Two recent SEC actions affect municipal issuers

Two actions recently announced by the Securities and Exchange Commission (Commission or SEC) affect municipal issuers, including conduit borrowers¹:

• On February 7, 2020, the SEC's Office of Municipal Securities issued a staff legal bulletin to remind municipal issuers that the antifraud provisions of the federal securities laws apply to their statements that are reasonably expected to reach investors and the trading markets (including EMMA filings, websites, press releases, and media interviews).²
• On February 10, 2020, the Municipal Securities Transparency Subcommittee of the SEC's Fixed Income Market Structure Advisory Committee (FIMSAC) voted to approve recommendations for SEC and congressional action to impose additional disclosure requirements on municipal issuers.³

Staff legal bulletin

The staff bulletin appears intended primarily to encourage municipal issuers to make more accurate, timely, and comprehensive information available to investors in the secondary market.⁴ It seems unlikely to result in more disclosure, since the staff bulletin is largely a repetition and consolidation of prior Commission statements that fail to fully address risks associated with voluntary post-issuance disclosure to investors. The staff bulletin does, however, remind municipal issuers that they should consult with competent counsel and develop or update effective continuing disclosure procedures and training to avoid securities law liability.

Covered public statements

SEC Rule 10b-5, implementing Section 10(b) of the Securities Exchange Act of 1934, makes it unlawful, in connection with the purchase or sale of any security, to make an untrue statement of material fact or omit to state a material fact necessary in order to make statements made, in the light of the circumstances under which they were made, not misleading.⁵ Together with a similar provision applicable to statements in connection with securities offerings, these provisions are known as the "antifraud provisions." The staff bulletin repeats the Commission's position that any statement (written or oral) by a municipal issuer or its officials or employees is a statement made "in connection with the purchase or sale of a security," and therefore subject to Rule 10b-5, if the statement is "reasonably expected to reach investors and the trading markets." The staff bulletin states this is the case even if the municipal issuer is not itself purchasing or selling its securities at the time and even if the statement is not intended for investors, and regardless of the medium of delivery.⁶

Unlike case law, the staff bulletin does not limit covered statements to those on which an investor would reasonably rely.⁷ Nevertheless, because a Commission enforcement action can substantially and adversely affect a municipal issuer even if it is acquitted, municipal issuers should assume that all statements made by them (or their officials or employees) that are accessible and would be of interest to investors will be judged under the antifraud provisions. The staff bulletin gives examples of such statements, including:

• Continuing disclosure filings on the Electronic Municipal Market Access (EMMA) system maintained by the Municipal Securities Rulemaking Board
• Information on issuer websites (including information linked from another site with express or implied issuer approval)
• Public announcements and press releases
• Interviews with media representatives, and discussions with interest groups
• Comprehensive Annual Financial Reports (CAFRs), budgets, mid-year financial reports, and other financial information and operating data reported to a constituent body (e.g., city council) or another governmental unit.⁸

Liability under the antifraud provisions

To subject a municipal issuer or official to liability under Section 10(b) and Rule 10b-5, a misstatement in or misleading omission from a public statement must be material and, if made outside a securities offering, must be made with "scienter."

The staff bulletin notes that, under case law, "a fact is material if there is a substantial likelihood that the information would have been viewed by the reasonable investor as having significantly altered the total mix of information available."⁹

The staff bulletin notes that "scienter" requires a "mental state embracing intent to deceive, manipulate, or defraud," but that it may be satisfied by "recklessness," i.e., by an "extreme departure from the standards of ordinary care."¹⁰

The staff bulletin is intended in part to encourage more voluntary disclosure by municipal issuers on EMMA. Accordingly, the staff bulletin notes that, unlike in primary offering disclosure (where Commission enforcement actions can be based on "negligent" misstatements and omissions), when they make post-issuance disclosures municipal issuers are exposed to liability only for "reckless" or intentional misstatements or misleading omissions of fact. It also notes that, when issuers disclose more information and do so more frequently and timely, inadvertent misstatements or misleading omissions are less likely to be material, because they are less likely to significantly alter the total mix of information available to investors.

Policies and procedures

The staff bulletin repeats Commission recommendations that municipal issuers establish practices and procedures for disclosing material information that reflects on the creditworthiness of their securities.¹¹ In a consent order resolving an enforcement action against the City of Harrisburg, the Commission stated that policies and procedures should identify the persons involved in the disclosure process, require that public disclosures be evaluated for accuracy and completeness, and ensure that the responsible persons receive adequate training about their obligations under the federal securities laws.¹²

Should municipal issuers voluntarily disclose more on EMMA?

The staff bulletin was issued in response to a request from SEC Chairman Jay Clayton to explain why issuers do not expose themselves to additional liability when they voluntarily disclose on EMMA financial and operating information that is otherwise accessible to investors.¹³ His intent appears to be to encourage such disclosure. Does the staff bulletin make the case?

The staff bulletin states that the same standard applies in determining whether a misleading omission of a material fact from a public statement is actionable, regardless of whether omitted from an EMMA filing, a website posting, a budget, or a governmental filing. It fails to acknowledge, however, that an omission from an EMMA filing that is directed to investors may be misleading even if the same omission from a website, budget, or government filing would not. Omissions from disclosures directed to investors are more likely to be misleading "in the light of the circumstances under which they were made." The staff bulletin also ignores prior Commission statements that raise doubt about whether issuers can protect themselves from liability for omissions through the use of disclaimers.¹⁴ Finally, the staff bulletin ignores the substantial time and expense that issuers would incur if they take appropriate steps to avoid misleading material omissions from EMMA filings, given the different circumstances under which they are made. For these reasons, municipal issuers should confer with experienced counsel for advice about risks that the staff bulletin fails to fully address.

FIMSAC subcommittee recommendations

FIMSAC's Municipal Securities Transparency Subcommittee approved preliminary recommendations for Commission action and legislation to improve the liquidity, transparency, and efficiency of the municipal securities market, specifically by requiring additional and more timely disclosures by municipal issuers and by authorizing the Commission to enforce disclosure requirements. The recommendations were adopted by a vote of 14 to 2. The Subcommittee recommended that:

• The SEC be given statutory authority to enforce compliance with continuing disclosure agreements
• The SEC be given statutory authority to provide a safe harbor for forward-looking statements made by municipal issuers on conditions like those afforded by the "bespeaks caution" doctrine, i.e., that the statements be made in good faith and accompanied by disclosure of assumptions and significant risks
• The SEC explore how to impose more certain and predictable deadlines for annual financial information and audited financial statements, in contrast to Rule 15c2-12's requirement that audit reports be provided only if and when available
• The SEC seek public comment on whether it should be given statutory authority to mandate a disclosure framework, including filing deadlines, for municipal issuers
• The SEC explore how to raise awareness of the potential future consequences of providing less timely and robust disclosure information (despite acknowledging that "there is currently not a significant differentiation in terms of yield from investors" for municipal issuers that make interim, timely, and robust disclosure of financial information compared to those that do not)

The Subcommittee recommendations are substantially similar to several contained in the SEC's 2012 Report on the Municipal Securities Market.¹⁵ That is no coincidence, since former SEC Chair Elisse Walter was a proponent of the 2012 report and is an active member of the Subcommittee. The substantially similar legislative recommendations in the 2012 report had no traction on Capitol Hill. It remains to be seen whether the Subcommittee's recommendations, and likely ensuing Commission efforts, will fare better.