by John C. Grugan and Tesia N. Stanl
The most significant enforcement strategy the U.S. Securities and Exchange Commission (SEC) employed in 2014 followed a well-worn path: through its Municipalities Continuing Disclosure Cooperation Initiative (MCDC Initiative), the SEC sought to regulate issuers by leveraging its authority over underwriters. Announced on March 10, 2014, the MCDC Initiative encouraged municipal securities issuers and underwriters to self-report possible securities law violations related to inaccurate representations in offering documents concerning an issuer’s prior compliance with its continuing disclosure obligations. The deadline for underwriters to self-report was September 9, 2014. Issuers, having the benefit of knowing whether their underwriters had reported any misrepresentations, had until December 1, 2014, to self-report.
Both underwriters and issuers had to decide whether to self-report based on little SEC guidance. In particular, the SEC declined to provide any framework related to which statements concerning past continuing disclosure compliance it considered to be material under the federal securities laws. On July 8, 2014, the SEC announced that it had brought an enforcement action against a school district in its first MCDC cease-and-desist order. The order provided little precedent for underwriters and issuers to consider: it gave little detail regarding how the alleged misrepresentations were material, and statements by LeeAnn Gaunt, Chief of the SEC Enforcement Division’s Municipal Securities and Public Pensions Unit, suggested that the school district already was under investigation. In the absence of materiality guidance from the SEC, and due to the penalty cap provided to underwriters, it now appears that both underwriters and issuers over-reported under the MCDC Initiative. Stated differently, it is unclear whether the SEC could prove liability in these cases if it were required to do so.
One tangible result of the MCDC Initiative is an increase in the number of continuing disclosure filings submitted by municipal securities issuers to the Municipal Securities Rulemaking Board’s (MSRB’s) Electronic Municipal Market Access (EMMA) website. When compared to the same time period in prior years, EMMA statistics show a notable spike in the filing of failure to file notices, which are required when an issuer misses a filing deadline, following the announcement of the MCDC Initiative. In June 2013, the number of notices of failures by municipal securities issuers and obligated persons to file annual financial information totaled 154. In June 2014, these notices totaled 718.
Another result of the MCDC initiative is an increased focus by municipal market participants on the manner in which secondary municipal market disclosures from municipal securities issuers are achieved. The SEC’s regulation of issuers’ secondary market disclosure continues to be accomplished through enforcement actions as well as through the SEC’s regulation of brokers, dealers, and municipal securities dealers under SEC Rule 15c2-12.
In response to the SEC’s November 2014 request for comment on the existing collection of information under SEC Rule 15c2-12, the Securities Industry and Financial Markets Association (SIFMA) submitted comments noting the “unnecessarily confusing, burdensome and complicated” requirements of Rule 15c2-12 and the increasing costs to underwriters under the SEC’s broad interpretations of underwriters’ duties under the Rule. SIFMA also noted that the Rule was adopted and amended before publicly-available information was widely available about municipal securities issuers, including on issuers’ websites. In its response to the SEC’s request for comment, the MSRB stated that its costs are also increasing due “in part to the increase in the number of filings with EMMA and the increased attention being paid to compliance with the disclosure requirements of Rule 15c2-12 following the SEC’s National Examination Risk Alert issued in March 2012 and as a result of the MCDC Initiative.”
The SEC’s efforts to regulate issuers indirectly through its ability to regulate underwriters directly appear to be its response to the denial of its request in its 2012 Report on the Municipal Securities Market, in which it sought authority to regulate directly the secondary market disclosures of municipal securities issuers. This would have all but required a repeal of the “Tower Amendment.” In that report, and among other things, the SEC sought legislation authorizing it to set timing, form, content, and financial audit requirements for continuing disclosures and providing the SEC with “tools” to enforce such requirements, and to be granted the authority to require trustees to enforce continuing disclosure agreements. Congress did not grant any of these requests, and consequently the SEC has again resorted to indirect regulation, such as that through the MCDC Initiative.
The MCDC Initiative was not the SEC’s only enforcement effort in 2014. As in recent years, the SEC continued to aggressively pursue enforcement actions against state and local governments. In June 2014, the SEC obtained an emergency court order to prevent the City of Harvey, Illinois, from selling bonds in the municipal market amid allegations the City engaged in fraudulent market transactions. Without admitting or denying the allegations, the City settled in December 2014. In August 2014, the SEC announced a settled action against the State of Kansas. The SEC alleged the State failed to disclose a significant unfunded liability in its pension system in any of eight series of bonds offered over an 11-month period. These two actions foreshadow two possible enforcement focuses in 2015: secondary market disclosures and pension disclosures.
“Pay-to-play” violations also are likely to remain a focus of SEC enforcement actions. In June 2014, the SEC announced its first enforcement action under investment adviser pay-to-play rules. In September 2014, a federal district court dismissed on procedural grounds a challenge to the rule brought by the state Republican parties of New York and Tennessee. The Republican parties are appealing the court’s ruling.
The prohibitions of the SEC’s investment adviser pay-to-play rule do not apply to “regulated persons,” which require such persons be subject to substantially equivalent or more stringent restrictions on political contributions than under the SEC’s rule. For this reason, the Financial Industry Regulatory Authority requested comment on its own pay-to-play rule, modeled after the SEC’s, in November 2014. Comments were due December 15, 2014.
Concerning municipal advisors, the SEC’s final registration rules went into effect July 1, 2014. In August 2014, the SEC announced an initiative by its Office of Compliance Inspections and Examinations to examine a large number of these newly regulated municipal advisors over a period of two years. The SEC identified compliance with the municipal advisor’s federal fiduciary duty to municipal entity clients as an area of potential scrutiny as well as compliance with requirements related to books and recordkeeping, disclosure, fair dealing, supervision, and employee qualifications and training. The MSRB has adopted, or is in the process of adopting, municipal advisor rules related to the areas identified by the SEC. Ms. Gaunt has made statements suggesting that the SEC may be poised to bring municipal advisor enforcement actions alleging breach of a fiduciary duty.
Another area of regulation addressed in the SEC’s 2012 Report on the Municipal Securities Market that the SEC will likely continue to pursue in 2015 is improved price transparency for retail investors. In December 2014, the SEC approved the MSRB’s adoption of a “best execution” rule. MSRB Rule G-18 provides that “[o]ne of the areas in which a dealer must be especially diligent in ensuring that it has met its best-execution obligations is with respect to customer transactions involving securities for which there is limited pricing information or quotations available.” In November 2014, the MSRB issued a proposal to require dealers to disclose certain reference information in customer confirmations related to pricing. Given the SEC’s focus on price transparency, it will likely undertake additional related initiatives in 2015.
Finally, in November 2014, the SEC demonstrated that it is also monitoring uniform practice standards for dealers. The SEC levied financial penalties against 13 dealer firms it alleged engaged in uniform practice violations by selling Puerto Rico high-yield bonds to investors below set minimum denominations.
Summaries of key municipal market SEC enforcement actions brought in 2014 can be found in the sections below:
Ballard Spahr’s Municipal Securities Regulation and Enforcement Group advises its clients on the latest securities issues in their public finance transactions, including in regulatory and enforcement matters of the SEC. We advise issuers in a broad range of public offerings and private placements of municipal securities in both the primary and secondary market.