UK: SEC Enforcement Action For Fraud Relating To Misrepresenting Continuing Disclosure Failings

On July 29, 2013, the Securities and Exchange Commission announced settled enforcement orders against an Indiana school district and the district's underwriter for material false statements in the school district's official statement relating to the district's failure to comply with its prior continuing disclosure undertakings.

Rule 15c2-12 (the "Rule") under the Securities Exchange Act of 1934 is intended to improve the quality and timeliness of disclosure in the municipal securities market. The Rule prohibits any underwriter from purchasing or selling municipal securities unless the issuer of the securities has entered into a written contract, usually referred to as a continuing disclosure agreement or undertaking, to provide notices of certain significant events and annual financial information and operating data of the type presented in the official statement relating to the securities. The Rule also requires issuers to disclose in their official statements all instances during the prior five years in which the issuer has failed to comply in all material respects with any previous continuing disclosure undertaking.

The West Clark Community Schools, an Indiana school district, entered into a continuing disclosure agreement in connection with a 2005 bond issue. The school district issued bonds again in 2007. City Securities Corporation served as sole underwriter in both bond offerings. The official statement prepared for the 2007 issue stated that the district had not failed in the previous five years to comply in all material respects with any prior disclosure undertakings. However, the official statement was false in this regard because, in fact, the district had failed to submit any of its required disclosures under the 2005 continuing disclosure agreement. Despite the omission of any mention of its two and a half year lapse in disclosure filings and a specific statement in the offering document to the contrary, district officials executed a closing certificate for the 2007 bonds attesting that the official statement did not contain any untrue statements of material fact.

The SEC concluded that the school district knew or was reckless in not knowing that it had not submitted the annual reports and significant event notices required by the 2005 continuing disclosure agreement. Citing the importance of financial disclosure to the integrity of the primary and secondary market for municipal securities, the SEC determined that by its untrue statements the school district had violated the antifraud provisions of the Securities Act of 1933 and the Exchange Act. The SEC ordered the school district to ensure that its required disclosure submissions were up to date and accurate, to adopt written disclosure policies and procedures and to implement training for district personnel involved in the bond offering process.

City Securities, the district's underwriter, was cited by the SEC for conducting inadequate due diligence, resulting in a failure to form a reasonable basis for believing the truthfulness of the district's 2007 official statement. The SEC faulted the underwriter for not taking reasonable steps to ensure it would receive prompt notice of the district's required disclosure filings, which might have alerted the underwriter to the issuer's failure to make those submissions. City Securities relied solely on the school district's assertions, and did not attempt to verify the district's compliance with its disclosure obligations. The SEC found that employees at the underwriting firm were not adequately trained about the requirements of the Rule. As a result, City Securities was sanctioned for willful violations of the Rule and antifraud provisions of the Securities Act and the Exchange Act. The SEC also sanctioned City Securities for violations of Municipal Securities Rulemaking Board ("MSRB") rules requiring fair dealing, prohibiting deceptive practices and barring improper gifts to issuers. The SEC censured and fined City Securities for its role in the matter. The supervisor of its Municipal Bond Department was individually fined and barred from working in the securities industry for one year.

Continuing Disclosure: Best Practices for Issuers

This matter highlights the importance of sound policies and procedures for monitoring and reporting significant events and annual financial information and for accurately disclosing compliance with continuing disclosure agreements. A continuing disclosure agreement remains in effect as long as the bonds and notes to which it applies remain outstanding. Issuers must employ measures to ensure that their securities disclosure obligations are met over the long term.

Issuers should consider adopting the following "best practices" for upholding their continuing disclosure responsibilities, including, in particular:

  • Establish written policies and procedures to ensure that the issuer submits all documents, reports and notices required to be submitted to the MSRB in a timely manner.

  • Review offering documents, confirm compliance with existing continuing disclosure obligations at the time of each new issue and promptly rectify any continuing disclosure lapses.

  • Disclose in each official statement any instances during the prior five years of any failure to comply in all material respects with applicable continuing disclosure obligations.

  • Implement annual training for personnel involved in the bond offering and disclosure process, including familiarity with the significant events described in the Rule and an understanding of the issuer's written policies and procedures governing disclosure practices, including continuing disclosure.

  • Identify an individual or individuals who will be responsible for reviewing and complying with the issuer's disclosure obligations on a regular basis.

  • Maintain a complete and accurate record of all of the issuer's continuing disclosure undertakings and filings, including electronic confirmation of disclosure submissions.

  • Develop a calendar reminder system to track annual filing deadlines and requirements.

  • Consult with counsel as needed to resolve potential issues and address any questions.

  • If desired, engage disclosure counsel or a designated agent to make continuing disclosure filings on the issuer's behalf.

Due Diligence regarding Continuing Disclosure Compliance

The SEC does not consider reliance on the issuer's affirmative statements alone sufficient to verify an issuer's compliance with its continuing disclosure obligations. Enhanced due diligence in this area may also include the following:

  • Review the issuer's policies, procedures and training regime used to ensure compliance with its disclosure duties and continuing disclosure undertakings.

  • Confirm the timeliness and completeness of the issuer's continuing disclosure submissions using online resources, including EMMA (described below), and for filings from September 7, 2004 until June 30, 2009, on

  • Request written evidence of past continuing disclosure submissions.

  • Sign up for EMMA alerts (discussed below) to receive prompt notice of the issuer's continuing disclosure filings.

Electronic Submission of Continuing Disclosure on EMMA

Under the Rule, continuing disclosure documents must be submitted in word-searchable PDF format to the MSRB via the MSRB's Electronic Municipal Market Access ("EMMA") system, either directly by the issuer, or indirectly through an indenture trustee or a designated agent of the issuer. EMMA provides electronic receipts to the submitter for each submission. EMMA has alert features to notify individuals whenever a submission is made relating to specified securities and to remind submitters when an annual financial report is due to be posted. In order to submit documents to EMMA, users must create an account on the MSRB Gateway. The EMMA website offers online training, FAQs and a user guide on its EMMA Dataport page:

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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