A recent SEC enforcement action against the City of Harrisburg, Pennsylvania serves as a warning to leaders of state and local governments with outstanding debt securities: be careful of what you say—you may be violating Rule 10b-5.

In May, 2013, the SEC announced that it had charged Harrisburg with securities fraud for its misleading public statements when its financial condition was deteriorating and financial information available to municipal bond investors was either incomplete or outdated.

Part of the City’s fiscal problems stemmed from its guarantee of $260 million of bonds issued by the Resource Recovery Facility (RRF) owned by The Harrisburg Authority (Authority).

The SEC found that Harrisburg, “a nearbankrupt city under state receivership” with outstanding bonds and bond guarantees, committed various violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, including the following:

  • The City failed to timely submit its audited financial statements and annual financial information for public dissemination as required by Rule 15c2-12; 
  • The City failed to provide timely notices of its failure to provide annual financial information and notice of material events consisting of a ratings downgrade by Moody’s; 
  • The City made misrepresentations in its annual report by stating that “there was a high degree of uncertainty regarding the Authority’s ability to operate at capacity in order to sustain their debt service obligation” when, according to the SEC, “the extent of the Authority’s financial difficulties was not uncertain.”

In addition, as a result of the City’s failure to provide its annual reports, the SEC found misleading statements and omissions in the City’s and its officials’ other public statements, including the following:

  • The City’s 2009 budget, which was available on its website, did not include funds for its RRF debt guarantees, even though the City had “informally” set aside money for such payments; 
  • The 2009 budget overstated the City’s credit rating; 
  • The Mayor’s 2009 State of the City Address, also available on the City’s website, omitted to state the amount of RRF debt that the City would likely have to repay from its general fund and the impact that the repayment obligation was already having on the City’s finances; 
  • The City’s Mid-Year Fiscal Report for 2009, also available on the City’s website, did not reference any of the guarantee payments the City had made on the RRF debt, which payments at that point totaled $2.3 million, or 7% of the City’s general fund expenditures, by the mid-year point; and 
  • The city failed to disclose a further credit rating downgrade in February 2012 until March 2011.  

The SEC issued a cease-and-desist order finding that the City violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, which the City accepted without admitting or denying the findings.

Additionally, the SEC issued a report of its investigation—which should be required reading for all public officials. The SEC provided the following observations on the obligations of elected and appointed officials, and employees, or their functional equivalents, of any State, municipality, political subdivision or any agency or instrumentality thereof [emphasis added]:

  • “Public officials should be mindful that their public statements, whether written or oral, may affect the total mix of information available to investors, and should understand that these public statements, if they are materially misleading or omit material information, can lead to potential liability under the antifraud provisions of the federal securities laws.” 
  • “Unlike many primary offering disclosure documents, statements by public officials that reach the secondary market may not be subject to the same comprehensive review with respect to the disclosure standards of the federal securities laws. Nevertheless, public officials may have liability under the antifraud provisions of the federal securities laws for such statements. Therefore, the statements of those public officials who may be viewed as having knowledge regarding the financial condition and operations of a municipal issuer should be carefully evaluated to assure that they are not materially false or misleading.” 
  • “Because statements are evaluated for antifraud purposes in light of the circumstances in which they are made, the lack of other disclosures by the municipal entity may increase the risk that municipal officials’ public statements may be misleading or may omit material information.” 
  • “Given this potential for liability, public officials who make public statements concerning the municipal issuer should consider taking steps to reduce the risk of misleading investors. At a minimum, they should consider adopting policies and procedures that are reasonably designed to result in accurate, timely, and complete public disclosures; identifying those persons involved in the disclosure process; evaluating other public disclosures that the municipal securities issuer has made, including financial information and other statements, prior to public dissemination; and assuring that responsible individuals receive adequate training about their obligations under the federal securities laws. Public officials may also look to Commission enforcement actions or Commission guidance in developing the disclosure policies, procedures and controls that they choose to establish.”  

Dictum sapienti sat est!7