The Securities and Exchange Commission is severely limited in authority to engage in pre-offering review of municipal securities issues and to provide substantial pre-offering disclosure guidance to issuers, officials, underwriters, municipal advisors and counsel alike. Nevertheless, in 1975, Congress enhanced the enforcement tool for the Commission through an amendment of the definition of "person" in the Securities Exchange Act of 1934. Enforcement is a post-offering regulatory tool. Although the Commission does not have many tools in its municipal securities market toolbox, it has used the enforcement tool to its great advantage in the past 3½ years. Although little noticed, Financial Institutions Regulatory Authority also is becoming more active in enforcement against dealers.
The Commission has significant limitations in terms of both funding and personnel that generally prevent a broad-based enforcement foray into the municipal market. The SEC has many other markets to oversee. The Municipalities Continuing Disclosure Cooperation Initiative was, therefore, a particularly imaginative enforcement solution directed toward a very specific disclosure issue.
Despite the Commission's practical limitations, issuers, officials and others in the municipal market should not mistake the sheer power and flexibility of the enforcement tool. Counting the MCDC actions, other actions against issuers, officials, underwriters and municipal advisors, as well as the actions against dealers for sales of bonds below minimum denominations, there have been approximately 180 enforcement actions brought by the SEC and FINRA in the 3½ year period.
The Commission has shown significant creativity in converting its enforcement program into a regulatory mechanism for changing the behavior of market participants. Among other things, the Commission demonstrated in recent actions how enforcement can be utilized to achieve direct regulation of, and to provide disclosure guidance to, issuers and officials, albeit through a rough form of disclosure guidance for the particular issuers and officials who are affected directly. The uncertainty of when and whom enforcement will strike adds to the in terrorem impact of this much more aggressive regulatory approach, so that all market participants now perceive the advisability of proceeding cautiously.
The discussion may be distilled down to the following key points:
- The Commission has become much more aggressive in enforcement against issuers and officials, which is an outcome of the legislative bargain in 1975.
- Control person liability and its potentially severe impact on issuer leaders is especially significant: The SEC need only prove control and primary violations by the issuer or another controlled person (e.g., a Finance Director); the "control persons" (e.g., Mayors, Board Chairs) must prove their good faith and lack of direct or indirect inducement of the violations, with civil penalties and bars from the market as sanctions. This is not the SEC's burden of proof. The concept of "control" is defined broadly as "direct or indirect" control, and does not require participation by the "control person" in the primary violation.
- Issuer adoption of disclosure policies and procedures may assist a control person in proving good faith, provided the issuer actually implements the policies and procedures.
- Personal liability for not reading carefully the documents one signs, even merely for negligence, also can be problematic for issuer officials: Such a violation may be easy for the SEC to prove, again with civil penalties and bars from the market as sanctions.
Counsel and municipal advisors serving issuers in bond offerings would be well-counseled to protect their clients' leaders by affirmative advice on these issues. No counsel or advisor should have client officials who are surprised after the fact when the SEC calls.
The SEC's recent aggressive enforcement program has realized actual substantial market-wide achievements. This was foretold by a Subcommittee of the National Association of Bond Lawyers in 1997, which stated in a Report Regarding Recent SEC Enforcement Actions Involving Municipal Securities Transactions: "Enhanced enforcement activity can do more to focus issuer and underwriter attention on their responsibilities than can any other alternative."
For example, as a direct result of the MCDC Initiative, the SEC achieved its goals of focusing the attention of market participants on the importance of continuing disclosure and of promoting sound issuer disclosure policies and procedures and underwriter due diligence practices.
Offering participants now pay much more careful attention during the offering process to the disclosure of financial information and operating data in official statements in order to satisfy securities law requirements. Once the issuers have made the offering disclosures, the financial information and operating data in the official statements form templates for continuing disclosure undertakings that issuers are better able to perform in satisfaction of the federal securities laws.
In addition, issuers now pay much greater attention to continuing disclosure compliance after bonds are sold. In significant part, that compliance now occurs at the urging of and with assistance from those legal and financial professionals who look beyond the short-term goal of merely closing bond issues to the task of effective issuer implementation of transactions.
In a technical sense, of course, the MCDC Initiative was directed in specific terms at misleading disclosure or nondisclosure in offering documents regarding prior issuer noncompliance with continuing disclosure undertakings into which the issuers had entered in earlier bond issues. The Commission, however, utilized the Initiative as a vehicle to require the underwriters of virtually all municipal bonds issued into the market to retain independent consultants "not unacceptable" to the Commission with respect to due diligence practices and to adopt practices recommended by the consultants. Those practices may include such matters as determinations of due diligence investigative steps to undertake in varying types of bond issues, retention of records to demonstrate the due diligence undertaken, supervision of diligence activities, and other matters of central importance to underwriter due diligence.
Improvement in underwriter practices was one of the SEC's stated goals in implementing the Initiative. The Bond Buyer quoted Andrew Ceresney, Director of the SEC's Enforcement Division, as stating: "In addition to effectively addressing this past misconduct, we believe the initiative has been effective in improving underwriter due diligence in municipal securities offerings on a going forward basis."
In addition, the Commission required self-reporting MCDC issuers constituting a substantial number of issuers in the market to adopt disclosure policies and procedures, to allocate disclosure responsibility, and to engage in staff training regarding securities law compliance. Those issuer actions are likely to form a pattern for new market standards expected to be adopted by a broad swath of municipal bond issuers. For example, in 2015, the National Association of Bond Lawyers published a paper on "Crafting Disclosure Policies" (Aug. 20, 2015) to provide assistance to local governments in structuring disclosure policies and procedures suitable within the context of their particular organizational structures and operations. This pattern is consistent with the SEC's approach in other recent enforcement actions settled with issuers that perhaps do not evidence fraudulent intent, but rather behavior more akin to negligence.
Significantly, when issuers adopt and implement appropriate policies and procedures, underwriters, municipal advisors and counsel all are less at risk of enforcement.
Of course, once issuers and underwriters adopt new policies and procedures, the issuers and underwriters would be well-advised to comply with those policies and procedures. Otherwise, in future actions, the Commission could, and likely would, use significant compliance failures against the issuers and underwriters. Previously, the SEC has noted failure to comply with internal policies in bringing enforcement actions.
In other words, the MCDC Initiative and other recent enforcement actions have served as a vehicle by which the SEC has been able to revolutionize, in a systematic manner, municipal securities due diligence practices by underwriters and disclosure practices by issuers. The SEC may not have been able to achieve that result by less intrusive or less sweeping methodologies.
Those significant SEC enforcement achievements represent classic regulatory outcomes. Active regulatory agendas seek to attain significant positive changes in the behavior of regulated parties. The SEC has attained that goal.
Despite the discomfort of many market participants, The Bond Buyer quoted Jessica Kane, the head of the SEC's Office of Municipal Securities, as stating: "From my perspective, the MCDC Initiative was very successful. There was robust participation. It especially heightened the focus of the market on continuing disclosure obligations."
The Bond Buyer quoted SEC Chair Mary Jo White describing the MCDC Initiative as "one of the commission's successful efforts [to] deter securities law violations and change market behavior."
Although many market participants are frustrated with aspects of the MCDC Initiative, it is difficult to dispute the SEC's assessment of its enforcement regulatory record. The follow-up questions are—what next?
And who is next?
Robert Doty is president of AGFS, a municipal securities litigation consulting firm in Annapolis, Md. This Commentary is excerpted from Doty's book, "Expanding Municipal Securities Enforcement: Profound Changes for Issuers and Officials," published by the International Municipal Lawyers Association and now available at
