DENVER – Strong policies and procedures and an awareness of recent Securities and Exchange Commission enforcement trends like individual liability and conflicts of interest are important if issuers want to avoid being caught up in SEC enforcement actions, several lawyers told government finance officials on Tuesday.

The comments were made during a panel at the Government Finance Officers Association’s annual conference here that was designed to explore SEC enforcement. Ben Watkins, Florida's bond finance director, moderated the panel that also included Peter Chan, a partner with Morgan, Lewis & Bockius in Chicago and former SEC lawyer, and Carol McCoog, a partner with Hawkins Delafield & Wood in Portland.

Chan, who Watkins said is “infamously” known for his leading role in creating the SEC’s Municipalities Continuing Disclosure Cooperation initiative, touched on MCDC, but also gave two key steps that issuers and issuer officials can take to protect against enforcement. MCDC promised underwriters and issuers would receive lenient settlement terms if they self-reported instances over the last five years where issuers falsely said in offering documents that they were in compliance with their continuing disclosure agreements.

“In many of the SEC’s cases, one of the messages is the expectation of reasonable policies and procedures to make sure there is accurate disclosure of key facts,” Chan said. It is not just important to have them, he said, but is important for issuers to be able to point to their compliance when the SEC starts asking questions. Chan added that good disclosure that will avoid fraud and won’t attract SEC attention is also about “getting the right people to make sure the offering statement is accurate,” whether those are actuaries for pension reports, auditors, or some other type of professional.

Watkins said that from a risk management perspective, having policies and procedures and qualified people in place is essential and that straying from that is playing “Russian roulette.”

Jeremy Joseph Drake defrauded a professional athlete and his wife of $1.2 million, says the SEC.
Securities and Exchange Commission
Lawyers expect the SEC to continue its focus on individual liability in enforcement actions as well as to increase its attention to conflicts of interest.

A solid foundation with those elements will be helpful for issuers as the SEC has gotten more aggressive in recent years and is likely to continue that trend under its new chair Jay Clayton, the panelists said.

Chan pointed to the recent SEC case involving the city of Miami and its former budget director Michael Boudreaux as an example of the commission’s willingness to impose steep penalties. A federal jury in September 2016 found the city and Boudreaux guilty of fraud related to misstatements about transfers between the city’s various fund pools to try to make its general fund look more stable.

Miami ended up agreeing to pay $1 million to settle with the SEC, by far the largest penalty an issuer has paid in connection with municipal securities enforcement.

Despite the steep penalty, Chan called it a “no-brainer” because Miami was a repeat violator and had broken an injunction from a 2003 fraud case the SEC brought. Miami was enjoined from committing securities fraud in the future after the 2003 case.

The more severe penalties for repeat violators also could connect to continuing disclosure post-MCDC, Chan said.

He acknowledged he was speculating, but said he believes the SEC's commissioners have the impression that all issuers, regardless of their size, should have an understanding of continuing disclosure requirements after MCDC. That means that if the SEC finds an issuer that either has insufficient policies and procedures or doesn’t have them at all, it is likely the commission will judge them more harshly, even if it is a first-time offense, Chan said.

He later added that the role of GFOA in informing its members about developments like MCDC and the resulting ramifications is very important given what he found to be a faulty belief from the SEC about how well it could get its message out to issuers.

“One thing I was surprised about was within the commission there is an assumption that once it makes a statement … everyone will know about it,” Chan said of his experience with the SEC after MCDC was announced. “It was a surprise to the staff that even after the announcement of MCDC and even after I spoke at a GFOA conference … there were quite a number of issuers … that not only had not heard of the MCDC initiative but did not hear about some of the [continuing disclosure] issues” the SEC had addressed in several prior reports and notices to the market,” including the 2012 Report on the Municipal Securities Market.

Aside from disclosure, Chan sees a continued emphasis on including gatekeepers like dealers, MAs, and public officials in SEC enforcement actions against issuers. He said it is likely to be a consensus issue for the commissioners, regardless of their party.

An aspect of that will be control person liability, which allows the SEC to hold public officials like mayors or city managers responsible for violations based on their control of the municipal entity that engaged in the fraud. The SEC used it in two 2014 actions, one against the former mayor of Allen Park, Mich. and the other against the mayor of Harvey, Ill.

Watkins pointed to the concern an issuer could have with control person liability by asking the audience how many of their mayors or council member read their official statements before signing off on them. Very few audience members raised their hands.

Chan circled back to the need for policies and procedures and effective people in charge of bond issuances to guard against the specter of control person liability.

“If I’m a mayor, even if I wasn’t involved in the drafting of disclosure document, I should be ready to say I reasonably believe that the folks I have in charge of the issuing process are adequately trained and I am well aware of the reasonable processes and procedures … even if I’m not involved,” Chan said.

Issuers and others should also be ready for “huge growth” this year and in the next few years in enforcement involving conflicts of interest and pay-to-play, Chan said.

“The reason that is going to be important is because in the midst of changes to the administration, Congress, and the SEC, enforcement has been a focus,” he said. “One area of consensus will be conflicts of interest.”

The SEC will likely be checking any gifts or entertainment an issuer official receives to see if they violate the issuer’s policies and procedures in the area, Chan said.

The panel also briefly touched on the SEC’s recent proposal to add two new material event notices to its Rule 15c2-12 on disclosure. The proposed notice that has garnered the most concern is one that would require an issuer or borrower to file a notice if it incurs a financial obligation that is material or agrees to covenants, events of default, remedies, priority rights or similar terms “any of which affect securities holders, if material.” The proposal defines financial obligations as "a debt obligation, lease, guarantee, derivative instrument or a monetary obligation resulting from a judicial, administrative or arbitration proceeding."

McCoog, echoing sentiments from many in the muni market, said she fears that “the time and cost associated with going through these numerous financial obligations and determining whether or not they are material is going to be immensely burdensome to issuers.”

The concern about materiality is not new and drew the most attention recently during MCDC when issuers, dealers and others were trying to figure out what the SEC might consider material. The SEC has refused to offer guidance on determining materiality but has pointed to a Supreme Court case that says something is material if a reasonable investor would find it important.

For that reason, Chan said he thinks any persuasive argument to the SEC as to what should or shouldn’t be material “will necessarily include the views of the buy side.” The buy-side has generally looked at the SEC’s proposal favorably, but groups like the National Federation of Municipal Analysts may be willing to give up required disclosures about leases to ensure that disclosure of bank loans and other similar debt obligations does become a requirement, a representative of the group told GFOA's debt committee.

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