Last month, we wrote that Robert Khuzami, the Securities and Exchange Commission's Director of Enforcement, had appointed five experienced SEC enforcement lawyers to head units focusing on particular areas. (Click here to read earlier alert.) One unit spotlights municipal securities?an area targeted by the SEC, particularly its Philadelphia Regional Office, in recent years.
Issuers of municipal securities can face significant liability when the due diligence process fails to lead to appropriate disclosures and careful review of internal controls. Among other practices, an issuer should:
- Designate a high-ranking staff member who is familiar with the issuer's affairs to compile and review information to be included in the offering document
- Enable the issuer's financial adviser, bond counsel, underwriter, underwriter’s counsel, and other professionals involved in the process to ask questions about the information and operations
- Present the offering document to the issuers governing body for its review, input, and approval and document that such a review took place
A look at SEC matters in the last several years underlines the importance of taking such steps:
- In the Matter of Neshannock Township School District. The SEC alleged that a school district administrator executed an inaccurate certificate concerning district plans to expend note proceeds and that his conduct constituted actionable misrepresentations under the federal securities laws. An administrative law judge agreed with the SEC and held that the district was reckless in misrepresenting and omitting material facts in the Official Statement on the use of the note proceeds and in explaining the resulting risk to the purported tax-exempt status of the notes. The district was ordered to disgorge any gains and to pay prejudgment interest.
- In the Matter of Utah Educational Savings Plan Trust. The SEC sued the agency managing Utah's educational savings plan pursuant to Section 529 of the Internal Revenue Code. An unscrupulous employee had taken advantage of a flaw in the agency's accounting system and redirected unallocated gains from participants' accounts to his personal accounts. According to the SEC, in investigating the misbehavior, the agency stated that no customer money was misappropriated, which was not true. As the SEC alleged, these facts demonstrated that the agency was employing weak internal controls. The agency settled the SEC's charges by agreeing to reimburse funds to appropriate accounts, change the agency's disclosure documents to accurately and fully state the manner in which the agency accounted for participant transactions, and retain an independent consultant to implement internal controls.
The SEC's focus on municipal securities fraud is not limited to issuers. In 2006, the SEC and U.S. Department of Justice began investigating a securities broker they accused of defrauding four Pennsylvania school districts of more than $11 million. As the SEC and DOJ alleged, Robert Bradbury sold the districts notes that were far riskier than the districts realized and in which his company had a financial interest. To prop up the notes' value, he purchased them at par value, then sold them to the school districts, enabling his company to avoid losses. Mr. Bradbury pleaded guilty to securities fraud and is serving a jail sentence of one year and a day. The SEC obtained a final judgment against him and his company enjoining it from future securities law violations and disgorging $5 million, which Bradbury's company paid over to the school districts.