WASHINGTON – Municipal market participants will once again see an active year for enforcement in 2016 as the Securities and Exchange Commission's self-reporting initiative largely wraps up and the enforcement division mixes a continued focus on pricing and market structure actions with potential new areas for enforcement like municipal advisors and bank loans.
"The pipeline is very full," said LeeAnn Gaunt, director of the SEC enforcement division's municipal securities and public pensions unit. "We're really operating on all cylinders."
The often-discussed SEC self-reporting program, the Municipalities Continuing Disclosure Cooperation initiative, is once again expected to account for a large amount of the enforcement activity from the SEC, observers said.
The initiative, which has so far led to settlements with 58 underwriters, allows underwriters and issuers to receive lenient settlement terms if they voluntarily self-reported any instances during the past five years in which the issuers falsely claimed in official statements that they were in compliance with their self-imposed continuing disclosure agreements and the underwriters were negligent in failing to discover the misstatements. The commission is expected to release one more round of underwriter settlements before getting to issuers and Gaunt said her unit still plans to follow the settlements with actions against negligent individuals and any issuers or underwriters who failed to file despite having actionable conduct.
John McNally, a partner with Hawkins Delafield & Wood in Washington, said he expects the SEC to finish with the underwriter and issuer settlements by the middle of next year. The enforcement unit will likely have to review a large number of issuer filings, he said, but he expects that the number of settlements will be limited because SEC enforcement officials do not have the same regulatory "leverage" against issuers as they do against underwriters. The SEC will have to charge issuers with negligence or recklessness under the federal antifraud laws rather than violations of Rule 15c2-12, McNally explained.
Paul Maco, a partner at Bracewell & Giuliani, and Elaine Greenberg, a partner with Orrick, Herrington and Sutcliffe and the previous director of the SEC's muni enforcement unit, both said it is hard to pin down when the SEC could finish with issuers, but added any SEC follow-up on individuals and non-filers could cause the initiative to stretch much longer.
While it is true that the process for working out settlements with issuers is less complicated than those with underwriters, because there is no need to consider waivers, hiring of independent consultants, or writing "big checks," Maco said, the process of negotiating and approving settlements for "a couple hundred" issuers, and then any individuals charged later, is "a good bit of work even for the relatively large team that the commission seems to have dedicated to the MCDC program."
Greenberg added that work from the initiative would stretch much further past 2016 if individuals facing SEC action chose to forego a settlement and instead litigate the SEC's charges.
Ernesto Lanza, a shareholder in Greenberg Traurig's Washington office, characterized the SEC's planned follow-up with individuals and non-filers as a "tail to MCDC that will be going on for a number of years." He predicts the tail could also include actions stemming from questionnaires the SEC sent to MCDC filers asking them to identify other professionals, like lawyers and advisors, who participated in the deals.
"One could imagine that if the SEC wanted to send a message saying 'professionals, you have obligations as well,' they can find a limited number of cases where professionals really dropped the ball and try to make a case to say watch out, you're a gatekeeper, you can't just be there with blinders on in a transaction," Lanza said.
Moving past MCDC, broker-dealer abuses in the primary and secondary markets, like the SEC found in August's Edward Jones case on primary market pricing of bonds and 2014's minimum denomination case on Puerto Rico bonds, will continue to be a focus, Gaunt said.
The SEC staff's work on the Edward Jones case, a first of its kind in muni enforcement, is expected to set the commission up well to bring similar actions in the future.
"Through that process, a lot of people in the enforcement division spent a lot of time focusing on how municipal underwritings occur," Maco said. "You have people who have had their hands on this for a good period of time and are familiar with it so that obviously leaves a group of people who are going to be sensitive to problems in that area."
Actions against municipal advisors, who are in the process of being examined by the SEC for the first time, is also "entirely possible," Gaunt said. She added the SEC's Office of Compliance Inspections and Examinations, which is doing the exams, is regularly in contact with muni enforcement about what they are finding.
If the MA exams find serious problems, like a possible antifraud violation, then Maco said the market may see some actions this year, but 2016 will most likely be a time where the enforcement division starts to develop actions that then play more of a role in 2017.
Lanza agreed, saying anything that would warrant an action would probably have to be "pretty egregious" and close to what would have been enforceable before the MA rules were established, like a fiduciary duty violation.
But he said there is a possibility that there could be something that is a relatively close call but SEC officials think is important. If that happens, the SEC officials could give guidance by going out with a light penalty to let people know it is wrong behavior, he said.
Leo Karwejna, managing director and chief compliance officer at Public Financial Management, said it is more likely the SEC will choose not to pursue enforcement actions after the exams conclude and instead will choose to release a risk alert or some other type of guidance to the market detailing its findings.
While 2015 "may be a little early" for MA actions, said California-based Dave Sanchez, a lawyer with Sidley Austin, MA enforcement using statutory fiduciary duty standards could be a part of a larger movement toward issuer protection cases in 2016. Sanchez said the SEC has faced pressure in the past to bring actions against broker-dealers for fair dealing violations if they got municipalities into troublesome deals like those that include auction rates or swaps, and MAs could be a logical extension if the commission decides to take action next year.
The SEC could also break new ground by bringing enforcement actions on use of bank loans in the market, some participants said. Many in the market have asked the SEC for guidance on considerations associated with the use of bank loans, but the commission has not released any to date.
Lanza said he could see the SEC wanting to bring a case on bank loans, specifically on the question of what constitutes a loan and what constitutes a security, if the commission found an instance where something was obviously a security and a financial advisor sold the bonds in a direct sale to an investor without using a registered broker-dealer.
"If they can provide something that says, here is some very broad guidance that gets you a few inches closer to you knowing what the line is without us having to make that fine distinction, it would be helpful and would give a little more information to the marketplace and show the SEC's seriousness [in having] people to analyze these things closely," Lanza said.
Tom Dannenberg, president and chief executive officer of Hutchinson, Shockey, Erley & Co. and a Bond Dealers of America board member, said the SEC could also weigh in on the related issue of the point at which registered municipal advisors working with loans for an issuer are engaging in broker-dealer activity as placement agents.
"I think you're going to see an example case in that arena," he said, citing the need for guidance. "I think 2016 is the year that spells it out pretty specifically for everyone."
