The Securities and Exchange Commission’s decision to charge South Miami with defrauding investors by making misstatements and failing to disclose that its bonds might lose their tax-exempt status establishes a precedent for a much wider array of documents that could become securities law liabilities, experts said Thursday.
The SEC announced Wednesday that it had settled securities fraud charges with the city, which falsely certified that it was complying with loan agreements to ensure two sets of pool bonds issued by the Florida Municipal Loan Council in 2002 and 2006 would be tax-exempt. Instead, the city had loaned some of the bond proceeds to a private developer and leased the entire project — a retail space and public parking lot — to it, sharing parking revenues with the private company.
John McNally, a bond lawyer at Hawkins, Delafield & Wood LLP, said the case establishes a new precedent that documents never meant for investors’ eyes could create a securities law problem.
The 2006 Ira Weiss case, in which a bond lawyer negligently rendered an opinion about the bonds’ qualification for tax exemption, established that a bond opinion can be materially misleading disclosure in the official statement, McNally said. The SEC’s recent action against Harrisburg, Pa., established that documents unrelated to bond issuance but reasonably expected to reach investors can be a fraud liability in the absence of proper disclosure.
South Miami is different, McNally said, because the certifications to the FMLC were neither included in an official statement or reasonably expected to reach investors.
“Clearly, these are not documents ‘reasonably expected to reach investors,’” McNally said. “But the prohibition under Section 17(a)(2) is that one cannot ‘obtain money . . . by means of any untrue statement of a material fact or any omission to state a material fact,’ and the SEC argued that South Miami violated 17(a)(2) because it was obtaining money from the conduit issuer by means of an untrue statement. Now we know that any document with which you obtain money can result in a securities law liability.”
McNally was referring to antifraud provisions of the Securities Act of 1933 that can apply to SEC enforcement actions on municipal securities.
Craig Conn, counsel to the FMLC, said the certifications serve as a “tickler” to remind the city how it is supposed to use the bond proceeds. The FMLC follows industry standard practice by accepting those certifications at face value.
South Miami and the FMLC settled the financings’ tax law violations with the Internal Revenue Service in 2011, preserving the tax-exempt status of the bonds by paying $260,345 and defeasing a portion of the two prior bond offerings at a cost of $1.16 million.
The SEC has maintained since the mid-1990’s that issuers, should disclose when the tax-exempt status of their bonds have been jeopardized by tax law violations to avoid violating the securities fraud laws, even if the IRS never investigates.
Paul Maco, an attorney at Bracewell & Giuliani and former head of the SEC’s muni office, said the SEC’s focus on actions that took place after the bond sales and internal documents is interesting. Maco said the major take-away for issuers is that they need to have internal procedures in place to make sure they do not commit these kind of violations, a point recent SEC cases have hammered home.
The SEC settled with San Diego, Calif. in 2006 and with Illinois earlier this year on charges that both failed to disclose pension obligation risk. Each was required to shore up internal procedures as part of the deal.
A bond lawyer who preferred not to be named agreed. “Look at San Diego. Look at Illinois. The settlement was all procedures,” he said. The lawyer added that issuers need to understand that the SEC might act even if no investors were harmed, as in this case. “Issuers cannot simply rely on bond counsel,” he said.
