SEC still aggressive despite fewer enforcement cases

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Though the frequency of muni enforcement cases may seem to be decreasing, the Securities and Exchange Commission is still aggressive in pursuing certain cases and focusing on the gatekeepers in the market.

Lawyers experienced with the SEC's enforcement program discussed the state of play a week after the commission's annual enforcement statistics report, which showed a slight decline in enforcement actions. Peter Chan, a partner at Baker McKenzie and former SEC enforcement lawyer, said he doesn’t see a drop off at all in the aggressiveness of the Enforcement Division. Numbers don’t tell the full story, Chan said.

Statistics about the number of enforcement actions fail to capture how "active and aggressive" those investigations are, Chan said.

SEC staff seem particularly aggressive in cases where the victims include retail investors, which is consistent with Chair Jay Clayton’s emphasis on protecting those investors specifically. There is also an apparent focus on gatekeepers, whom Chan defined as muni advisors, underwriters, bond lawyers, and auditors. Those are the professionals who are supposed to be responsible for avoiding violations, Chan said.

“We continue to be strongly committed to meaningful and effective enforcement in the municipal securities market,” said LeeAnn Gaunt, chief of the Public Finance Abuse Unit in the SEC’s Division of Enforcement. “As demonstrated by the SEC’s actions over the last several years, we are focused on all major areas of this important market, including addressing wrongdoing by issuers, broker-dealers, and municipal advisors.”

Chan referenced two cases over the past year that forecast where SEC enforcement may be headed.

In June, the SEC charged Comer Capital Group, LLC, a municipal advisor and its managing partner Brandon Comer for failing to protect its client in a 2015 bond offering for the Harvey Illinois Public Library District.

They also settled an administrative proceeding against IFS Securities, the underwriter of the bonds, for allegedly not acting with reasonable care in underwriting the bonds. The SEC said the when the firm had a hard time finding investors, that it sold bonds to another broker-dealer at a price that was not fair and reasonable.

For practitioners the Comer case was huge, Chan said, because it reaffirms that the SEC’s Public Finance Abuse Unit continues to be focusing on municipal advisors but shows a focus on the pricing process.

“The rule of the gatekeepers, be it the underwriter or the municipal advisor in making sure that the price is fair both for the issuer and for the retail investor,” Chan said.

In September, the SEC charged the Montebello Unified School District in Los Angeles County for defrauding investors in the sale of $100 million of general obligation bonds.

The SEC said the district deprived investors of material information regarding the audit of its financial statements. The district allegedly concealed that its own auditor raised concerns about potential fraud and internal control problems at the district.

The takeaway from the case, Chan said is that the SEC is showing no lack of interest in issuer disclosure cases and that it continues to look at gatekeepers.

With the Comer case, Chan said some may say it’s a small case because the issuer and municipal advisor are smaller. However, from a policy perspective, it is significant, Chan said.

The Comer case could bring enforcement momentum and more cases against gatekeepers, Chan said.

“If they (SEC) investigate and find something wrong, and then they look again and find something wrong in the same patter with something else, they will put in more resources to look the same way,” Chan said.

After the financial crisis, the SEC adopted a “broken windows” approach to enforcement, brought on by former SEC Chair Mary Jo White. White believed it was important to pursue even the smallest infractions.

“I don’t think the term broken window is used anymore, but the flip side of it is that the staff at the same time does not feel any obstacle when the situation is right to bring a case where they believe there has been a violation based on negligence,” Chan said.

Kathleen Marcus, shareholder at Stradling law firm, said the SEC has been more strategic in the cases they bring and also believes the SEC has shifted away from its broken window approach.

“The shift away from broken windows does not mean that the SEC is less active or aggressive,” Marcus said. Marcus said they’re still bringing smaller cases, but the overall philosophy is to be strategic about the cases they bring.

Since Sarbanes-Oxley in 2002 — a law that helps protect investors from fraudulent financial reporting by corporations — Marcus said gatekeepers have had an elevated focus by the SEC.

“Since that legislation, there has been an elevated emphasis on the gatekeeper and then the SEC finds a gatekeeper in their crosshairs, they hold them to a higher standard of knowledge and understanding,” Marcus said.

Following the Municipal Securities Rulemaking Board’s proposal this week to display the timing of annual financial disclosures on EMMA, Oklahoma Finance Director Kenton Tsoodle was concerned it was a gateway to more disclosure rules in the future.

“Is that something they’re going to use to create more rules and bring more enforcement action?” Tsoodle said.

Tsoodle said they’ve seen it in the past with voluntary bank loan disclosures on EMMA, which led to amendments to SEC Rule 15c2-12.

“We saw a pattern there that began something in EMMA and it leads to some rulemaking, so that’s why I think the issuer community has some concerns in that area,” Tsoodle said.

Earlier this month, SEC Commissioner Hester Peirce emphasized that each enforcement case is unique and urged people to take the enforcement statistics with a grain of salt.

Peirce recommended strengthening the SEC’s enforcement program by looking for rules that need to be written, eliminated or rewritten. The commissioner referenced a case brought last year to enforce the ban on testimonials under its investment adviser advertising rules.

“Ought we really to be spending enforcement resources to ensure that radio personalities keep mum about their positive advisory experiences?” Peirce said.

On Peirce’s comments, Chan said there continues to be a dialogue as to how much enforcement there should be versus guidance, compliance and rulemaking.

“The sense that I have is that is an ongoing debate and I think that will continue to be true in the upcoming year,” Chan said.

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SEC enforcement SEC regulations Broker dealers Municipal advisors MSRB rules SEC Washington DC