Investors and regulators> are growing increasingly concerned about the quality and timeliness of information that state and local governments are disclosing about their finances.
The Securities and Exchange Commission is inquiring about public statements Illinois made about its pension funds amid the agency's increased scrutiny of the municipal-bond market, a representative for the governor said.
Amid governments' financial woes, meanwhile, angry investors are finding themselves blindsided by bad news. Those concerns are reflected in a forthcoming study that shows that public issuers routinely file information about their financial health well beyond the date they promise to bondholders, if at all.
This weak disclosure is raising anxiety in the $2.9 trillion market, where investors withdrew more than $20 billion from municipal bond funds in recent weeks.
Federal regulators' power in this realm is limited because municipal borrowers are unregulated. But they are trying to crack down on the disclosure issue.
"If a municipality is in dire financial straits, we want to know if that information was disclosed to bond holders in a timely fashion," says Elaine Greenberg, who runs the municipal-bond unit set up by the SEC last year. "It's not good enough to put the information out there late. Investors need information that is current, not stale, to make informed investment decisions."
At the request of The Wall Street Journal, DPC DATA Inc., a specialist in municipal disclosure, did an extensive analysis of disclosure and found the problem growing since a 2008 study. Of 17,000 bond issues it studied, more than 56% filed no financial statements in any given year between 2005 and 2009. More than one-third of borrowers entirely skipped three or more years, and the number grew to 40% in 2009, as credit woes mounted. Another 30% filed extraordinarily late in 2009.
"This works out to insufficient ongoing disclosure information for more than $2 trillion of the $3 trillion in outstanding bonds," says Peter Schmitt, chief executive of DPC of Fort Lee, N.J.
While earlier studies by DPC and others show municipalities' sluggish filing, the new study suggests that municipalities are getting worse at a time when investors need information the most.
The rampant lack of current official filings reflects a broader disclosure problem. Many cities, states, hospitals and other public borrowers don't make general financial records accessible, investors and regulators say, and if they do, they are often so confusing or spotty that even professionals can't make sense of them.
The annual audited statement itself often contains detailed and vetted information that isn't included in other documents, such as pension and health-care liabilities, according to Mr. Schmitt.
In contrast, public disclosure for corporate bonds and stocks are consistent and released far more quickly.
Media reports, of course, are rampant about city and states' fiscal woes. Many municipalities that don't file timely financial statements may have public information available to ambitious investors, such as minutes of public meetings.
But it isn't enough for an issuer's woes to be publicized through word-of-mouth or a newspaper story, Ms. Greenberg says. The information has to be filed with the Municipal Securities Rulemaking Board, a self-regulatory organization that posts the documents on a publicly accessible website called EMMA.
The SEC is looking for cases in which municipalities failed to warn investors of fiscal problems. The agency recently brought a case against New Jersey, claiming that the state failed to give bond investors a full picture of its large pension obligations.
New Jersey authorities settled the SEC case without admitting or denying wrongdoing.
Illinois is facing an SEC inquiry on a similar issue, about its communications concerning measures it has undertaken to reduce pension costs, according to the state's recently prepared bond documents.
The state has provided the agency with news releases and emails from state officials related to the measures, according to a person familiar with the matter. The inquiry isn't focused on one particular government office, this person said.
In an effort to improve its disclosure documents to bond investors, the Illinois governor's office said, the state hired a law firm in August, shortly after New Jersey was accused by the SEC of failing to disclose to investors certain details of its pension funds. The SEC contacted Illinois in September and the state has been "cooperating fully," with the agency's information requests, the bond documents say.
Bond lawyers say any action by the SEC over allegedly misleading statements made outside of bond documents would be rare. SEC officials declined to comment.
Instances of muni-bond investors getting caught off guard by bad news are emerging as governments and other borrowers struggle in recent months.
The Clay Gas and Utility District of Clay County, Tenn., didn't file disclosures for 10 years, until one in November saying it didn't expect to make future payments.
A spokesman for the utility didn't return a phone call seeking comment.
Helen Kirkpatrick, a retired journalist in Chevy Chase, Md., spent $25,000 10 years ago on Maryland Health and Higher Education bonds. She said she checked regularly for updates online and didn't see anything amiss. But then in October, she says, she was stunned to get a letter from a broker offering 50 cents on the dollar, saying there was no promise the issuer would pay more in the future. She searched for information and found none and couldn't reach the issuer, she says. Confused, she took the deal.
A spokesman for Maryland Health and Higher Education didn't return phone calls for comment.
Chowchilla, Calif., defaulted on its bonds used to renovate city hall earlier this month. The city, which bills itself the "Gateway to Prosperity," had never filed documents notifying investors that a default was coming.
The city's most-recent financial statement currently on file is for the fiscal year ending in June 2009.
More recently, there have been several red flags.
The city last year dipped into its reserves to pay bond investors, putting it in technical default. This means that while it ran out of money from the normal fund meant to pay bond holders, it still paid. It reported this issue and indicated it would make the payment.
The city's financial problems worsened and became public in some press reports. Some investors apparently got cold feet and sold at a loss in December, according to data on trades at the Municipal Securities Rulemaking Board.
Still, several experts say, investors had no reason to know that the city in January would have trouble paying them.
"The reasons for the default that they list in their resolution expenses in excess of revenues, late payments from the state, etc. were happening in just about every city in California," says Justin Marlowe, a public finance professor at University of Washington, who studied this bond disclosure. "But only a few have actually defaulted."
He says that Chowchilla's financial reports were incomplete and didn't alert investors of its forthcoming default.
The default even surprised Wayne Padilla, assistant city administrator. He says the trustee stopped paying investors because the reserve fund was $500 short. "I can't warn you about something I don't know is happening," he says.
The city and the trustee later worked out an agreement to pay bondholders, again out of the reserve, according to a statement by the trustee, which didn't comment on the original decision to stop paying.
Richard Little, a retired financial advisor in Danville., Calif., with about 60% of his multi-million portfolio in municipal bonds, says he has taken to driving to municipalities where he holds stakes to see if stores are full and the roads have traffic.
"Historical data shows you the risk is low," he says. "In reality, I'm petrified."—Michael Corkery
and Jeannette Neumann contributed to this article.