Congress and the SEC were confident that the municipal market was well in hand. But in Washington State, as the industry newspaper The Bond Buyer put it, “everything that could go wrong did.” 13 Perhaps that should have been expected from the Washington Public Power Supply System (WPPSS), whose name was commonly pronounced “whoops.”
WPPSS was founded in 1957 to build new generating capacity on behalf of 17 local utility districts. Its first hydro plant came in 25 percent over budget, but when studies indicated steadily-escalating demand in years to come, WPPSS ventured into nuclear power. WPPSS undertook its first three nuclear projects in concert with a deep-pocketed federal agency, the Bonneville Power Administration (BPA), but the BPA opted out when WPPSS proposed building nuclear plants 4 and 5 in the mid-1970s. Instead, WPPSS assembled a group of 88 utilities, each signing a “take or pay” contract presumably obligating them to share construction costs whether the plants were completed or not.
It was a bad time to build. In the late 1970s, material and labor costs soared as inflation entered into the double digits. By the early 1980s, interest rates skyrocketed as the Federal Reserve choked off inflation. The five plants were supposed to cost $4.1 billion. By 1981, the tab was $23.8 billion and rising. WPPSS was issuing $200 million in bonds every 90 days to become the top bond issuer in the United States. Then it became clear that the Northwest would not need all that electricity after all.
In early 1982, WPPSS cancelled projects 4 and 5. Chemical Bank, trustee for the bond issue, asked the courts to enforce the take or pay provision. It was customary in cases of innovative offerings for bond counsel to bring a test case in advance to ensure that bond contracts met statute, but counsel for WPPSS had never tested the take or pay provision and underwriters had never questioned it. Courts in both Oregon and Washington invalidated them, and after WPPSS defaulted in June 1983, The Bond Buyer called it “as much a failure of Wall Street as it is of the Supply System.” 14
Small investors nationwide, enticed by the sky-high yields that WPPSS had been obliged to offer, were left holding greatly-diminished assets. A few organized. More sent letters. Many of those ended up on the desk of U.S. Representative John Dingell (D-Michigan), chair of the House Committee on Energy and Commerce and one never reluctant to reprimand regulators. The result was a comprehensive study and a SEC Staff Report released in 1988. The report noted with particular distress that the debacle came after the well-studied New York financial crisis and several years of industry self-regulation. Worse, WPPSS was not an entirely isolated case. During the troubled years from 1972 to 1983, the municipal default rate of .7 percent was startlingly close to the corporate rate of 1.1 percent. The Staff Report found fault with everyone involved in the WPPSS fiasco, but, at the bottom of it all, the problem of insufficient issuer disclosure remained.
Neither angry WPPSS bondholders nor an infuriated John Dingell could change the fact that issuers were exempt from direct regulation. The MSRB and the SEC began to seek what issuers had feared all along: indirect regulation through broker-dealers. The SEC stratagem was a creative masterstroke. Rather than focus on the substance of disclosure, the new rule focused on process. Instead of extending the SEC’s existing disclosure requirements, it was superimposed on existing antifraud provisions in the 1934 Act. The arrangement achieved the desired end “without subjecting municipal issuers to the more formal disclosure regime applicable to corporate issuers.” 15
The 1988 SEC Staff Report proposed Rule 15c2-12. In addition to establishing the basic responsibilities of full disclosure for issues exceeding $10 million, including no material misstatements or material omissions, the rule required broker-dealers to obtain and make available primary offering official statements in sufficient quantity that all purchasers could obtain them. These statements could only come from issuers. Where would they go? The MSRB had already taken care of that. In December 1987, MSRB Chair James Hearty offered to establish within the MSRB a central repository for issuing information. 16 The SEC adopted Rule 15c2-12 in June 1989; a year later, the Commission approved MSRB Rule G-32 requiring broker-dealers to provide the MSRB with primary offering official statements.
In the end, mistakes made by a Washington State power commission had precipitated a striking shift in the regulation of the municipal market. In 15c2-12, the SEC had finally, if indirectly, breached the wall between the issuers and investors. In Rule G-32, the MSRB stood behind 15c2-12 and agreed to serve as a repository of information critical to the functioning of a transparent municipal securities market. The long-term implications of that step were great.
(13) Howard Gleckman, “WPPSS: From Dream to Default,” The Bond Buyer, January 1984.
(15) Edward L. Pittman and Robert A. Fippinger, “Disclosure Obligations of Underwriters of Municipal Securities,” The Business Lawyer, November 1991, 127-156, see page 156.
(Courtesy of Washington State Archives)
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