It has traditionally been a fairly common practice in the municipal bond arena for issuers to either select or have significant input into the selection of underwriter’s counsel in connection with the issuance of municipal bonds. On July 27, 2017, the Municipal Securities Rulemaking Board (MSRB) issued a strong warning to the industry against continuation of these practices by publication of Notice 2017-14. Continue Reading MSRB Issues Warning Guidance On Issuer Involvement In Selection of Underwriter’s Counsel
On June 7, 2017, new IRS regulations that change the way state and local governments issue tax-exempt bonds went into effect. The new rules change the way municipal issuers determine the issue price of tax-exempt bonds they issue, and amend existing IRS regulations under section 148 of the Internal Revenue Code. The new rules have produced immediate changes to many common documents used by municipal issuers and their advisors in municipal bond transactions.
Following his inauguration on January 20th, President Trump issued several Executive Orders, one of which was issued on January 25, 2017 and titled, “Enhancing Public Safety in the Interior of the United States” (referred to herein as the “Order”). Among other things, this Order punishes so-called “sanctuary jurisdictions” by stripping them of federal grants. As justification for this punitive measure, the Order states that “sanctuary jurisdictions … willfully violate Federal law in an attempt to shield aliens from removal…. These jurisdictions have caused immeasurable harm to the American people and to the very fabric of our Republic.”
In the months since the Order, many state and local entities have parsed the Order to determine whether they would be considered a “sanctuary jurisdiction,” what funding may be in jeopardy, and whether they can modify their policies to limit or eliminate application of the Order. In the midst of these uncertainties, many municipalities also have been faced with the issue of how to address the potential consequences of “sanctuary jurisdiction” status in their public offering documents when they are considering issuing municipal bonds for sale to the investor public.
The National Association of Bond Lawyers (NABL) and the Securities Industry and Financial Markets Association (SIFMA) recently released model issue price documents in connection with the soon-to-be effective Treasury Regulations on establishing the issue price of a tax-exempt bond issue. NABL’s model documents can be accessed here; SIFMA’s documents can be accessed here.
These model documents have been issued in response to the finalized Treasury Regulations on issue price, published by the Department of the Treasury on December 9, 2016. The final regulations – which become effective on June 7, 2017 – retain the existing rule that in general, the issue price of a series of bonds is the first price at which a substantial amount (10%) of the bonds is sold to the public. The regulations add two special rules, however, which may be selected by the issuer in connection with the determination of the issue price: a special rule for competitive sales, and a special rule where the underwriter or underwriters agree to “hold the price” on the initial sale of the bonds to a price that is not higher than the initial offering price.
The model documents published by SIFMA and NABL provide a uniform solution for underwriters and issuers to ensure compliance with the final regulations, in particular in determining which of the three rules for determining issue price apply, and ensuring that the requirements for application of the rule are met. It is expected that both SIFMA and NABL will finalize these forms in the coming weeks after receipt of any comments from the public. Professionals working in the public finance industry should carefully review the forms now to get familiar with their requirements in advance of the effective date for the final regulations.
At its meeting on March 1, 2017, the United States Securities and Exchange Commission (SEC) voted to formally propose and publish for comment amendments to Rule 15c2-12 to add two additional disclosure events to written continuing disclosure undertakings required to be obtained by underwriters in primary securities offerings.
Who has not heard of the Bridgegate scandal? The George Washington Bridge spanning the Hudson River between New Jersey and New York City is the busiest motor vehicle bridge in the world. Two of three toll lanes for a street entrance from Fort Lee, NJ to the George Washington Bridge were closed for five days in September 2013. This resulted in huge backups in Fort Lee. As one of the individuals convicted in the incident emailed, “Time for some traffic problems in Fort Lee.”
Following its announcement in August that it had entered into settlements with over seventy municipal issuers in connection with the Municipalities Continuing Disclosure Cooperation (MCDC) initiative, there was speculation as to whether additional settlements would be announced, or if this first round of settlements represented all of the enforcement actions against municipal issuers that would come from MCDC.
It now appears that the SEC has elected to formally close the book on the MCDC Initiative. LeeAnn Gaunt, the chief of the SEC enforcement division’s public finance abuse unit, recently indicated that the SEC would not bring any additional settlements under MCDC. However, Gaunt also issued a warning: the SEC had begun looking at those underwriters and issuers that chose not to participate in the initiative despite committing violations.
From The Bond Buyer:
“We currently do not expect to recommend enforcement action against any additional parties under the initiative,” [Gaunt] said. “We now think it is appropriate to turn our attention to issuers and underwriters and obligors that didn’t participate.”
The unit’s enforcement lawyers view the underwriters and issuers who may have committed violations but did not self-report as part of MCDC as a high risk for future violations, Gaunt said, adding, “That is a group of particular interest to us and we intend to devote significant resources to identifying violations by those parties.”
Which underwriters and issuers could the SEC go after next? Obvious low-hanging fruit would be those underwriters and issuers that chose not to participate despite their counterpart doing so.
There is also the question of how aggressive the SEC will be in going after individual government officials that participated in violations. After prevailing in a securities fraud case against the City of Miami and its budget director, the SEC saw its request for a fine of $450,000 reduced to only $15,000 by the Judge presiding in the case. While actions against individuals will likely continue, the Judge’s decision on the fine to be imposed may be of sufficient chastening effect for the SEC to reserve enforcement actions against individuals for only particularly egregious behavior.
In the first federal jury trial against a municipality for securities law violations, the U.S. Securities and Exchange Commission (SEC) on September 14, 2016 successfully obtained a verdict against the City of Miami and a former city official for violations of various anti-fraud provisions of US securities laws. The SEC is seeking injunctive relief and award of civil monetary penalties against the defendants.
The case in the U.S. District Court for the Southern District of Florida, Securities and Exchange Commission v. City of Miami, et al., 1:13-cv-22600, was brought by the SEC in July 2013 against the City and its then budget director as a result of various temporary inter-fund transfers of funds in the approximate amount of $37.5 million from restricted city accounts to the City’s General Fund during the period 2007-2009. The SEC alleged that these transfers constituted a “shell game” intended to conceal from bond investors the deteriorating financial condition of the City and to maintain the financial reserves required by the City Commission. The City was previously subject to a cease and desist order entered by the SEC in March 2003 as a result of alleged anti-fraud violations in connection with a 1995 bond issue, which the SEC claims has now been violated by the City.
Specifically, the SEC alleged, and the jury agreed, that the transferred monies, which were subsequently returned to the original capital funds, constituted restricted monies dedicated to specific city capital projects and, consequently, the transfers were illegal; the transfers to the General Fund did not comply with applicable government accounting standards; the transfers were not adequately disclosed in the offering documents for three series of bonds in excess of $150 million issued by the City during the period in question, to the rating agencies or in the City’s on-going financial reporting to existing bondholders; the budget director misled the City’s outside auditors regarding the transfers; and the transfers allowed the City to obtain more favorable bond ratings, and consequently financing terms, than would have been possible if the true financial condition of the City had been properly disclosed.
The former budget director had unsuccessfully argued, on interlocutory appeal to the Eleventh Circuit Court of Appeals, that he was immune from personal liability on the SEC claims by reason of the qualified immunity available to public officials. The Eleventh Circuit, while recognizing the defense in cases where damages are sought in a private lawsuit, found that such immunity does not extend to public officials in governmental enforcement actions seeking punitive civil monetary penalties for wrongful actions.
A ruling by the Court on the specific injunctive relief and civil penalties to be imposed is pending further submissions by the SEC.
The SEC announced today enforcement actions against 71 municipal issuers of bonds in connection with the Municipalities Continuing Disclosure Cooperation (MCDC) Initiative. The enforcement actions follow previous announcements from the agency, charging 72 municipal underwriting firms with similar violations discovered through voluntary reporting under MCDC.
The MCDC Initiative was announced by the SEC in 2014 and offered municipal issuers and underwriters the opportunity to receive favorable settlement terms if they voluntarily self-reported that they had made inaccurate statements in bond offerings about their prior compliance with continuing disclosure obligations specified in Rule 15c2-12 under the Securities Exchange Act of 1934.
Municipalities swept up in the enforcement action represented 45 states, with four Pennsylvania municipal entities agreeing to settlement orders. Violations reported for which settlement orders were entered include material misstatement of prior compliance with continuing disclosure responsibilities, as well as the failure to disclose prior instances of noncompliance.
The municipal settlements agreed to by the SEC did not include monetary penalties, in contrast to the settlements entered in connection with the charges brought against municipal underwriting firms. Underwriters were required to pay fines, which varied based on the volume of underwriting conducted by the firm and the bond size of the offering, to settle their cases.
The municipal settlements instead focused on ensuring future compliance with municipalities’ continuing disclosure obligations. Per the announcement:
The parties settled the actions without admitting or denying the findings and agreed to cease and desist from future violations. Pursuant to the terms of the initiative, they also agreed to undertake to establish appropriate policies, procedures, and training regarding continuing disclosure obligations; comply with existing continuing disclosure undertakings, including updating past delinquent filings, disclose the settlement in future offering documents, and cooperate with any subsequent investigations by the SEC.
The SEC noted that, in agreeing to the settlements, it gave credit to the municipalities for their participation in the MCDC Initiative – suggesting that municipalities that did not participate in the MCDC Initiative may not be afforded the same leeway.
While these settlements must be disclosed in the affected issuers’ future offering documents, it seems unlikely that the settlements will have an impact on credit ratings. S&P recently released a report in which it indicated that its expectation was that the settlements would have very limited credit impact. However, S&P did state that the existence of the settlement will be considered in its analysis, as an issuer’s disclosure practices are an important aspect of its ratings methodology.
The SEC did not clarify whether it will pursue enforcement actions against other municipal issuers that participated in MCDC, or whether it is finally ready to close the book on the MCDC Initiative.
Following its July 27-28, 2016 quarterly board meeting, the MSRB has announced that it will not pursue “at this time” new regulations to mandate disclosure of bank loan information by municipal securities issuers. However, the MSRB continues to stress the importance of voluntary disclosure of information about bank loans, and is working to institute changes to its website (EMMA) to make the process to disclose such information easier for issuers.
Municipal securities issuers should consult their legal counsel and financial advisor before making any voluntary disclosure of bank loan information through EMMA. Our advice on this topic over a year ago still rings true: there are significant issues in voluntarily disclosing such information, and municipal securities issuers may be opening themselves up to liability under the securities laws in connection with such disclosures where none previously existed.