On May 6, 2013, the Securities and Exchange Commission (“SEC”) instituted cease-and-desist proceedings against the City of Harrisburg, Pennsylvania (the “City” or “Harrisburg”) pursuant to the Securities Exchange Act of 1934, and imposed a cease-and-desist order (the “Order”) against Harrisburg. The Order charged Harrisburg with misleading investors about its credit ratings and financial health in its 2007 and 2008 Comprehensive Annual Financial Reports, its 2009 Budget and Transmittal Letter, the 2009 State of the City Address, and the 2009 Mid-Year Fiscal Report (together, the “publicly available information”), all of which were posted on the City’s website.

The Harrisburg action is notable because it is the first time the SEC has charged a state or local government with securities fraud based on public statements made outside of the disclosure documents prepared for bond issues. It is also notable because the SEC specifically cited the City’s failure to comply with previous continuing disclosure undertakings for over two years as a contributing factor to its commission of securities fraud. The Order specifically notes that for over two years, Harrisburg did not submit any information pursuant to its prior Continuing Disclosure Certificates (including the required notices of its failure to timely file), resulting in incomplete and outdated financial information available to the market.

The Order finds that Harrisburg violated the antifraud provisions of the Securities Exchange Act due to recklessness, which is defined in case law as “an extreme departure from the standards of ordinary care, and which represents a danger of misleading buyers or sellers that is either known to the defendant or so obvious that the actor must have been aware of it.”

The Order states that “As a result of Harrisburg’s multi-year failure to provide financial information and notices as Harrisburg had agreed pursuant to its Continuing Disclosure Certificates, investors and the trading markets did not have certain information regarding the City’s financial condition and had to seek out other public statements made by Harrisburg for current information on the City’s finances.” Those public statements (which were comprised of the publicly available information described above) “misrepresented and omitted to state material information regarding Harrisburg’s deteriorating financial condition and credit ratings downgrades” resulting from the City’s guarantee of approximately $260 million in debt for the municipal Resource Recovery Facility (the “RRF”) owned by The Harrisburg Authority.

The Order found that the publicly available information contained several material misstatements and omissions with respect to the RRF guaranty payments already made by the City and the likelihood that future required payments would negatively impact the City’s general fund and overall financial health. The publicly available information also stated that the City’s bond rating from Moody’s was “Aaa” based upon insurance; however, Moody’s had announced a downgrade of the City’s rating in December 2008 (and announced further downgrades in October 2009 and February 2010). The City did not file material event notices for the downgrades until after the SEC began its investigation.

Harrisburg, which is currently under State receivership, did not admit or deny the findings in the Order and did not pay a penalty. However, the City has instituted formal written policies and procedures (the “Disclosure Policy”) to ensure that financial information it releases to the public is accurate in all material respects and to ensure compliance with its Continuing Disclosure Certificates. The City also must implement annual training for City employees involved in the disclosure process to ensure compliance with the Disclosure Policy and to provide an overview of the City’s obligations under the federal securities laws.

The Harrisburg Order does not find that the City committed securities fraud solely based on its failure to comply with its Continuing Disclosure Undertakings. However, the failure to provide ongoing financial and operating information bolstered the finding of reckless behavior resulting in securities fraud. Municipalities and other local government clients, therefore, should take note of the following:

  • Market studies indicate that many local governments are out of compliance with their continuing disclosure undertakings. The Harrisburg Order is evidence that the SEC may use such noncompliance as a basis to examine ordinary communications, such as a Mayor’s speech, for evidence of securities fraud. It is therefore very important that local governments comply with their continuing disclosure obligations.
  • Regardless of compliance with continuing disclosure obligations, the Harrisburg Order is evidence that great care should always be taken by public officials when discussing their government’s finances in public, particularly if the government is experiencing financial difficulties