The Securities and Exchange Commission’s (SEC’s) recent release, “Municipalities Continuing Disclosure Cooperation Initiative” (MCDC or MCDC Initiative) provides some benefits to certain issuers and underwriters of municipal bonds, Municipalities Continuing Disclosure Cooperation Initiative. It is the latest in the SEC’s continuing effort to encourage regulated entities to self-report violations by providing some type of credit-for-cooperation. The release identifies the factors that the SEC’s Division of Enforcement will consider in assessing whether to recommend favorable settlement terms, as well as the general parameters of what those terms look like. Issuers and underwriters should carefully consider the terms of the MCDC, evaluate whether those terms would apply to them and, if so, the potential impact to them of self-reporting violations. Most significantly, the MCDC has an impending expiration date: issuers and underwriters have until September 10, 2014 to avail themselves of any benefits from the MCDC Initiative.
The MCDC Initiative applies only to a very narrow set of violations - those in which there is a continuing disclosure obligation under SEC Rule 15c2-12. That provision requires an issuer of municipal securities to provide continuing disclosures regarding the security and the issuer, in particular information about the issuer’s financial condition and its operating data. The SEC has filed enforcement actions against issuers that make false or misleading statements in the Official Statement (OS) that the issuer was in compliance with its obligations. Enforcement actions also have been brought against underwriters in this area when the underwriters failed to conduct reasonable due diligence to assess whether the issuers were in compliance with Rule 15c2-12, and the underwriters thereby could not have had any reasonable basis for evaluating the issuer’s representations in the OS. The SEC emphasizes in the MCDC release that an underwriter likely will not meet this reasonable basis standard simply by relying on a certification from the issuer that it has provided all filings and notices – the underwriter must instead conduct affirmative and rigorous due diligence regarding prior filings.
The MCDC Initiative, however, applies only to inaccurate statements by an issuer relating to the issuer’s compliance with its continuing disclosure obligations. Any other potential misconduct by an issuer or underwriter would be outside of the terms of the MCDC Initiative, and could be the subject of the normal investigation and enforcement process, if applicable. The MCDC also does not apply to individuals – rather, it applies only to issuers and underwriters.
In terms of who could benefit from the MCDC Initiative, the release specifically identifies any issuer who has made a materially inaccurate statement in a final OS regarding the issuer’s continuing disclosure obligations. Other parties who could avail themselves of the benefits from the Initiative include underwriters who have participated, either as lead underwriter in a syndicate or the sole underwriter, in an offering in which the OS contains materially inaccurate statements.
If an issuer or underwriter elects to self-report under the MCDC Initiative, they must complete the Questionnaire attached to the release. Among other things, the Questionnaire requires information relating to the particular offerings at issue, the identities of various important actors in the offerings (including the lead underwriter, municipal advisor, bond counsel and underwriter’s counsel), and a statement that the self-reporting entity intends to consent to the applicable settlement terms under the MCDC Initiative.
The release provides some insight regarding the outcomes and benefits of self-reporting and cooperation. In the event that the SEC’s Division of Enforcement recommends a formal enforcement action against the self-reporting entity under the MCDC Initiative, any subsequent settlement will include terms consisting of the following:
- A cease-and-desist proceeding (and an administrative proceeding for underwriters);
- Undertakings including: (1) cooperating with any subsequent investigation by the SEC; (2) providing compliance certifications regarding the applicable undertakings on the one-year anniversary of the date of institution of the proceedings; (3) establishing appropriate policies and procedures regarding continuing disclosure obligations (in the case of an issuer); and (4) retaining an independent consultant (in the case of an underwriter); and
- Reduced civil penalties with respect to underwriters (based on the size and number of offerings), and no civil penalty in the case of an issuer.
The SEC pointedly notes that, for issuers and underwriters that would otherwise be eligible for the terms of the MCDC Initiative but who elect not to self-report, it may well seek sanctions and other terms in a subsequent proceeding that are higher than those that would be imposed had they self- reported.
The MCDC Initiative is the latest in efforts by regulators to encourage regulated entities to self-report regulatory violations. These efforts include Cooperation Agreements, Deferred Prosecution Agreements, and Non-Prosecution Agreements. Given the potential benefits of self-reporting, any issuer or underwriter who could fall into the class of entities covered by the MCDC Initiative should carefully assess the benefits to be gained by participating in the Initiative, along with the nature of their violations and the likelihood of detection.