DALLAS (Bloomberg) ? Municipal bond insurers may sue issuers, underwriters and attorneys for fraudulent disclosure under a court ruling that gave insurers the same status as bondholders, a federal appeals court ruled.

New York-based Financial Security Assurance Inc., the largest US municipal bond insurer, won the right to sue Stephens Inc. under federal securities laws over information used to market bonds sold for a Georgia solid waste facility, the 11th US Circuit Court of Appeals in Atlanta ruled May 31.

The decision supports Financial Security Assurance?s claim that under its bond insurance contact it could end up with an ownership interest of the bonds in case of a default.

?We?re very pleased that the court upheld the rights of insurers to rely on bond documents,? said Betsy Castenir, spokeswoman for Financial Security Assurance. ?We think it is significant.?

The decision may give municipal bond insurers a new tool in their efforts to minimise losses when state and local governments default on their debt. In 2005, $228.10 billion, or 55.9 percent, of the record $408.33 billion of municipal bonds sold last year carried insurance.

Financial Security alleged in its lawsuit that Little Rock, Arkansas-based Stephens failed to disclose financial information related to bonds sold for a Crisp County, Georgia, solid waste facility.

Stephens underwrote the $69.6 million in November, 1998 that provided financing for a facility to remove recyclable material from garbage before sending the trash to a landfill. The facility was going to charge users of the landfill fees to generate revenue to repay the bonds.

Financial Security, after conducting a review of the facility and examining preliminary bond documents, agreed to insure the debt. Then, following the completion of the bond sale, the Solid Waste Management Authority of Crisp County informed Financial Security that it was amending revenue projections to reflect changes in contracts.

In November 2000, the facility was unable to make a scheduled debt payment, prompting Financial Security to cover the amount.

A month later, Financial Security sued Stephens, alleging fraud under federal securities rule 10b-5, which makes it illegal to make untrue statements or omit material information to mislead investors. The lawsuit also alleged state law claims for fraud and negligent misrepresentation.

The federal district court dismissed the 10b-5 claim because Financial Security wasn?t the purchaser of the bonds and the insurer appealed, making arguments for why it should be able to sue.

The appeal drew a friend-of-the-court brief from the New York-based Bond Market Association, which represents securities dealers and investment banks, asserting the insurer should have done its own due diligence review of the transaction before agreeing to insure the bonds.

While the appeals court dismissed several arguments made by Financial Security, it said the contract the insurer signed to guarantee bond payments could lead to it be the owner.

?To the extent that FSA has an enforceable contract to otherwise acquire the bonds, however, it has an ownership interest in the bonds regardless of whether it has physical possession of them,? the court wrote in the May 31 decision.

Katrina Keller, a spokeswoman for the Bond Market Association, and Frank Thomas, a spokesman for Stephens, didn?t immediately respond to a request for comment.

It remains to be seen how far-reaching the decision will be for the municipal bond market, said Patrick Born, who chairs of the Government Finance Officers Association?s debt committee. Underwriters may start asking insurers to sign ?big boy letters?, or disclosures stating that they reviewed bond documents and understand the risks, he said.

?While the ruling represents a change, it?s not like bond insurers are unsophisticated investors,? said Born, who is chief financial officer for Minneapolis. ?They?re not little old ladies in tennis shoes who buy a couple of bonds. The underwriters will ask for a defence in advance.?