beneficial owners and a list of all nonobjecting beneficial owners;

* provide an undertaking of the issuer to pay to the nominees other than DTC the reasonable costs of transmitting the notice to persons for whom the participant acts as nominee, including the nonobjecting beneficial owners if the nominee has notified the registrar that it will mail the notice to nonobjecting beneficial owners in lieu of providing the listing requested by the registrar;

* provide to each nominee other than DTC the requested number of copies of each notice for retransmission; and

* mail the notice directly to each beneficial owner identified to the issuer or registrar.

Furthermore, it is recommended that bond documents should permit individual beneficial owners to identify themselves to the registrar to receive a direct mailing of notices from the registrar. Bond documents also should explicitly require that notices follow the recommended format. Moreover, issuers should consider adding to the section of their official statement that contains disclosure regarding the book-entry registration system, a discussion of steps that beneficial owners can take to augment the receipt of notices related to their securities.

Nominee Practices

Firms that hold nominee positions in municipal securities should make reasonable efforts, upon receipt of an undertaking for reimbursement of reasonable costs, to transmit notices related to those securities to the persons for whom the nominee firms hold nominee positions, whether brokerage firms or banks, mutual funds, or individual owners. Nominees should make known the name and contact information of the person in their organization to whom notices concerning municipal securities should be directed. Persons who are designated by nominees to serve as contacts should have adequate training and resources available to them to assure that notices that are received can be promptly retransmitted to the person for whose benefit the nominees serve as the registered holder of the securities.

Reasonable assistance must be provided to registrars and issuers by nominees who are seeking to contact the beneficial owners of their security issues. That includes responding promptly to requests for nonobjecting beneficial owner lists and to requests for information concerning the numbers of copies of notices to be provided to the nominee for remailing to the objecting beneficial owners by the nominee. The groups strongly recommend that nominees, wherever they may be in the chain of title of a security, upon receipt of reasonable assurance of reimbursement for their costs, either

* provide a list of nonobjecting beneficial owners to the issuer or registrar and retransmit the furnished notices to the objecting beneficial owners, or

* retransmit to the appropriate parties such notices or communications immediately upon receipt.


GFOA and the other groups responsible for the "Joint Recommendations" believe that issuers and nominees can improve the notice distribution process by adhering to these recommendations. If the recommendations are consistently followed, beneficial owners of defaulted municipal securities will receive notices from issuers and others on a timely basis. Finally, following these recommendations will preserve the benefits of the book-entry system, including lower costs for maintaining records of ownership of securities and reductions in the cost of making payments to bondholders.

To obtain a copy of the "Joint Recommendations," visit the GFOA Home Page ( in the Federal Liaison section or fax a request to the Federal Liaison Center at 202/429-2755.


1 In addition to GFOA, the National Association of Bond Lawyers, The Bond Market Association, the American Bankers Association, the National Federation of Municipal Analysts, and the National Association of State Auditors, Comptrollers, and Treasurers participated in the effort.

2 The largest depository is the Depository Trust Corporation (DTC). It acts as a clearing corporation for trades in the securities industry and is owned by various exchanges, the National Association of Securities Dealers, Inc., and other participants. These other participants include firms involved in the securities industry, such as brokerage firms, banks, and trust companies.

Under the DTC book-entry system for securities, an issuer of securities directs the registrar to register the entire issue in the name of the nominee of DTC. DTC then maintains records of the participants for whom it holds the securities that are registered in the name of its nominees.

3 DTC's Proxy Department is now located at 7 Hanover square, 23rd Floor, New York, NY 100042579, but it is expected to relocate to 55 Water Street, 50th Floor, New York, NY 10041-0099. The phone number is 212/709-6870.

4 Nonobjecting beneficial owners (NOBOs) are those persons for whom the DTC participant acts as nominee who have not objected to the disclosure of their names and security positions. Beneficial owners who have indicated that they do object to disclosure are considered to be objecting beneficial owners (OBOs).

This article was prepared by CATHERINE L. SPAIN, former director of the GFOA Federal Liaison Center.
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Title Annotation:Government Finance Officers Association
Author:Spain, Catherine J.
Publication:Government Finance Review
Date:Feb 1, 1998
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