SEC Enforcement in the Municipal Securities Market
Written by Dave Thompson
If your entity is considering the issuance of municipal bonds, you would be well advised to pay close attention to the process. The Federal Securities and Exchange Commission (SEC) probably is! In fact, over the last five years, the SEC has significantly stepped up its enforcement activity in the municipal bond market.
A Cautionary Tale
The latest cautionary tale comes from the Town of Oyster Bay on Long Island, New York. Two days before Thanksgiving 2017, the SEC filed suit against the town, charging the town and its former town supervisor — the town’s top elected official — with securities fraud. The SEC’s complaint charged the town with violations of the Securities Act of 1933 and the Securities Exchange Act of 1934 and Rule 10b-5. The town supervisor was also individually charged with liability under the Exchange Act as a “controlling person” for the violations by the town, and with aiding and abetting violations. On March 1, 2018, the former deputy town supervisor/town attorney agreed to settle charges brought by the SEC for his role in the matter. On the same date, the U.S. Attorney’s Office for the Eastern District of New York filed a superseding criminal indictment that included securities fraud charges against the former town supervisor.
The SEC’s allegations were based on the town’s failure to fully and accurately disclose in its more than 26 municipal bond offering documents between 2010 and 2015, indirect guarantees of four private loans, totaling approximately $20 million, to a long-time concessionaire who operated restaurants and other businesses in town facilities. The SEC further alleged that potential liability for the loan guarantees represented a potential liquidity risk for the town and was therefore information that would have been material to a potential investor evaluating a decision whether to purchase the town’s municipal bonds.
The charges of “control person” liability against the town supervisor arose from the personal involvement of the town supervisor and deputy town supervisor in seeking second outside counsel assistance in structuring the guarantees when, in 2010, the town’s regular outside counsel advised town officials that guaranteeing a private loan violated the New York Constitution. The SEC also alleged that the town assisted the concessionaire as a result of a personal relationship with various town officials, and a long pattern of gifts, bribes, kickbacks, and political support to town officials.
SEC Steps Up Enforcement Actions
In 2010, the SEC established a special enforcement unit to focus on the municipal bond market. Since then, the SEC has continued a drumbeat of enforcement actions involving municipal bond issuers, attorneys, mayors, and other local government officials. In his October 4, 2017 testimony before the U.S. House of Representatives Committee on Financial Services, SEC Chairman Jay Clayton reiterated that “the Commission and its staff will remain vigilant and focused on municipal securities issues,” and that “our staff will continue to administer and vigorously enforce our rules and the statutory provisions within our jurisdiction concerning municipal securities brokers and dealers, municipal advisors, municipal issuers and investors in municipal securities.”
What Else Is the SEC Finding?
In 2014, in Harvey, Illinois, the SEC intervened to prevent the issuance of bonds, alleging that prior bond issues had been used for impermissible purposes. In this case, a former city comptroller and an outside consultant had conspired to divert bond proceeds. As a consequence, the consultant was barred for life from municipal bond deals. The mayor wasn’t directly implicated in these acts but was fined $10,000 on a “control person” theory. In other words, according to the SEC, since the mayor was in charge of the bad guys, he was responsible for their bad acts.
The SEC has used this control person theory in other enforcement actions. In 2015, in Allen Park, Michigan, the SEC found securities fraud in the case of bonds issued to finance the redevelopment of some abandoned factories into movie studios. The disclosure documents for the bonds failed to disclose that state funds once promised for the project were no longer forthcoming. In this case, the city administrator was barred for life from municipal bond deals, and the Mayor was fined $10,000 on the control person theory.
In 2016, the SEC charged Westlands Water District in California with securities fraud for failing to disclose in an official statement for a revenue bond issue that accounting adjustments had been made in prior years to show adequate debt service coverage without disclosure of those accounting adjustments. The district’s general manager was fined $50,000. A striking feature about this and other recent SEC enforcement actions is that no investor lost money, but the SEC found fraud anyway.
How to Avoid Trouble
A number of these cases involved activities by local government officials that plainly violated state or local laws. The takeaway is that even if you’re confident your staff and other elected officials are obeying the law, you must still review and document each step in the process. Local government officials need to be sure that procedures are in place to avoid even inadvertent disclosure matters in connection with municipal bond issues.
- Ask the professionals you hire to assist with bond financing — lawyers, financial advisers, underwriters — to advise you on the disclosure obligations of your entity.
- Require staff training regarding the entity’s disclosure obligations in connection with bond issuances.
- Make sure that internal accounting controls are strong and that personnel who prepare financial statements are involved in any municipal bond issuance.
- Make sure (and consider documenting) that the appropriate staff (and in particular, persons outside just the Finance Department) and officials review the official statement or other disclosure material prepared for any municipal bond issuance.
- Adopt procedures to ensure compliance after bonds are issued with annual and ongoing disclosure obligations.
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