As the Securities and Exchange Commission's enforcement and litigation activity in 2012 demonstrates, the agency's focus on municipal market enforcement has increased dramatically, and this trend seems likely to continue under the SEC's new leadership.
The SEC demonstrated this focus more than two years ago, when its Enforcement Division formed a specialized Municipal Securities and Public Pensions Unit. That unit, in turn, has filed increasing numbers of cases each year, including a record number of municipal market enforcement actions in 2012.
The municipal securities unit announced five priority enforcement areas — offering and disclosure fraud, tax or arbitrage-driven fraud, pay-to-play and public corruption violations, public pension accounting and disclosure violations, and valuation and pricing fraud — and brought enforcement actions in all of these areas in 2012.
Just this week, the SEC again demonstrated this enforcement focus by settling its second action directly against a state related to public pension disclosures. The agency charged the State of Illinois with failing to disclose to investors in multiple bond offerings that its statutory plan to fund the state's pension obligations — including the impact of pension holidays and other legislative amendments to the statutory plan — resulted in significant underfunding.
Although Illinois disclosed that its pension obligations were funded through a statutory plan, the SEC found that the state failed to disclose in its offering documents that the contributions required under the statutory plan pursuant to a 50-year pension contribution schedule did not adequately fund the state's pension obligations, deferred public pension contributions, and increased its unfunded pension liability. As it did with its 2010 order settling charges related to the State of New Jersey's public pension disclosures, the SEC ordered Illinois to cease and desist from committing or causing future securities law violations without imposing any monetary fines.
In September 2012, the SEC settled a historically significant action: its first action ever for "pay-to-play" violations under Municipal Securities Rulemaking Board (MSRB) Rule G-37 on the basis of "in-kind" non-cash political contributions. The SEC charged an underwriter and one of its former vice presidents with violating pay-to-play prohibitions by providing undisclosed in-kind and cash contributions to a former state treasurer during his campaign for governor of Massachusetts.
While there was a $400 indirect cash campaign contribution by the former vice president, the SEC's allegations were based on in-kind contributions such as drafting speeches, approving campaign expenditures, arranging advertisements, reviewing office space leases, and providing legal advice. The SEC found that the former vice president conducted some of these activities during business hours and while using the resources of the underwriter. The underwriter consented to the SEC's order without admitting or denying its findings and agreed to pay approximately $7.5 million in disgorgement, $670,000 in prejudgment interest, and $3.75 million in penalty fees, minus $2.1 million in credit for payments pursuant to an action by the Commonwealth of Massachusetts.
In another groundbreaking 2012 enforcement action, the SEC settled its first action ever against borrower's counsel in connection with the offer and sale of municipal bonds to finance the borrower's acquisition of a casket manufacturing facility. The SEC alleged that borrower's counsel failed to disclose to key transaction participants material information regarding criminal proceedings against the principal of the borrower for financial fraud as well as the unfavorable terms of a $200,000 loan to the borrower.
The SEC alleged that by failing to correct misstatements and omissions in the Official Statement known by borrower's counsel, borrower's counsel aided and abetted the borrower and its principal in violating securities laws. The SEC further alleged that the opinion letter by borrower's counsel constituted an anti-fraud violation by stating that there was no "action, suit or proceeding at law or in equity" pending or affecting the borrower that would have an adverse financial impact on the borrower and that the Official Statement did not "contain any untrue statement of a material fact, and did not omit to state any material fact necessary to make the statement therein … not misleading."
Without admitting or denying the SEC's findings, borrower's counsel consented to a permanent injunction from committing or causing future securities law violations and was suspended from appearing or practicing before the SEC as an attorney. Borrower's counsel further agreed to pay $10,000 in disgorgement, $3,052 in prejudgment interest, and a $25,000 civil penalty.
The SEC is seeking to complement its aggressive enforcement agenda with additional authority, including the power to set the timing and accounting method standards used for market disclosures. Furthermore, the SEC will likely soon be led by Mary Jo White, the former U.S. Attorney for the Southern District of New York. Ms. White, the first former prosecutor nominated as SEC Chairman, is widely expected to lead the agency to a more aggressive enforcement agenda. In addition, the SEC is expected soon to provide a final definition of "municipal advisor" for registration purposes under the Dodd-Frank Act, a precursor to additional municipal advisor regulation and enforcement.
The SEC's recent enforcement activity demonstrates its increased focus on the sufficiency and accuracy of disclosures, as well as on the integrity of the underwriting and investment contract processes. All signs point to a continuation of this increased municipal market enforcement trend.
John C. Grugan, a partner at Ballard Spahr, advises clients in
investigations and litigations conducted by the SEC, the U.S. Department of Justice,
self-regulatory organizations, and state securities regulators.
Tesia N. Stanley, an associate in Ballard Spahr's Public Finance and Litigation Departments, has worked as a senior writer for the MSRB and as a research specialist for the SEC.