Continuing Disclosure Misstatements – A Window of Opportunity Before the SEC (Securities and Exchange Commission) Comes Knocking
The Division of Enforcement (the “Division”) of the U.S. Securities and Exchange Commission recently announced the Municipalities Continuing Disclosure Cooperation Initiative (the “MCDC Initiative”). The MCDC Initiative provides favorable settlement terms for issuers and obligated persons (collectively, “issuers”) and underwriters that self-report violations of materially inaccurate statements in offering documents relating to an issuer’s compliance with continuing disclosure obligations under Rule 15c2-12 of the Securities Exchange Act of 1934.
Background: Continuing Disclosure Obligations
Rule 15c2-12 requires an underwriter to obtain the commitment of an issuer to provide continuing disclosure regarding the municipal security and the issuer. To satisfy Rule 15c2-12, the underwriter usually has the issuer execute a continuing disclosure agreement in which the issuer agrees to provide operating and financial information on an annual basis and notices of certain specified events within 10 business days of the occurrence of such events. Rule 15c2-12 also requires the final official statement for a primary offering of a municipal security to disclose any failure of an issuer to materially comply with its continuing disclosures obligations within the prior five years.
What the MCDC Initiative Covers
The MCDC Initiative focuses on the disclosure of an issuer’s compliance with its continuing disclosures obligations and addresses the securities violations that arise from materially inaccurate statements in offering documents relating to such compliance. It does not resolve violations arising from the failure itself or other materially inaccurate statements in offering documents. For example, a school district with a fiscal year end of June (the “District”), executed a continuing disclosure agreement for bonds issued in May 2009. The District issued bonds again in 2011. In the final official statement for the 2011 bonds, the District stated that it had complied with all of its continuing disclosure obligations within the last five years and could increase its enrollment to 450 students. In truth, the District never filed the 2009 and 2010 annual reports and could only increase enrollment to 360 students. The MCDC Initiative will settle the securities violations arising from the false statement relating to its compliance with continuing disclosure obligations. It will not resolve violations arising from the District’s actual failure to file its annual report for 2009 and 2010. Nor will it resolve any securities violations arising from the false statement relating to enrollment.
Who Is Eligible?
The MCDC Initiative is limited to issuers and underwriters. It does not cover municipal officers or officers, directors or employees of underwriters who ultimately may be responsible for the material misstatements. The Division will evaluate each instance on a case-by-case basis in determining whether to recommend enforcement against the responsible individuals. Factors that the Division will consider are level of intent and cooperation of the individual.
An issuer or underwriter taking advantage of the MCDC Initiative will enter into a settlement agreement with the Division which will include certain undertakings by the issuer or underwriter and a cease and desist order. The undertakings will include obligations to 1) correct the underlying failures (in the example above, the District will need to file its 2009 and 2010 annual reports), 2) implement procedures and training to avoid future violations, 3) provide a compliance certificate on the one-year anniversary of the settlement, and 4) in the case of underwriters, to hire an independent consultant. The cease and desist order will be based on negligence and not on intentional fraud. The Division will in turn recommend no civil penalties for an issuer and reduced civil penalties for an underwriter, and the settlement agreement will include a provision citing no admission of liability.
Act Now! The Window Will Close
The MCDC Initiative runs through September 9, 2014. The Division has made it clear through publications and interviews that the settlement provided by the MCDC Initiative is the best offer issuers and underwriters that have made materially inaccurate statements regarding continuing disclosure will receive. The Division has also publicly announced that it will increase enforcement efforts after the MCDC Initiative concludes. If there is an issue, it is best to address it through the MCDC Initiative, but before doing so, make sure you consult with legal counsel who knows and understands these issues.