Last week, the National Association of Bond Lawyers held its 13th Annual Tax and Securities Law Institute.  Some of the panels included current and former employees of the SEC who spoke on several of the more notable recent developments with respect to enforcement actions in the Municipal Securities space:

1)  The SEC is policing negligence.  Peter Chan, a former staff member of the SEC’s Enforcement Division, acknowledged that suspicion of recklessness is no longer seen by the Staff as a prerequisite for opening an SEC investigation of an issuer – negligence is sufficient.  He noted how “people walking in a fog can cause as much harm as people conspiring to do wrong.” Chan also cited SEC Chairman White’s “broken windows” strategy in support of this practice, and said that the MCDC Initiative is a prime example. However, Chan also acknowledged that the SEC is not likely to bring a case if an issuer has followed sound disclosure policies and procedures and engaged in thoughtful deliberations, even if the SEC questions the accuracy of statements made in the Official Statement.

2)  Exploration of Allen Park and control person liability.  During one of the panels, Mark Zehner, Deputy Chief of the Enforcement Division’s Municipal Securities and Public Pension Division Unit, spoke at some length about the Allen Park, Michigan case in which the SEC, for the first time, charged a municipal official (the mayor of the city) as a “controlling person” under Section 20(a) of the Exchange Act.  Mr. Zehner noted that the SEC has a lot of experience with control person liability, and has brought more than one thousand such cases in the private sector. From his presentation, it appeared as if one of the reasons why the SEC chose to assert a Section 20(a) claim in the Allen Park case was the somewhat more flexible standard for proving control person liability that exists in the Sixth Circuit.  Mr. Zehner noted that the SEC has a lot of ways to hold someone liable (e.g., aiding and abetting) without having to resort to Section 20(a) liability and that there is a good faith exception to control person liability written right into the statute. Reading between the lines, it appears as if the SEC believed they had proof that Allen Park’s mayor was complicit in the alleged fraud and they had an opportunity to use control person liability in a way that would make headlines and create a deterrent for other municipal officials around the country.

3)  Update on the MCDC initiative.  LeeAnn Gaunt, Chief of the Enforcement Division’s Municipal Securities and Public Pensions Unit, spoke at some length about the MCDC Initiative. She did not disclose the number of reports the SEC received, but from her comments it appears as if the SEC received a substantial number of them.  She explained that the Staff is dealing with the broker-dealer submissions first, but are cross-checking to see if issuers reported the same transactions. Settlement orders will be released in batches so as not to stigmatize individual broker-dealers. The orders will identify two or three types of material failures but will not identify issuers or transactions. The broker-dealers will be given two weeks to sign the papers and return them. Ms. Gaunt did not commit to a timetable as to when this would occur, but implied that there would likely be several waves of orders during this calendar year. Every party that self-reported will receive a response from the SEC at some point. Issuers who were reported by broker-dealers but did not self-report will not necessarily hear from the SEC.

By Len Weiser-Varon

The U.S. Securities and Exchange Commission recently settled the first securities fraud charges brought against a municipal official alleging “control person” status under the federal securities laws.  The SEC’s settlement with the former mayor of the city of Allen Park, Michigan bars him from participating in future securities offerings and imposes a $10,000 penalty. A city administrator also was charged and barred from participation in future securities offerings

The SEC’s enforcement actions, brought against the city and the two city officials, alleged that the offering documents for a “double-barreled” general obligation bond issue contained false and misleading statements.  In particular, the SEC alleged that the offering documents failed to disclose adverse developments relating to a proposed public-private transaction for a film studio project to be located on land purchased with the bond proceeds; the project was not consummated, leading to financial difficulties that caused the state of Michigan to appoint an emergency manager for the city.  The bonds issued for the project were rated A by S&P and subsequently downgraded to BB+, and recent audited financial statements for the city have carried a going concern qualification.

The enforcement action against the city was brought under  Section 17(a)(2) of the Securities Act of 1933, which permits administrative action by the SEC for negligent conduct, and under SEC Rule 10b-5, which permits administrative action by the SEC as well as a private right of action by affected investors, but requires proof of “scienter”, or an intent to deceive (which has been interpreted to include highly unreasonable conduct or recklessness.)

More notably, the SEC charged the mayor as a “control person” under Section 20(a) of the Securities Exchange Act, under which any person who directly or indirectly “controls” another person found liable for a violation of the Securities Exchange Act or any regulation thereunder is jointly and severally liable, to the same extent as the controlled person, to any person to whom the controlled person is liable.  Liability as a “control person” can be avoided if the “control person” establishes that he or she acted in good faith and did not directly or indirectly induce the act or acts constituting the violation.

Liability under Section 20(a) generally requires two elements: a primary violation of the federal securities laws by the “controlled person”, and proof that the person charged with the Section 20(a) “controlled” the primary violator.  It is unclear whether there are any circumstances under which a municipal official sitting on a multi-person board or council could be held to “control” an issuer, or issuer personnel, found to be a primary violator responsible for fraudulent statements in an offering document for municipal securities.  But in the Allen Park enforcement action the SEC appears to have alleged that the mayor controlled the city, the alleged primary violator.

If a primary violation and “control” of the person or entity that made the misleading statement is established, the burden shifts to the “control person” to establish good faith, which, unsurprisingly, means the absence of bad faith, which is akin to the absence of scienter.  In theory, even if an accused official does not establish good faith, he or she can avoid liability upon proof that he or she did not “induce” the primary violation.  The courts have not conclusively adjudicated whether to “induce” requires active encouragement, or whether in some circumstances the failure to exercise efforts to prevent a violation can be deemed to induce the violation.

The Allen Park enforcement action was settled by the issuer and the officials without admitting or denying liability, and sets no precedent on what type of conduct by an issuer official constitutes “control” over a primary violator of the securities laws or induces the violation.  But it suggests that in the aftermath of U.S. Supreme Court decisions that have eliminated aiding and abetting liability in private actions under Section 10(b) of the Securities Exchange Act and narrowed the circle of potential primary violators that the SEC can allege “make”, within the meaning of Section 10(b), a fraudulent statement in a securities offering document, the SEC intends, when feasible, to use a “control person” theory to go after actors it deems culpable for securities fraud in municipal offerings but cannot reach as primary violators.

Initial reaction to the SEC’s introduction of “control person” charges to municipal securities enforcement actions has included concern that public officials involved with municipal entities that issue bonds or other securities may now face charges and potential vicarious liability for disclosure malfeasance by other issuer officers or employees.  However, the SEC will face an uphill battle proving allegations of “control”, bad faith and “inducement” of a primary violation by an issuer board member or official who may have approved the distribution of an official statement but was not actively involved in its preparation, did not sign the official statement, and did not urge another official to exclude or include particular disclosure. The extent to which the SEC will include “control person” charges in future enforcement actions alleging primary securities law violations by an issuer or another issuer official remains to be seen, but such charges are most likely to be brought where there is evidence of active complicity in deceptive disclosure.



The post on our securities litigation and compliance blog titled “SEC Steps Up Scrutiny of Municipal Bonds: Recently Filed Enforcement Actions”  surveys recent SEC enforcement actions against municipal bond issuers.  As discussed in the post, the SEC’s charges in these actions include charges based on issuer negligence (versus the “scienter” standard of knowingly or recklessly misleading disclosure applicable to private securities law claims against municipal bond issuers), and also notes the SEC’s position that an officer’s state of knowledge can be imputed to a municipal bond issuer for purposes of establishing the issuer’s “scienter” in a securities fraud action.


As indicated in the adjacent blog posts, the SEC is increasing its enforcement presence in the municipal bond market, including enforcement and self-reporting initiatives relating to disclosures about an issuer’s historic compliance with Rule 15c2-12 continuing disclosure agreement obligations.  Mintz Levin is hosting a webinar to review these developments and the conundrums the self-reporting initiative may cause for issuers and underwriters.   Registration for the free webinar is available through the link below.


A New Era of SEC Muni Enforcement

Tuesday, April 29

1:00 pm ET


Over the last few years, the SEC has put its spotlight on the municipal market, increasing its scrutiny of issuers and underwriters alike. This new and aggressive approach has broken unspoken barriers that long defined the SEC’s long-standing policy of minimal regulation and intervention in the municipal market. Most notably, the SEC has increased its enforcement actions and imposed steep sanctions against individuals, issuers, and underwriters.

Join us for a review of the SEC’s recent enforcement actions and a discussion of its priorities and initiatives for 2014, including the new Municipalities Continuing Disclosure Cooperation (MCDC) Initiative.

Register Here:



For an analysis of the SEC Enforcement Staff’s recent announcement that it is one year into a general sweep of financially distressed municipal bond issuers and that it has commenced formal investigations against some of these issuers, please view the post on our securities litigation and compliance blog titled, “SEC Enforcement Staff’s Investigations of Financially Stressed Municipal Issuers.”

That blog post examines several legal issues arising out of this sweep and the resulting investigations, including how this announcement by the Staff could be intended to put further pressure on municipal issuers and underwriters to self-report inaccurate disclosures, how investors may be swept up into these investigations, and the potential collateral legal issues that can arise if the SEC brings more actions in this area.


On February 14, 2013, SEC Chairman Elisse Walter at long last indicated, in testimony for the Senate Banking Committee, that the SEC’s final regulations regarding “municipal advisors” will “address ,,, the need for an exception” to the definition of “municipal advisor” for appointed board members of municipal securities issuers.  This acknowledgment came more than two years after the firestorm ignited by the SEC’s suggestion in proposed regulations issued December 20, 2010 that appointed board members of issuers of municipal securities were or might be required to register as “municipal advisors,”  That suggestion provoked a substantial share of the over 1,000 comment letters received by the SEC on the proposed regulations.

The SEC’s final regulations have not yet been issued and the phrasing of the exception remains to be seen.  However, Chairman Walter’s testimony is consistent with the conclusion long since reached by most municipal market participants that the SEC’s interpretation of the Dodd-Frank legislation as requiring or potentially requiring registration as municipal advisors by non-elected board members who provide input relating to issuance of municipal securities in the course of their board duties was an overreach that would not be implemented.  For board members appointed to municipal bond issuers or to issuers of state-sponsored Section 529 program municipal fund securities, Chairman Walter’s pronouncement is as close to a valentine as the SEC dispenses.



On March 19, the SEC’s Office of Investor Education and Advocacy issued an Investor Bulletin to help educate individual investors about municipal bonds.

While the Investor Bulletin is fairly basic and addressed primarily to investors generally, the list of some of the risks of investing in municipal bonds included in the Bulletin may be helpful to issuers and underwriters when preparing or reviewing disclosure documents.  The risks highlighted in the Bulletin (and a few additional thoughts) are outlined below:

Call risk. Call risk refers to the potential for an issuer to repay a bond before its maturity date.  (It should be noted that in addition to the “call” provisions which might apply to the obligations being offered for certain types of obligations, investors may also be interested in information as to past call practices of the issuer.)

Credit risk. This is the risk that the bond issuer may experience financial problems that make it difficult or impossible to pay interest and principal in full.  (Credit ratings are of course available for many bonds, and used by many individuals as a proxy for their own credit analysis; however, in light of the recent problems with “rated” mortgage-backed and asset-backed obligations, an increasing number of investors are attempting to look through the credit ratings and make their own determination of credit risk.)

Interest rate risk. A bond’s market price will move up as interest rates move down and it will decline as interest rates rise, so that the market value of the bond may be more or less than its par value. U.S. interest rates have been low for some time. If they move higher, investors who hold a low fixed-rate municipal bond and try to sell it before it matures could lose money because of the lower market value of the bond.

Inflation risk. Inflation is a general upward movement in prices. Inflation reduces purchasing power, which is a risk for investors receiving a fixed rate of interest. It also can lead to higher interest rates and, in turn, lower market value for existing bonds.

Liquidity risk. This refers to the risk that investors won’t find an active market for the municipal bond, potentially preventing them from buying or selling when they want and obtaining a predicable price for the bond. Many investors buy municipal bonds to hold them rather than to trade them, so the market for a particular bond may not be especially liquid and quoted prices for the same bond may differ.

Change in tax law risk. While not included in the Bulletin’s list of risks, discussions in Washington as to the possible repeal or limitation of the exclusion of interest on municipal obligations are raising concerns in the municipal markets.  Changes in the tax treatment of municipal obligation will have an immediate effect on market values of affected obligations.

The Investor Bulletin is clearly intended as fundamental guidance to investors. The list of risks included in the Investor Bulletin is by no means comprehensive and not necessarily a list of risks that should be disclosed in offering documents. However, the list does highlight factors the SEC believes are important to investors and similar disclosures have become fairly routine in corporate and mutual fund risk disclosure sections.


On March 19, the SEC’s Office of Compliance Inspections and Examinations released a National Examination Risk Alert reporting on its examinations of broker-dealers for compliance with municipal bond underwriter due diligence obligations under the SEC’s prior interpretive releases and under SEC Rule 15c2-12.

The release of the Risk Alert dovetails with remarks made by SEC officials at recent municipal bond conferences to the effect that the SEC is ramping up its enforcement-related reviews of municipal bond underwriters’ due diligence practices.   

Findings in the Risk Alert include:

  • The compliance examinations revealed instances where underwriters neither maintained nor had policies requiring the maintenance of written documentation regarding due diligence efforts.  The Risk Alert notes that some underwriters asserted that it is not industry practice to maintain such written records and that their outside counsel had recommended that such records not be maintained.  The Risk Alert states that such a practice of intentional non-documentation makes it difficult for underwriters to demonstrate that they have complied with their due diligence obligations and their supervisory obligations relating to conduct of due diligence.  The Risk Alert indicates that “[t]his approach might lead to lax due diligence practices at a time when there are growing concerns over the fiscal well-being of some municipalities.”
  • The Risk Alert identified examples of certain practices used by certain underwriters that “evidence some due diligence and supervisory review” and that could assist underwriters in compliance/ enforcement examinations regarding whether and how they are meeting their due diligence obligations: 

*                 detailed written policies and procedures addressing the nature of due diligence requirements under Rule 15c2-12 and the firm’s expectations as to how its personnel can develop the reasonable belief in the truthfulness and completeness of key representations in an offering document required under SEC interpretive guidance;

*                  senior level “commitment committees” that review and approve categories of underwritten deals, including review of due diligence memoranda describing diligence calls and documentary due diligence, and, for categories of transactions that are exempted from committee review based on ratings or recent prior review by the committee of a transaction involving the same issuer, review of such memoranda by the committee chairman or another committee member;

*                  firm-developed diligence checklists, which may include narrative responses relating to past familiarity with the issuer and other factors relevant to the requisite reasonable belief relating to the offering document;

*                  due diligence memoranda prepared by bankers detailing the subjects discussed in due diligence calls, issues noted and how such issues were resolved;

 *                 outlines for diligence calls prepared by counsel;  

 *                 records regarding on-site examination activities such as site visits, discussions with issuer personnel and examinations of issuer records and forecasts; and

 *                  recordkeeping checklists that assist personnel in generating and preserving due diligence documentation.





Various comment letters have been filed, and more are being prepared, on the can of worms opened up by the SEC’s December 20, 2010 interpretation that the term “municipal advisor” includes unelected board members of municipal entities who provide “advice” to the entity they serve regarding the issuance of municipal securities, swap transactions and/or investments.

The SEC has not officially addressed the most pressing question: is its interpretation a “proposed” interpretation, so that unelected board members need not be concerned about its application to them before the SEC reviews and reacts to the comments?

The answer, apparently, is that the interpretation is currently effective, but that most board members should not be concerned about needing to register as municipal advisors.  What sort of activity might require registration?  Unfortunately, that remains unclear.

Based on discussions with an SEC official with knowledge of the matter, it appears that to this point the SEC has not been persuaded to back off its distinction between elected and unelected board members.  According to the SEC official, the SEC is concerned about the scenario of a Governor-appointed board member who may dictate, or attempt to dictate, financial decisions to one or more boards.  Apparently, the SEC has particular examples in mind.

The SEC is aware that its interpretation has raised concerns with the large number of unelected board members on state authorities and agencies.  Unfortunately, the SEC official with whom I spoke indicated that the SEC could not offer any comfort that its interpretation is not effective at this time.  However, the SEC official indicated that “we never intended for our interpretation to cover voting on a board resolution or ordinary course board discussions.”  The SEC apparently is actively considering issuing an interim clarification that such “ordinary course” board participation does not constitute “advice” that would cause an unelected board official to be a “municipal advisor”, but is having some difficulty illustrating where ordinary course discussion stops and “advice” starts.

It is understandable why the SEC is struggling with a line-drawing exercise around the meaning of “advice.”  In other contexts, such as the Investment Advisers Act of 1940, there is no definition of “advice” – the need to register arises when a party holds itself out as being in the business of providing investment advice and provides such advice to another party for compensation.  However, the SEC, by suggesting that unelected board members may be “municipal advisors”, has already indicated that a person can be a “municipal advisor” even if the only “advice” the person renders is to the entity or entities  on whose board(s) the person sits, and the SEC has expressly rejected compensation as a factor in whether a person is a “municipal advisor.”

If, as appears to be the case, the SEC wishes to be able to exercise regulatory jurisdiction over certain appointed board members acting in the course of their duties as board members in extraordinary or particularly aggressive ways, it is indeed a difficult line to draw.  And the difficulty in drawing the line, of course, is not just the SEC’s, but that of unelected board members who, apparently, are currently required to figure out whether or not they have crossed that as yet undefined line.

As noted in our advisory on this subject, this same dilemma is being faced by board members and employees of conduit borrowers from municipal issuers (a/k/a “obligated persons”), who may likewise be deemed “municipal advisors” if they provide “advice” to their entity regarding municipal bond issuance, swaps or investment of bond proceeds.

As they say, stay tuned.



Per today’s Bond Buyer, an “attorney who asked not to be named” dismissed as “hysteria”  concerns about whether unelected board members of municipal entities that issue bonds or invest public funds are currently, or will be, required to register with the SEC and MSRB as municipal advisors.

As an arguable contributor to such “hysteria” (see Andrew Ackerman’s Jan. 6 Bond Buyer article), I don’t disagree that the odds favor some sort of modification or dilution of the SEC’s stated position on this point.  But of course the reason it is unlikely that unelected board members will be subject to a blanket registration requirement is that the SEC will be hearing from numerous municipal entities and trade associations that the SEC’s position on this is unwarranted and problematic.  So the “hysteria” is a necessary element of ultimately getting to the right place on these requirements.

What’s more, a dispassionate don’t-worry-about-it reaction would be easier to adopt if this did not involve an SEC interpretation of existing law.  Unelected board members who “advise” their municipal entities (as well as board members and financial officers of conduit borrowers who advise their “obligated person” entities) may be out of compliance with the registration requirements unless the SEC changes its interpretation.  That’s easier for unidentified attorneys to shrug off than for the affected board members and CFOs.

The SEC would do everyone a favor by clearly stating that it does not expect such board members to register unless and until the proposed rules that accompanied its interpretation are finalized.