CHICAGO — Underwriters upset they might have lost business to competitors that offered gifts to issuers in potential violation of municipal securities rules shouldn't stoop to their level: they should call the Securities and Exchange Commission.
That was the message an SEC municipal enforcement official conveyed to broker-dealer representatives at the Bond Dealers of America's national fixed income conference in Chicago.
"Don't even get close to the line" when it comes to potential violations of pay-to-play and other anti-corruption regulations, Peter K.M. Chan, assistant regional director in the SEC's Division of Enforcement, said Thursday. Chan acknowledged the pressures on underwriters who follow the rules yet lose business to a competitor who might have used gifts, sports tickets, or charitable donations in an improper manner to sway an issuer.
"Don't get mad," Chan said during a panel discussion on market regulation and enforcement priorities. "Call the SEC .we would love your lead."
Chan said the strong interest of criminal investigators in public corruption should provide all the more incentive — in additional to civil enforcement penalties — for underwriters to follow regulations. Criminal prosecutors are "very, very interested" in this area, he said.
Chan's comments followed those of fellow panelist Cynthia Friedlander, director, fixed-income regulation at the Financial Industry Regulatory Authority, who recounted recent FINRA enforcement actions.
They included the agency's acceptance last month of St. Louis-based broker-dealer L.J. Hart & Co.'s settlement offer over alleged violations of municipal rules on gifts and supervision.
The firm was censured and paid a $200,000 fine to settle allegations it improperly distributed more than $183,000 in tickets to professional sporting events — including games of the St. Louis Rams and Cardinals and Kansas City Chiefs and Royals — to issuer clients between early 2009 and 2011. The firm does not admit or deny the allegations in the settlement order.
The Municipal Securities Rulemaking Board's Rule G-20 limits the value of gifts to $100 per year if they are in relation to a broker-dealer's municipal securities activities.
The firm also was accused of violating the MSRB's supervisory Rule G-27 for failing to establish and maintain an adequate system to supervise the ticket gifting.
Panelist Lawrence Sandor, deputy general counsel at the MSRB, stressed just where regulators draw the line on G-20 rule, as it does allow for some exceptions in cases where a broker-dealer is hosting a business-related event in the category of entertainment.
"Once you don't attend, it turns from entertainment to a gift," he said, adding that there are limits to permitted entertainment.
"There's a presumption that an ordinary business dinner may be appropriate under G-20, but if it becomes extensive or lavish, that in and of itself could be a violation of G-20 separate and apart from the gift rule, where dealer personnel are just giving someone something of value," Sandor said.
FINRA's efforts at curtailing violations of pay-to-play and other corruption-related rules include reviewing broker-dealer campaign contributions and their disclosure and in-kind contributions along with the hiring of issuer officials and potential conflicts, Friedlander said.
Chan also told bond dealers that municipal enforcers remain zeroed in on issuer disclosure, potential fraud in the sale of securities, proper secondary market disclosure on sales and trading and information shared with customers, especially on the retail end.
Chan stressed the importance of broker-dealer due diligence and warned underwriters against solely relying on issuer disclosure. He highlighted the SEC's first ever action in July charging an issuer, an underwriter, and one of its officials with falsely claiming in bond documents that the issuer was meeting its secondary market disclosure obligations when it wasn't.
The issuer was West Clark Community Schools, Ind., and the underwriter was Indianapolis-based City Securities Corp.
The disclosure charges came 18 years after the SEC Rule 15c2-12 secondary market disclosure requirements took effect. The rule bars firms from underwriting bonds if the issuer has not contractually agreed to disclose annual financial information and events as they occur. The issuer must disclose any instances in which it has failed to comply with its disclosure obligations over the past five years. The district agreed in offering statements to disclose the information but failed to disclose annual financial and operating information as well as event notices.
City Securities failed to conduct adequate due diligence and, as a result, failed to form a reasonable basis for believing in the truthfulness of material statements in an issuer's official statement, the SEC said in its filings.
Chan told broker-dealers they should have a process in place to document their due diligence. He described a hypothetical scenario in which the SEC is conducting an examination of a firm's due diligence and told by a compliance officer that it's privileged because of the involvement of an underwriters' counsel. Such arguments won't halt the examination.
"Don't get cute," he said about using privilege as a defense. "It actually gets us more curious" and will prompt a deeper review of emails, interviews and other communications to assess the adequacy of a firm's due diligence, he said.