A careful look at several recent Securities and Exchange Commission muni enforcement cases reveals that the agency is quietly seeking a new sanction: "industry bars" against municipal officials. Industry bars are court orders that prohibit municipal officials from participating in future offerings of municipal securities. As discussed below, the significance of this new SEC enforcement strategy should not be overlooked. An industry bar can essentially serve as a career-ending sanction for an individual working in the municipal finance sector.
SEC Focus On Muni Officials
As market participants know, the SEC has recently stepped up its efforts to police the municipal securities market. As part of this aggressive enforcement agenda, the SEC has sought to hold municipal officials more accountable when official statements contain disclosure violations. To illustrate this new trend, one needs to look no further than the SEC's novel use of a "control person" charge against the former mayor of Allen Park, Michigan for alleged disclosure violations in official statements. The SEC's decision to start targeting municipal officials marks a departure from the agency's prior policy of affording municipal officials significant deference when filing cases.
SEC Attempts To Bar Muni Officials
In its November 2014 case against the former mayor and the former city administrator of Allen Park, the SEC sought to bar the officials from participating in future municipal securities offerings. In its complaint filed in federal court, the SEC sought, among other sanctions, a court order "permanently barring [defendants] from participating in an offering of municipal securities , including engaging in activities with a broker, dealer, or issuer for purposes of issuing, trading, or inducing or attempting to induce the purchase or sale of any municipal security, provided, however, that such injunction shall not prevent [defendants] from purchasing or selling municipal securities for his own personal account."
Similarly, in June 2014, when the SEC filed an emergency court action against the City of Harvey, Illinois and its comptroller to halt an alleged fraudulent bond offering, the SEC sought an industry bar against the comptroller. On Dec. 8, the court issued its preliminary ruling in that case granting the SEC's request for the bar sanction. The court ruled that, based on the evidence presented by the SEC, "[t]here is good cause to believe that [defendant] is unfit to continue as a participant in municipal bond offerings."
Practical Implications Of An Industry Bar
The imposition of an industry bar against a municipal official will undoubtedly affect that individual's current and future employment in the public finance sector. For some municipal officials who are routinely involved in the functions of municipal finance, including participating in muni debt offerings, a bar may serve as a career-ending sanction. By seeking industry bars of this type, the SEC is sending a clear message that it expects municipal officials to play a meaningful role in ensuring that disclosures in official statements do not mislead investors.
Legal Basis For Industry Bars
The SEC is relying on a certain "catch-all" provision in the securities laws to bar municipal officials. The SEC has dusted off an infrequently used provision of the Securities Exchange Act of 1934 -- Section 21(d)(5), which provides: "In any action or proceeding brought or instituted by the Commission under any provision of the securities laws, the Commission may seek, and any Federal court may grant, any equitable relief that may be appropriate or necessary for the benefit of investors."
Traditionally, when the SEC seeks industry bars against individuals, it relies on statutory provisions that explicitly authorize the relevant bar sanctions. For example, when seeking an officer and director bar, the SEC relies on Section 21(d)(2) of the Exchange Act, which explicitly authorizes courts to prohibit individuals from acting as officers or directors of public companies. Similarly, when seeking a penny stock bar, the SEC relies on Section 21(d)(6) of the Exchange Act, which explicitly authorizes courts to prohibit individuals from participating in penny stock offerings. In the context of an agency administrative proceeding, the SEC routinely imposes "association bars" pursuant Section 15(b)(6) of the Exchange Act, which explicitly authorizes the SEC to prohibit individuals from future employment with certain regulated entities, such as broker-dealers, investment advisers, and municipal securities dealers.
Because there is no analogous bar provision in the federal securities laws that explicitly prohibits individuals from participating in municipal securities offerings, the SEC is relying on the general catch-all provision found at Section 21(d)(5).
Remedial or Punitive
The SEC ultimately bears the burden of proving in court that the industry bars it seeks are necessary to protect investors (a remedial sanction) and not to punish municipal officials (a punitive sanction). The line between remedial and punitive sanctions is not always clear and depends on the underlying conduct and the individual's state of mind. Because Section 21(d)(5) is intended to provide for general equitable relief, there may be opportunities to challenge the SEC's new bar strategy in litigation by arguing that it amounts to prosecutorial overreach. In certain cases, the collateral damage to a municipal official's career resulting from the imposition of an industry bar may far outweigh any benefit to investor protection interests. This may be particularly true where the SEC seeks industry bars for conduct that was unintentional and did not result in any investor harm.
The SEC's muni bar sanction is even more significant now that the Dec. 1, 2014 filing deadline for the Municipalities Continuing Disclosure Cooperation (MCDC) Initiative has passed. The SEC enforcement staff is currently combing through the municipal issuers' self-reports and will be making charging decisions soon. When the SEC announced the MCDC Initiative in March 2014, it was careful to note that the program's favorable settlement terms are only available to municipal issuers (and underwriters) and not to individuals who may find themselves involved in future muni enforcement investigations.
