Municipal advisor and SEC spar over first-ever G-42 charges

A municipal advisory firm and one of its principals charged in a first-of-its-kind Rule G-42 case involving a fee-splitting arrangement has reiterated its request that the federal court in California dismiss the charges.

But the Securities and Exchange Commission is pushing back, arguing in part that the defendants had fair notice that fee-splitting was wrong.

The defendants, Choice Advisors and Matthias O’Meara, filed an initial motion to dismiss in December following September charges by the SEC against them for violating fiduciary duties and engaging in unregistered municipal advisory activities.

Specifically, the SEC found that O'Meara and another principal, who has since settled with the SEC, entered into a fee-splitting arrangement with their former employer without disclosing either the arrangement or their relationship with the underwriting firm, to their clients.

“While still employed at the underwriting firm, O'Meara allegedly improperly operated in a dual capacity, simultaneously serving as a registered representative for the underwriting firm, and also as a municipal advisor where he purported to serve as two clients' fiduciary,” the SEC said.

Bloomberg News

The SEC further alleged that O’Meara, in particular, took action to increase the overall fees paid by the clients to enrich himself and Choice, resulting in nearly $40,000 in additional fees for one school.

In their motion to dismiss, filed in December, Choice and O’Meara argued that the SEC’s allegations are without merit in part because “fee splitting” is not clearly defined in the MSRB rule. Defendants further argued that the SEC’s complaint is flawed because it lacks support in both prior cases and the MSRB rule, and violates due process principles.

In a reply filed Jan. 14, the SEC laid out the various components of Rule G-42 to support its charges against Choice and O’Meara, writing, “The complaint identifies precisely how defendants violated the various provisions of MSRB Rule G-42, including but going well beyond the provision prohibiting arrangements to split fees with underwriters.”

Responding to defendants’ contention that the SEC failed to define the phrase “fee-splitting arrangement,” the SEC argued that it provided a “clear description of the time, place, and nature of the violative conduct” and does not have a duty to supply such a definition.

“Contrary to defendants’ argument, Rule 9(b) [governing legal pleading requirements] requires the plaintiff to identify the conduct that is alleged to be violative; it does not impose a separate or additional duty to supply 'definitions',” the SEC told the court.

Also, pushing back on Choice and O’Meara’s due process argument, the SEC contended that the defendants had fair notice that fee splitting is wrong.

Citing a 1972 case, Grayned v. City of Rockford, the SEC noted that “to satisfy due process, a regulation should be sufficiently specific to “give the person of ordinary intelligence a reasonable opportunity to know what is prohibited.”

As a result, the SEC argued that the stated purpose and context for the prohibition on fee-splitting–i.e., the “irreconcilable conflict between the municipal advisor and the client”--is clear and was known to defendants.

“It would be difficult to imagine a more blatant realization of the concerns underlying the fee-splitting prohibition set forth in MSRB Rule G42(e)(i)(D)—that by engaging in a fee-splitting arrangement with an underwriter, a municipal advisor is set on a path to violate its fiduciary obligations,” the SEC wrote in its reply.

In their reply filed Jan. 24, Choice and O’Meara again accused the SEC of using the charges as a “test case to deprive defendants of their livelihood.”

Choice and O’Meara also argued that the SEC did not “seriously engage” with the issues presented in defendants’ motion to dismiss. They told the court that this includes a failure by the SEC to allege scienter, i.e., intent or knowledge of wrongdoing, and to provide an objective meaning of the term “fee-splitting” in its complaint against them.

“Instead, [the SEC’s response] presents a broadly dismissive attitude, relies heavily on the same type of conclusory reasoning the motion highlighted, and delves into long, non-responsive interludes about the history, structure, and context of MSRB action, without truly addressing the missing connections articulated in the motion,” Choice and O’Meara contended.

Consequently Choice and O’Meara reiterated their request that the federal district court in California dismiss the SEC’s complaint, while the SEC reiterated its request for the court to deny Choice and O’Meara’s motion.