When a municipal official…controls the activities of others who engage in fraud, we won’t hesitate to use every legal avenue available to us in order to hold those officials accountable.”

 --LeeAnn Ghazil Gaunt, 
Chief of the SEC Enforcement Division’s 
Municipal Securities and Public Pensions Unit

What is “Control Person” Liability and how does it relate to municipalities?

Section 20(a) of the Securities and Exchange Act states that anyone who controls any person that violates a federal securities law “shall also be liable jointly and severally with and to the same extent as such controlled person.” 

Accordingly, if any municipal official, employee, or staff member violates the securities laws, any other person in control of the violator, directly or indirectly, will also be liable.  This could include a mayor, council members, or other public officials.

A recent example

In a November 6, 2014 complaint, the SEC charged the city administrator of the City of Allen Park, Michigan, with violating federal securities laws by making materially false and misleading statements in offering documents for two municipal bond issuances in 2009 and 2010.  The SEC claimed the city administrator was the primary source of information for the bond offering documents, which stated that the bond proceeds were to raise funds for the development of a $146 million professional movie studio project.  The SEC also alleged that the project deteriorated into merely building and operating a vocational school on the site, and these changes were not reflected in the bond offering documents.  In addition, the city allegedly used outdated budget information in the disclosure documents, failing to disclose a $2 million deficit. 

Most notably, the SEC charged the mayor of the city with liability to the same extent as the city administrator based on the mayor’s position of control over the city administrator.  The SEC did so without alleging that the mayor participated in drafting the disclosure documents or even had knowledge of their contents.  This was the first time the SEC had charged a municipal official based on “control person” liability, and comments in its press release indicate that the SEC will not hesitate to do so again. 

There is an exception to control liability if the controlling person “acted in good faith and did not directly or indirectly induce the act or acts constituting the violation.” While this may seem like a relatively broad carve-out, the SEC alleged only that the mayor “championed” the movie studio project and made numerous public statements promoting it, indicating that the SEC feels such actions are enough to negate the exception and impose control liability on a municipal official.  The mayor and the SEC initially agreed to settle the matter with the mayor agreeing to pay a $10,000 penalty; however, a federal judge has since vacated the consent judgments citing a lack of full knowledge of all the relevant facts.

How can a municipal official avoid exposure to control person liability?

Federal and state securities laws are plentiful and complicated, and the issuance of municipal securities involves a large amount of information and activity with many moving parts.  Therefore, municipal officials should ensure they are receiving sound, independent legal advice. One way to do so is to engage the specific legal services of a disclosure counsel for the issuer, whose role in the transaction is to focus on the information disseminated by the municipality in the offering documents and advise the municipal entity and its municipal officials.