WASHINGTON — Municipal securities dealers, worried that their participation in a voluntary disclosure enforcement program could lead to a partial shutdown of their businesses, have asked regulators for assurance that this won't happen.
At issue is whether underwriters, who self-reported and want to settle their own securities law violations under the Securities and Exchange Commission's Municipalities Continuing Disclosure Cooperation initiative, would become disqualified from certain safe harbors in SEC rules as well as loss of their Financial Industry Regulatory Authority membership.
These issues arise in most enforcement actions, but the unprecedented scope of the MCDC program and recent complaints by a congresswoman and SEC commissioners about the SEC's longtime practice of granting "waivers" to firms who break the law, has drawn concerns from muni underwriters, attorneys said.
Sources told The Bond Buyer that the Securities Industry and Financial Markets Association sent a letter to the SEC on waivers with respect to MCDC settlements.
A number of SEC rules contain exemptions that are not available if one of the participants in the transaction is a "bad actor." These are rules that may not relate to muni business, but could impact large Wall Street firms that engage in virtually every kind of securities business.
For example, Rule 506 of Regulation D is the safe harbor that governs how a company can offer its securities without being bound by all the requirements of public offerings. The rule prohibits a corporation from using the safe harbor if it is a "bad actor" or a bad actor is participating in an offering. Events that could disqualify the use of the safe harbor include SEC orders that place limitations on the activities and functions of a dealer or other firm.
"It is notable that SEC administrative orders that 'place limitations on the activities functions or operations' of a firm are considered 'bad actor'-designating events," attorneys with Skadden, Arps, Slate, Meagher & Flom wrote in an October 2014 commentary. "While seemingly directed at more serious sanctions on its face, the SEC staff has taken the view that this disqualification would apply to a relatively innocuous undertaking to engage a consultant to review, for example, a firm's compliance policies as a condition of a settled action."
The SEC can waive such a disqualification. Without the waiver, an entire firm can suffer.
SEC chair Mary Jo White addressed that exact example at a March 12 speech she gave at Georgetown University in Washington.
"For example, a firm's broker-dealer charged with violating our net capital rules could, as part of a settlement with us, agree to retain a compliance consultant to help shore up the companies' policies and procedures and to ensure future compliance," White said. "Absent a waiver, this particular term of the settlement agreement alone - a provision that is obviously designed to prevent the re-occurrence of the net capital violation and strengthen the broker-dealer's compliance - could disqualify the entire firm from participating in private placements under Rule 506 because agreeing to retain a compliance consultant in this context constitutes a limitation on the business of the broker, which is an event triggering disqualification under that rule."
A securities lawyer who did not want to be identified said the SEC has historically granted such waivers quite routinely, and that firms settling with the commission would generally apply for a waiver during the settlement process.
But the entire waiver issuer has become politically sensitive in recent months and the tension reached a new crescendo more recently when Sen. Elizabeth Warren, D-Mass., sent White a letter critical of the chair's leadership and the SEC's practice of issuing routine waivers to "well-known seasoned issuers" or WKSIs that include major banking firms. WKSI designation is another way to avoid certain SEC requirements but can also be lost through violating the securities laws.
Also, SEC Commissioners Luis Aguilar and Kara Stein, both Democrats, have dissented from granting waivers in recent months.
Another securities lawyer who asked not to be identified said underwriters who participated in the MCDC are probably overestimating the danger that waivers would not be granted to them. The commission encouraged self-reporting under the MCDC initiative and wouldn't want to be perceived as "tricking" firms who came forward voluntarily, the lawyer said. Such a move would make future voluntary enforcement programs a very tough sell, he said.
"Hypothetically speaking, it would be very surprising if even the Democratic commissioners would do anything to make the MCDC not a success," the lawyer said.
A related but separate issue is FINRA membership. FINRA rules disqualify a firm from membership if they are subject to an SEC order that finds that they "willfully" violated the securities laws. The SEC defined has defined that term to mean that “the person charged with the duty knows what he is doing.'"
Noting that it had become aware of dealer concerns stemming from the MCDC initiative, FINRA recently posted a "frequently asked questions" document telling dealers that if they become disqualified they will receive a letter notifying them of that fact. Firms could then fill out a Form MC-400A application for continued membership that FINRA will review and then send to the SEC. Dealers would be able to continue business during an eligibility proceeding, according to the FAQs.
SIFMA did not respond to repeated requests for information about its waiver concerns.
