SEC Continuing Disclosure Training
Forging Financial Statements, Certificates of Completion, and Claiming ‘We have $6 Million in Reserve” in State of City Speech are all Fraud
Beaumont City Council SEC Continuing Disclosure Training Presented by Vanessa Legbandt from the Law Firm of Stradling Yocca Carlson on February 6, 2018. Due to ‘technical difficulties’ the City was unable to record the Training, so I recorded the training for them: https://drive.google.com/open?…
The Powerpoint Presentation can be viewed here: https://beaumont.civicweb.net/…
4:00 Legbandt: The Federal Securities Laws, in many respects, are not applicable to municipal securities, but two of the anti-fraud provisions are applicable to municipal securities. These rules generally say that when you are ‘speaking to the market’ / ‘speaking to investors’ ; your statements have to be accurate and complete. Generally; there is no requirement to speak to the market. You don’t have to issue statements when things happen, you don’t have to take calls from investors of your securities – none of that is required. But there are times when we speak to the market. That’s preliminary official statements and official statements when you are doing a public offering of municipal securities.
5:00: Your Continuing Disclosure Filings are speaking to the market – that’s the whole purpose. Your Audited Financial Statements and annual Financial Reports; things that you expect investors might look at. Press Releases, Public Statements by the Mayor or the City Manager, the State of the City Address [2018 “The City has $6 Million in Reserve”] That can be considered speaking to the market. Anywhere where you think that investors will be looking to receive information that they can use when deciding whether or not to buy. It’s come up in case law where, especially where there’s a pending bond issue and it relates to a specific development and you don’t get really great comments about the public development; you have to be careful about that, right, and make sure you are taking into consideration the fact that you are speaking to investors about …
6:00: The Securities and Exchange Commission does not have much authority over municipal securities issuers. You are subject to the anti-fraud rule and even though you don’t have to register your with the SEC and you don’t have their periodic reporting requirements that a corporate bond issuer would have. Quotes; “When a municipal issuer releases information into the public that is reasonably expected to reach investors and the trading markets, such disclosure is subject to anti fraud provisions.”
7:00: “The fact that statements are not published for purposes of information the securities market does not alter the mandate that they not violate the anti fraud proscriptions” That’s what we were just talking about. Your State of the City Address wasn’t intended to be speaking to investors, but you still have to be aware that they may be one of the places that they’re looking for information about the City. So the anti fraud rule is found i two places in the Securities’ Laws. Rule 10b-5 of the 1934 Act and Section 17(a) of the 1933 Act.
8:00: Under Rule 10b-5 the SEC can only get you if they prove intentional or reckless behavior. But under Section 17(a) of the Securities Act of 1933 they only need to prove negligence, which means you knew or should have known that the Statements were untrue or were not completed. The City’s Cease and Desist Order refers to the second provision, the negligence standard in Section 17(a).
9:00 Moving towards continuing disclosure obligations. Rule 15c-12 is not imposed directly on municipal issuers. The way that they get you is that they prohibit Underwriters, they prohibit the banks from purchasing or selling municipal securities unless the bank reasonably believes that the issuer has undertaken an obligation to provide annual reports and material events that’s listed in the Rules in an agreement for a contract either directly or through a Trustee or a disseminating agent. The annual report has to include through the financial and operating information, but underwriters are allowed to ask you to commit yourselves to provide additional information, that’s all.
10:00: That’s the continuing disclosure certificate or the continuing disclosure agreement that you enter into when you issue bonds and more and more I’m realizing that issuers are not paying enough attention to that upfront. It really is a document that people use the form of and they copy if forward deal after deal after deal and it really is important to look at it, to make sure you understand what the requirements are going to be to make sure that if you have a dissemination agent or a consultant that’s going to be be compiling the information for the court; make sure that they look at it. Make sure that they can comply with it. You’ll find things in reports from five and ten years ago where people aren’t sure what their required actions should be or they’re not sure that the scope of it is or things had changed and it wasn’t really applicable any more.
11:00: It’s an important document that’s not given enough attention when it’s being drafted and designed. It’s that next year when you have to actually prepare the reports that you realize you’re not happy with it. Rule 15c-12 and your continuing disclosure undertakings also require you to provide notice of any material events. There are material events listed in Rule 15c-12 and they get recited at the disclosure. Some of them require notice if certain things happen like a late payment of a debt service, an unscheduled draw on a reserve or fund, a draw on a reserve or fund surety, bankruptcy, and ratings changes for the issuer or the insurer of the municipal bonds.
12:00: Other material events only require notice if the event is material. That’s an adverse tax opinion and/or if there’s been an amendment to the indenture that changes the rights of the bond owners or nonpayment or defaults, things like that. If it’s material to the bond owners or investors, then you have to disclose. Post issuance disclosure continuing the annual reports and material event notices need to be posted on EMMA and they need to be linked to all of the applicable places for the securities.
13:00: We’ve talked about things having to be material several times. The materiality standard applies to all of this. It applies whether you post an event, it applies to whether you have to disclose something in your official statements, and it applies to – in the official statement you have to report on any material non compliance with your continuing disclosure obligations in the past five years if material. And this is where the MCDC initially really focused, on official statements that said ‘we’re in compliance with all actives of disclosure obligations’, but in fact things were filed late or not filed at all, or material event notices ensuring ratings changes
14:00: White: What is MCDC
Legbandt: MCDC happened about two years ago, it was an initiative and I don’t remember what the acronym stands for, but it was the initiative of the SEC that essentially offered that issuers and underwriters could review their compliance with the requirement to not just file things on a timely basis, but if they had accurately disclosed an official statement, whether or not they had been in compliance. So lots of issuers and all of the underwriters reviewed their past compliance and if you discovered that you had not complied entirely, you filed things late or not filed at all, you could self-report to the SEC.
15:00: They offered reduced sanctions. They offered, I think, no financial penalties for issuers and things like that.
White: There was a deadline for the City of Beaumont to comply?
Legbandt: That’s right, that is correct.
White: Do you know when that deadline was?
Legbandt: It was November or December, 2015, I want to say, I’m not 100% sure, but around that time. Maybe 2016. It was quite a while ago.
inaudible mumbling from council and Legbandt.
16:00: So, Beaumont, in its most recent compliance representations Beaumont has disclosed all of the known failures to comply and going forward since August, 2017, Beaumont also needs to, in official statements, disclose the facts of the Cease and Desist Order from the SEC.
17:00: The materiality standard. Like I said; this applies to everything. The materiality standard is defined as a substantial likelihood that a reasonable bond investor would consider a piece of information important in deciding whether or not to purchase the bonds and also would a reasonable investor see a particular piece of information as kind of changing the risk profile or changing the total mix of information that they’re getting about a particular security. The materiality standard is really hard to know for sure. It’s subjective. It’s clear that the SEC takes a very kind of aggressive view on it. There’s a low threshold of for materiality.
18:00 And especially with things that are included in Rule 15c-12; they put it in the Rule because they want you to disclose it. Arguing that it’s not material that it wasn’t disclosed; it’s kind of an uphill battle. The other thing that happens is that materiality gets reviewed in hindsight. In a lot of cases it’s after things have gone wrong. Not in Beaumont, but in other jurisdictions it’s been after there’s been a default or a failed project or a natural disaster or whatever thing went wrong that made people focus on the jurisdiction and their debt; that’s what you in the official statement to see what was disclosed.
19:00: Slide 11 Reliance on Professional Services. The issuer is responsible for and accountable for the statements that create for public disclosure documents and you can not delegate this responsibility.
20:00: You can’t delegate it to your consultant, to your attorney, to the underwriter, to anybody.
I think for a long time and in some types of deals more than others, this can be hard to remember. The financing team worked on the official statement, the consultants prepared the continuing disclosure filing. And it can be really hard for staff and for the council to remember that those documents are your responsibility. An official statement, the front is what, 60 to 80 pages long and it’s lots of boiler plate, so it’s understandable that people don’t want to read it, but it is important to make sure that the City and the CFD and the Authority Staff and Council are looking at the parts that you have knowledge about because it is your document and your responsibility.
21:00 Libi: And you can’t ‘Receive and File’ , right, and pretend it didn’t happen to you?
Legbandt: Well, it’s important, you know, to ..
Libi: Accept responsibility.
Legbandt :.. make sure the City Council has access to the documents. I alway make sure the entire official statement is put into the agenda packet and not just on file with the city clerk for exactly that reason.
22:00: The fact that an attorney is drafting the document initially or is involved in the preparation of the document does not constitute an advise of counsel as a defense. That defense is only available if you waive the privilege and also it’s only available if there’s been a specific request for advise on a particular topic, not just overall disclosure council grated in the POS.
Slide 12 Key Elements of the Disclosure Policy.
23:00 A formal, written disclosure policy was adopted on April 19, 2016 and expected to be updated with input from the Independent Consultant. It established process and governing policies ensuring accuracy of disclosures. It requires you to hire outside disclosure counsel. This is a practice in California that is routinely followed now, but not as much in other States. But your disclosure policies now requires that you hire an outside disclosure counsel when you’re having an official statement prepared. Other best practices on disclosure are to make sure you have the right people involved in the disclosure. Make sure that for a CFD that planning staff are involved for full disclosure about the project.
24:00: About the public facilities that are needed, about the status of the development. And make sure that whatever staff has volunteered to do this, make sure that they are empowered to ask questions, to provide feedback, raise issues up the ladder to make sure that they are not just rubber stamping it. Make sure that you’re having conference call meetings on the staff level. Make sure there are meetings to review the disclosure. Again, if the entire thing is done at the consultant level and there’s never even a conference call to go over the documents, it doesn’t look like the City was handling the document or really in charge of it.
25:00 Your disclosure policy also requires periodic training, that’s why I’m here today. Policies contains details on annual disclosure requirements and the timing for those filings; financial data, operating data, audited financial statements or CAFRs, and material event notices. Material event notices can be tricky because they’re not always things that are directly within the City or city staff’s knowledge, like the insurer’s rating changes, and you’re required to find out about it and post a notice about it within ten days. So processes have to be in place to make sure you’re equipped to do that. Your City’s Finance Director is charged with the responsibility for preparing and filing your annual reports and your material event notices.
26:00: So the SEC is going after municipal issuers, as you know. There can be financial penalties. They look for almost strict liability on these things. They look for financial penalties, they go after individuals under a control person liability theory. They sometimes seek criminal charges at the same time they’re seeking civil penalties. For many years these cases were settled with no admission of wrong doing; we neither admit nor deny that we’ve done these things.
27:00: Recent cases have sought an admission, not that the issuer was at fault for its wrongdoing, an admission of negligence, things like that, but they really are being more and more aggressive. They look for liability in public statements that are made outside of offering materials in continuing disclosure. We talked about public officials making statements about a new project they’re promoting in town, things like that. In Beaumont’s case, because there’s an existing Cease and Desist Order, if there’s future findings negligence or failures to comply, I think you can expect that the SEC will seek heightened penalties and will seek more oversight.
28:00: White: What does the Cease and Desist Order say we must cease and desist from; getting bonds?
Libi: Forging Documents.
Legbandt: No, it simply says – it’s kind of a double negative. It requires you to cease and desist from not complying with Rule 17(a) of the Securities Act of 1933, the Antifraud Rule which was found against you by the SEC based on an investigation
White: Do all of the other stuff you were teaching .. inaudible .. Would all of those issues .. inaudible ..
29:00 Legbandt: Essentially yes. so 17(a) and Rule 10b-5 essentially say that when you are speaking to the market, investors of municipal securities your statements to the market need to be accurate and complete, not misleading. And that covered all of the things we’ve been talking about; your continuing disclosure filings, preparation of official statements, and public speeches, investor polls..
White: I guess what i’m asking is if we had violated this on some issue those would have been included .. inaudible.. In other words; they were addressing the nondisclosure .. inaudible ..
Legbandt: Right, it addressed failures to comply with your continuing disclosure obligations that are a variety of continuing disclosure sets.
30:00: And in official statements; failing to disclose those earlier failures to comply. And this training is broader than that because it’s a full disclosure.
White: I’m not misunderstanding, I’m just trying to – there’s a lot talk that we’ve broken all sorts of rules and laws and we’ve learned during the SEC investigation that multiple additional complaints for all sorts of other violations were sent to the SEC, so that’s why I was asking that question. And by the way, the MCDC deadline was extended through December 1st of 2014.
White: It’s critical because Mike and I came in on December 2nd.
Libi: That’s what it’s all about.
31:00: Page 15: SEC Cartoon
Legbandt: I feel like I’m preaching to the choir, but this is going through the nightmare of an SEC investigation. It’s not litigation, which means that you don’t get the protection that you would get in litigation. The SEC has an active whistle blowers’ program and they are actively trying to find people to go after, issuers to go after. They have broad document subpoena power, they have a team of lawyers and accountants who ..
32:00: Libi: Love me.
Legbandt: …who have a mandate to go find failures to comply to prosecute it. They don’t have a specific timeline or budget necessarily for any particular investigation. They just go and find what they can find. They will issue personal subpoenas to officials and staff. And the reference to the Yates Memorandum is really interesting. This memo essentially says that if we want to stop the failures to comply, we want to really hone in on the issuers, we have to, and it was also in the corporate contracts.
33:00: They really point out that if they want stop corporate or municipal failures to comply with these laws; they have to drill down hard on the individual because those are the people doing or not doing things. And it’s also the best way to ensure cooperation in an investigation to essentially have the threat of going after the individual people involved. On that note, cooperation and credibility are extremely important and helpful in getting through that SEC investigation. My understanding in Beaumont’s case; you guys were already ramping up to contact them.
34:00: Libi: No girl, that ain’t what happened, no. That was funny, but no girl, that ain’t what happened.
Legbandt: The terms of an SEC settlement can take many forms. Frequently you can get a settlement and neither admit or deny the allegations, which is the case in your settlement, but they sometimes require an admission of wrongdoing and we’ve seen that in recent cases. They’ll require a Cease and Desist Order that you have to consent to. There can be financial penalties or disgorgement including against individuals.
35:00: They can bar individuals from participating in the issuance of municipal securities, from participating in the market for a period of years or a period of months or forever. They can require compliance undertaking, like in our case, require an outside consultant to be hired to oversee, or requiring additional policies and procedures requiring trainings like this one, which are a good practice for any municipal issuer and we do them all the time. They can try to get you to cooperate with them against others under investigation like the banks or underwriters that have been involved.
36:00: Back to Attorney Client Privilege. This is something that has several recent cases have made it very clear that attorney/client privilege in these transactions has not been taken seriously enough. When we are – right now – this is not attorney/client privilege because there are other people in the room. In order for something to be protected by attorney/client privilege people who are not necessary to the conversation can not be involved. In the preparation of an official statement, for example, as is a wide practice, we send out the first draft and then we have a ‘all hands’ conference call, the underwriter provides comments and the financial advisor provides comments and the staff provides comments – that’s not privileged.
37:00: We have taken very seriously the process where we – if there is an issue that comes up that is substantive at all or that we don’t know the answer to; we go directly to staff and work through it. We may put a placeholder in the document until we resolve, until we know what the disclosure should say. Because once you try to air the issue out with the financing team, those issues are not privileged any more. Consultants and financial advisors can be part of the privilege, but only if they are necessary to helping the issuer resolve the issue. So just because you’ve got a financial advisor who wants to be involved in everything and be helpful and help manage the transactions; if that’s the only reason they’re there, then they’re destroying the privilege.
38:00: We take people off conference calls, we set up separate conference calls to discuss things, we have things involve location, kind of authorized profession items. We also clearly mark things as ‘privileged’ whenever we think that might be an issue because it can be very expensive to go through voluminous material to weed out attorney client privilege material. We try to be sure they are brightly marked so they don’t accidentally get disclosed.
39:00: Insurance Coverage for Investigations during the renewal process. That’s the end of this training and I’ll be happy to answer any more questions.