Carrot or Stick? The Impact of Regulatory Leniency on Municipal Disclosure Compliance

We examine how the SEC's 2014 Municipalities Continuing Disclosure Cooperation initiative (MCDC) affects disclosure compliance in the municipal bond market. In an effort to increase transparency in the municipal debt market, the MCDC granted favorable settlement terms to municipal-debt issuers and underwriters that voluntarily self-reported having violated SEC disclosure requirements. Although there was widespread participation among underwriters, the vast majority of municipal issuers did not participate in the MCDC initiative, despite having publicly observable disclosure violations. Consistent with an improvement in underwriter oversight of the initial bond offering following the MCDC, we find that official statements were less likely to include false claims regarding past disclosure compliance, particularly for issuers with participating underwriters. However, contrary to the SEC's intention, we find that issuers' compliance with continuing disclosure requirements decreased by 9% after the MCDC initiative. Overall, our findings suggest that, because the MCDC lacked a credible ex-post enforcement threat, it exacerbated noncompliance by revealing the weaknesses of the existing regulatory regime.