On March 10, 2014, the Division of Enforcement of the Securities and Exchange Commission (“SEC”) announced a new cooperation initiative that is designed to encourage issuers and underwriters of municipal securities to self-report securities laws violations.1 The Municipalities Continuing Disclosure Cooperation Initiative (“MCDC Initiative”) allows for eligible issuers and underwriters to take advantage of standardized, favorable settlement terms if they self-report violations of Rule 15c2-12 of the Securities Exchange Act of 1934.2 According to the SEC, the MCDC Initiative is designed to promote improved compliance by encouraging responsible behavior by market participants that have not met their regulatory obligations in the past.3
Rule 15c2-12, which became effective in 1996, requires underwriters of municipal securities to “reasonably determine” that the issuer of the municipal security has undertaken, in a written agreement or contract for the benefit of bondholders, to provide continuing disclosure documents to the Municipal Securities Rulemaking Board (“MSRB”).4 Continuing disclosure includes information that could affect either the bonds’ value prior to maturity or the issuer’s ability to repay the bonds. This includes any payment delinquencies, defeasances, and rating changes, as well as any material tax events that could affect the securities’ tax status.5 In addition, Rule 15c2-12 requires that municipal bond offering documents contain a description of “any occurrences in the previous five years in which the issuer failed to comply, in all material respects, with any previous commitment to provide such continuing disclosure.”6
Underwriters independently must review issuers’ disclosure documents and certifications “in a professional manner” in order to expose any possible inaccuracies or omissions.7 However, the SEC has made clear that review of disclosure documents and issuer certifications is the minimum amount of due diligence required by underwriters; the SEC expects that underwriters will monitor MSRB filings, and research any prior filings by the issuer, to obtain evidence reasonably sufficient to determine that the issuer is in compliance. According to the SEC, the underwriter “therefore must rely upon its own judgment, not solely on the representation of the issuer” to reasonably determine whether the issuer has filed continuing disclosure documents.8 In other words, underwriters may not solely rely on written certifications from an issuer that the issuer has complied with all filings and notices.
Until recently, the SEC rarely brought enforcement actions against issuers or underwriters for violations of Rule 15c2-12. However, in 2012, pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC established the Office of Municipal Securities and intensified its focus on the municipal securities market. As a result, the SEC focused its attention on bringing more enforcement actions related to misleading statements regarding municipal securities. Although most of the enforcement actions have been against issuers,9 there have been notable enforcement actions against underwriters, suggesting a trend toward increased scrutiny on underwriters.10 For this reason, both underwriters and issuers should strongly consider taking part in the MCDC Initiative, described below.
The MCDC Initiative
The MCDC Initiative, launched by the SEC’s Division of Enforcement on March 10, 2014, allows municipal securities issuers and underwriters to take advantage of standardized settlement terms in exchange for self-reporting any violations of the continuing disclosure requirements of Rule 15c2-12.
Any issuer that may have made materially inaccurate statements in an official statement regarding its prior compliance with continuing obligations under Rule 15c2-12 is eligible under the new MCDC Initiative. Likewise, underwriters of offerings in which the offering documents contain materially inaccurate statements regarding an issuer’s prior compliance with continuing disclosure obligations are eligible to participate.11 Importantly, the MCDC Initiative covers any underwriter – whether sole, lead or a member of the syndicate – and both competitive and negotiated underwritings.12
In order to participate in the MCDC Initiative, eligible issuers and underwriters must self-report the violations of Rule 15c2-12 on a standardized questionnaire and submit the questionnaire to the SEC by 12:00 am on September 10, 2014.13 Notably, the MCDC Initiative covers only issuers and underwriters, not any individuals. Nonetheless, cooperating individuals may try to negotiate favorable terms under other cooperative initiatives.
Standardized Settlement Terms
Under the MCDC Initiative, the Division of Enforcement staff will recommend that the Commission accept standardized settlement terms for eligible issuers and underwriters.14 The settlements will require the issuer or underwriter to consent to a cease and desist proceeding, without admitting or denying the findings of the SEC.
For eligible issuers, the recommended settlement terms require that the issuer: (1) establish appropriate policies, procedures and training regarding continuing disclosure obligations; (2) comply with existing continuing disclosure undertakings, including updating past delinquent filings; (3) cooperate with any subsequent investigation by the SEC regarding the false statement, including the roles of individuals and/or other parties involved; (4) disclose the settlement terms in any final official statement for an offering by the issuer within the following five years of the settlement; and (5) provide the SEC with a compliance certification one year after settlement. If the issuer agrees to these terms, the Enforcement Division will recommend that the Commission accept a settlement in which there is no civil penalty.
For eligible underwriters, the recommended settlement terms require that the underwriter: (1) retain an independent consultant to conduct a compliance review and provide recommendations regarding the due diligence process and procedures; (2) take reasonable steps to enact the consultant’s recommendations; (3) cooperate with any subsequent investigation by the SEC regarding the false statement, including the roles of individuals and/or other parties involved; and (4) provide the SEC with a compliance certification one year after settlement. If the underwriter agrees to these terms, the Enforcement Division will recommend that the Commission accept a settlement in which the underwriter consents to a civil penalty of $20,000 per offering containing a materially false statement, applicable for offerings of $30 million or less. For offerings of over $30 million, the underwriter will pay a civil penalty of $60,000 per offering containing a materially false statement. The maximum civil penalty under the MCDC Initiative, however, is $500,000.
Risks Inherent in Not Self-Reporting
Eligible issuers and underwriters that do not self-report under the MCDC Initiative are offered no assurances that the Enforcement Division staff will recommend similar settlement terms as those available under the MCDC Initiative. Instead, Andrew Ceresney, the Director of the Division of Enforcement, made clear that entities “who do not self-report and instead decide to take their chances can expect to face increased sanctions for violations.”15 Because the MCDC Initiative applies to both underwriters and issuers, there is a risk that one will self-report and thus implicate the other, creating a game-theory environment resulting in both of them taking advantage of the MCDC Initiatve to avoid being saddled with additional penalties for failing to self-report the same violation.
A Good Deal for Underwriters?
Underwriters should consider availing themselves of the SEC’s new MCDC Initiative for at least three reasons. First, Rule 15c2-12 – as the SEC Staff has interpreted it – places a difficult burden on underwriters to conduct due diligence of the disclosure requirements of issuers. Self-reported violations by issuers could be used as the basis to charge underwriters that have not self-reported with violating their prior diligence requirements. As a result, the MCDC Initiative provides an opportunity for underwriters to avoid the collateral harm from issuers that are incentivized under the MCDC Initiative to self-report and receive no penalty. Second, the terms of the MCDC Initiative are transparent and the penalty is capped at $500,000, which is minor compared to the SEC’s recent call for increased penalties and admissions of wrongdoing.16 Third, underwriters that do not self-report will face aggressive enforcement with increased penalties for not self-reporting.
Because the MCDC Initiative has a sunset provision that requires self-reporting no later than September 10, 2014, underwriters do not have the luxury to “wait and see” precisely how the MCDC Initiative will be applied by the SEC. This arrangement counsels in favor of erring on the side of self-reporting a possible violation. Underwriters should consider hiring counsel to do an initial review and to evaluate the benefits and risks of participating in the MCDC Initiative. This counsel also could serve as the “independent consultant” required to satisfy the self-reporting conditions, if violations are discovered.