New SEC Enforcement Program Targets Issuers and Underwriters Who Fail to Live Up to Their Continuing Disclosure Obligations

By: Paul Maco, Michael Bernard, Kristen Elizondo, and Britt Steckman, attorneys at the law firm of Bracewell & Giuliani LLP

On March 10, 2014, the Securities and Exchange Commission (SEC) announced a new initiative out of its Enforcement Division, the Municipalities Continuing Disclosure Cooperation (MCDC), to encourage municipal issuers and underwriters to self-report violations of their continuing disclosure obligations under Rule 15c2-12 of the Securities Exchange Act of 1934.  Rule 15c2-12 prohibits underwriters from purchasing or selling municipal securities unless the issuer has committed to providing continuing disclosures regarding the security and issuer, including information about its financial condition and operation data.  The rule also requires that any final official statement prepared in connection with a primary offering of municipal securities contain a description of any instances in the previous five years in which the issuer materially failed to comply with any previous commitment to provide such continuing disclosure.  As an incentive to self-report under the MCDC, issuers and underwriters are promised lesser, standardized, and more favorable sanctions for violations than if the issuer or underwriter waits for their violations to be detected.

In July 2013, the SEC charged a school district in Indiana and its underwriter (including the individual who heads the public finance and municipal bond department for the underwriter) with falsely stating to investors in an official statement prepared for a 2007 bond offering that the school district was in compliance with its disclosure obligations related to prior bond offerings, when it was not.  The parties ultimately reached an agreement where the school district and underwriter consented to cease and desist from committing further violations, and the underwriter agreed to pay disgorgement and prejudgment interest of $279,446, in addition to a $300,000 penalty.  If the Indiana school district and its underwriter had been eligible to self-report, and had done so, the issuer would have been guaranteed no civil penalty, and the underwriter’s penalty would have been $20,000 or $60,000, depending on the size of the offering, with a maximum civil penalty to the underwriter for all offering violations not to exceed $500,000.

The SEC may expect a broad response from issuers and underwriters seeking to take advantage of what they view as generous settlement terms.  To encourage a broad response, they have consciously created a “prisoner’s dilemma” in which issuers and underwriters are required to report all participants to a transaction, including each other.  Since more severe penalties await those that do not report potentially inaccurate statements that others do report, more complete reporting and cooperation in reporting is expected.

However, in order to self-report, an eligible entity must complete and submit a standardized questionnaire, which carries implications that must be considered.  For example:

  1. The questionnaire must be completed by an individual duly authorized by the entity and requires identification of the lead underwriter, municipal advisor, bond counsel, underwriter’s counsel, and disclosure counsel.  The SEC provides no assurance that any individual(s) found in violation of federal securities laws will be offered similar terms as the self-reporting entity.
  2. It may be assumed that the questionnaire will be shared with other federal, state, or local regulatory body, and any resolution or settlement with the SEC may not cover any action(s) taken by other regulatory bodies.
  3. The MCDC covers only statements or omissions regarding reported continuing disclosure compliance, thus other non-reported disclosure or fraud violations discovered during any investigation that follows self-reporting may not result in equally favorable adjudication.
  4. The questionnaire requires certain admissions by the entity, and an agreement that the entity intends to consent to the applicable settlement terms under the MCDC initiative; which allows little leeway, if any, for the entity to negotiate more desirable settlement terms.

The SEC creates additional pressure on issuers and underwriters by imposing a self-reporting deadline of September 10, 2014.  This leaves little time to analyze potential problems and assess the risks and benefits of self-reporting.  After that time, all available sanctions, penalties, and remedies are on the table. For more information, please contact Michael Bernard or Kristen Elizondo in San Antonio at (210) 299-3400, or Paul Maco or Britt Steckman in Washington D.C. at (202) 828-5800.

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