On April 1, 2025, the SEC issued a press release regarding an
- These three individuals were responsible for facilitating an offering of revenue bonds for a non-profit that they owned and operated.
- Allegedly, much of the financial information provided to the underwriters for these two deals was fraudulent, misleading and contained fabricated information.
Looking at this case from an outsider's perspective, it's difficult to imagine being in the shoes of an underwriter on a deal like this. The painful memories of the SEC's Municipalities Continuing Disclosure Cooperation (MCDC) Initiative still live rent free in the minds of many industry participants, and it's hard not to look at a case like this and feel triggered.
For those unfamiliar, the MCDC initiative was a voluntary program run by the SEC in the 2010s. This initiative allowed underwriters to self-report their own alleged failures to conduct proper due diligence on bonds they'd underwritten. Many industry firms undertook painstaking efforts to conduct look back reviews, which required reviewing the deal files underwritten in the previous five years to, essentially, "monday morning quarterback" their processes of ensuring that an issuer's continuing disclosure undertaking (CDU) was accurate.
The major difference, of course, between an underwriter's obligation for continuing disclosure under SEC Rule 15c2-12 and a case such as this is that the rules make it clear what the expectations are for an underwriter when reviewing an issuer's CDU. The potential liability for an underwriter in a case like this, however, is murkier.
The individuals at the center of this case supplied the underwriter with a great deal of information regarding its financials. Among those things:
- Letters of intent that were designed to represent interest in the bonds that containing fake client information and forged signatures.
- Fabricated "pre-contracts" that were designed to represent commitments from parties that would be using the facility to generate revenue streams for the bonds.
- Pro-forma financial statements that showed revenue at figures that were multiple times the amounts owed in payments to bondholders.
- A peer-reviewed study containing data that was manipulated by the individuals charged in this case.
All this information was used in the creation of the offering memoranda for the two deals, which the SEC stated would have been material to a reasonable investor.
While this case rightly focuses on the individuals who perpetrated the fraud, there are certainly risks posed to the underwriter. There may not be a looming MCDC-like initiative on the horizon, but to mitigate issues like reputational risk, it may be worth reviewing any processes and checklists you have in order to understand how a deal like this might unfold on your own desk. It is sadly not possible to prevent 100% fraud scenarios such as this from occurring; however, reassessing your firm's processes for identifying red flags may be a good place to start.
As an underwriter, consider your firm's level of involvement in a deal, as that could impact the level of liability associated with identifying these types of issues. Liability may not be limited to only sole/lead managers, so it's important to have processes in place if your firm has any involvement in the new issue process. There are definitely good vendors out there that provide services to support a firm's compliance program, and firms can and should leverage these services when necessary. But its important to remember that the responsibility for maintaining a strong compliance program rests with the member firm.
