Tucked in a recent memo sent by the Financial Industry Regulatory Authority to brokers is a stern warning about what they should worry about on their next exams:

Proving that they supply appropriate disclosure to investors about the risks of municipal bonds.

Disclosure requirements are nothing new for broker-dealers. They know to disclose the terms of the purchase and the risks involved as well. This applies equally to stocks and bonds.

But when it comes to municipal bonds, broker-dealers face an unusual challenge that is beyond their control, according to a survey just released by DPC Data, a Fort Lee, N.J.-based municipal data vendor.

The broker-dealers have no way to anticipate just when issuers or obligors of muni bonds will disclose any information on their ongoing financial health, assuming they file disclosures at all. Neither does any regulatory agency.

“In any given year it would be impossible to analyze credit risk or find any warning of default from officially filed disclosure data on significantly more than half of the issues studied,” says Peter Schmitt, chief executive officer of DPC Data. “The disclosures were either not filed or filed too late to provide timely and useful information.”

Until July 1, 2009, DPC Data had been one of four data vendors designated by the SEC as nationally recognized municipal securities information repositories (NRMSIRs); the others are Bloomberg, Interactive Data and Standard & Poor’s.

That was the day the SEC designated the Municipal Securities Rulemaking Board’s Electronic Municipal Market Access platform or EMMA as the sole repository for muni bond disclosures. Those disclosures include regularly required financial statements as well as 12 types of "material events” that warrant separate notices. These include payment delinquencies, technical defaults, unscheduled draws on credit enhancements, bond calls and ratings changes.

In its survey of 17,000 muni bonds issued from 2003 to 2009, DPC Data found that about 56 percent filed no financial statements for one or more years between 2005 and 2009.

And it also found that 19 percent did not file annual disclosures for all of those four years. During fiscal 2009 about 72 percent of expected disclosure filings were either not filed at all or filed more than 180 days late.

That’s not only bad news for investors attempting to keep up with the credit risk in their bonds holdings, but for dealers and advisors who are responsible for informing investors about the “suitability” of a muni investment at the point of sale.

While the SEC’s Chairman Mary Schapiro petitions Congress for legislation enabling the regulator to enforce disclosure standards on issuers, broker dealers and financial advisors are taking the heat for protecting investors.. The Municipal Securities Rulemaking Board (MSRB), which oversees muni dealers, is placing increased pressure on dealers to be aware of anything that could affect the value and risk profiles of bonds they plan to sell.

End result: at the very least muni-dealers' trading, credit research and compliance departments need to gather all the official disclosure information available, both annual filings and material event notices.

The solution?

EMMA’s service may be free but, by itself, that won’t cut it. Broker- dealers need to ensure they always can deliver a synopsis of the municipal bond's financial health, as well as information about whether the issuer is current on its disclosure obligations. And do so when needed, quickly.

That means dealers are likely to choose to use commercial vendors such as former official repositories Bloomberg and DPC Data which purchase real-time data feeds from EMMA. Those vendors are maintaining their roles as primary infrastructure data vendors in the municipal market; in addition to more recent filings obtained through EMMA, the former NRMSIRs hold annual financial statements and material events filed before July 1, 2009..

The difference between free disclosures from EMMA or paid services from the vendors?

Speed, for starters.

With approximately 100,000 material events filed annually, broker-dealers attempting to keep up with proprietary holdings or issues of interest must continually look up the issue to see if anything new has been filed on EMMA.

The vendors offer far easier access through better linkage of disclosures by indexed parameters. That means that research which could take days to uncover on EMMA can be gathered in minutes from vendor-supported platforms.

Risk-management services, such as DPC Data’s MuniGuard, identify material event notices related to potential default, and alert subscribing clients.

Another DPC Data service is MuniPoints, which are bullet-point abstracts of bond features condensed from the offering statements which can be integrated into trading systems and linked to other disclosures related to the issue.

Although DPC Data declines to provide either a fee breakdown or disclose the number of users, it cites growing interest as broker-dealers attempt to survive increased regulatory demands and the threat of enforcement action.