Cor­rup­tion Tar­gets Set For 2019

The Bond Buyer - - Front Page - By Kyle Glazier

WASH­ING­TON – En­force­ment of the fed­eral se­cu­ri­ties laws is likely to fo­cus on dis­clo­sure and pub­lic cor­rup­tion is­sues in the com­ing year, with a pos­si­ble in­creased em­pha­sis on the emerg­ing area of mu­nic­i­pal ad­vi­sor en­force­ment, mar­ket par­tic­i­pants said.

Se­cu­ri­ties lawyers and other stake­hold­ers dis­cussed the prob­a­ble fo­cus of Se­cu­ri­ties and Ex­change Com­mis­sion and Fi­nan­cial In­dus­try Reg­u­la­tory Au­thor­ity en­force­ment of the laws and mu­nic­i­pal se­cu­ri­ties rules in 2019 in sep­a­rate in­ter­views with The Bond Buyer. While en­force­ment ac­tions arise from the dis­cov­ery of bad con­duct and aren’t to­tally pre­dictable, the broad pri­or­i­ties set by the reg­u­la­tors and an ex­am­i­na­tion of the re­cent trends can pro­vide some

clue as to what the muni mar­ket can ex­pect.

“You can ex­pect to see en­force­ment ac­tion in the same gen­eral ar­eas as you’ve seen in re­cent years,” said LeeAnn Gaunt, chief of the SEC’s Pub­lic Fi­nance Abuse Unit.

Among the ar­eas Gaunt said her of­fice ex­pects to ad­dress is dis­clo­sure fraud, which she said is likely to arise mainly from false in­for­ma­tion in pri­mary of­fer­ing doc­u­ments but could also come from mis­lead­ing pub­lic state­ments. Gaunt said her at­tor­neys would also be look­ing into cases of ap­par­ent pub­lic cor­rup­tion and al­le­ga­tions of pay-to-play ac­tiv­ity.

Gaunt said she didn’t ex­pect

any par­tic­u­lar spike or drop in en­force­ment ac­tiv­ity rel­a­tive to prior years. But she did add that the SEC has be­come more ed­u­cated about the mu­nic­i­pal ad­vi­sor busi­ness since the ef­fec­tive­ness of the SEC’s MA reg­is­tra­tion rule in 2014. Since that time, the SEC’s Of­fice of Com­pli­ance, In­spec­tions, and Ex­am­i­na­tions has been con­duct­ing ex­ams of MA firms and the SEC has brought a num­ber of ac­tions against muni ad­vi­sors.

“Bring­ing them into the reg­u­la­tory fold and hav­ing them be sub­ject to the ex­am­i­na­tion of OCIE has helped us all learn more about how that busi­ness op­er­ates,” Gaunt

said of MAs. “It’s be­com­ing an in­creas­ing area for our at­ten­tion.”

OCIE’s 2019 exam pri­or­i­ties, an­nounced ear­lier this month, state that the of­fice will be look­ing closely at MA op­er­a­tions.

“OCIE will con­tinue to con­duct select ex­am­i­na­tions of MAs that have never been ex­am­ined, con­cen­trat­ing on whether these MAs have sat­is­fied their reg­is­tra­tion re­quire­ments and pro­fes­sional qual­i­fi­ca­tions as well as con­tin­u­ing ed­u­ca­tion re­quire­ments,” ac­cord­ing to the pub­lished pri­or­i­ties. “OCIE will also pri­or­i­tize whether MAs pro­vided the ap­pro­pri­ate dis­clo­sures re­gard­ing their con­flicts of in­ter­ests or other­wise vi­o­lated their fidu­ciary duty to a mu­nic­i­pal en­tity. Ex­am­i­na­tions will also re­view for com­pli­ance with re­cently-ef­fec­tive MSRB rules, in­clud­ing those re­lat­ing to ad­ver­tise­ments by MAs and the stan­dards of con­duct for MAs ob­tain­ing CUSIP num­bers on be­half of is­suers.”

Leo Kar­we­jna, man­ag­ing direc­tor and chief com­pli­ance of­fi­cer at PFM, said the SEC’s ini­tial round of in­spec­tions was prob­a­bly ed­u­ca­tional for both the SEC and for the MA com­mu­nity. He said the SEC is prob­a­bly up to speed now.

“The first go-around they were try­ing to

fig­ure out how this all worked,” Kar­we­jna said. “Now, by and large, they have that un­der­stand­ing.”

Un­der fed­eral law, muni ad­vi­sors have a fidu­ciary duty to put the in­ter­ests of their mu­nic­i­pal en­tity clients ahead of their own and the SEC has used that pro­vi­sion of the law to bring ac­tions against MAs. Kar­we­jna said he ex­pects muni ad­vi­sor en­force­ment will con­tinue to fo­cus on con­flicts of in­ter­est, though MAs should be wary of how they will op­er­ate in a world with­out ad­vance re­fund­ings.

Since the Repub­li­can tax over­haul elim­i­nated tax-ex­empt ad­vance re­fund­ings, many in the mar­ket have pre­dicted an in­crease in com­plex trans­ac­tions as is­suers seek to re­al­ize sav­ings by other means. Kar­we­jna said muni ad­vi­sors had bet­ter be sure that they have the knowl­edge to prop­erly ad­vise their clients on those kinds of trans­ac­tions. If not, they should bring an MA into the deal who does.

Other OCIE pri­or­i­ties in­clude a fo­cus on costs paid by in­vestors, ac­cord­ing to the SEC.

“Pro­tect­ing Main Street in­vestors con­tin­ues to be a pri­or­ity in 2019,” the com­mis­sion said in a re­cent re­lease. “OCIE will fo­cus ex­am­i­na­tions on the dis­clo­sure and cal­cu­la­tion of fees, ex­penses, and other

charges in­vestors pay, the su­per­vi­sion of rep­re­sen­ta­tives sell­ing prod­ucts and ser­vices to in­vestors, bro­ker-deal­ers en­trusted with cus­tomer as­sets, and port­fo­lio man­age­ment and trad­ing.”

John McNally, a part­ner at Hawkins De­lafield & Wood in Wash­ing­ton, said he be­lieves the SEC is in­ter­ested in pro­vid­ing guid­ance on muni mar­ket dis­clo­sure and will limit its en­force­ment ac­tiv­ity to clear vi­o­la­tions of the se­cu­ri­ties laws. McNally was a par­tic­i­pant in the SEC’s one-day muni dis­clo­sure con­fer­ence Dec. 6, and said the par­tic­i­pa­tion of all the SEC com­mis­sion­ers, as well as Gaunt and muni of­fice Direc­tor Re­becca Olsen, in­di­cates that the SEC is plac­ing a high pri­or­ity on im­prov­ing mu­nic­i­pal mar­ket dis­clo­sure.

“The SEC is in­ter­ested in what guid­ance they can pro­vide to the mu­nic­i­pal mar­ket in a new in­ter­pre­tive re­lease, the last one of which was pub­lished in 1994,” McNally said. “It is clearly is a pri­or­ity for the SEC, as ev­i­denced by the par­tic­i­pa­tion of the chair, the other four com­mis­sion­ers, the direc­tor of the Of­fice of Mu­nic­i­pal Se­cu­ri­ties, and the chief of the Pub­lic Fi­nance Abuse Unit. As a re­sult, I think that the mu­nic­i­pal en­force­ment ac­tions over the next year will be di­rected to ac­tiv­ity or dis­clo­sure that is in clear vi­o­la­tion of the fed­eral se­cu­ri­ties laws.”

Is­sues such as the role of mu­nic­i­pal ad­vi­sors in pre­par­ing of­fi­cial state­ments, due dili­gence re­spon­si­bil­i­ties in the con­text of pri­vate place­ments, and how un­der­writ­ers can show they “rea­son­ably de­ter­mined” that is­suers have com­plied and will com­ply with con­tin­u­ing dis­clo­sure re­quire­ments will prob­a­bly be ad­dressed via guid­ance, McNally said.

Mar­ket ob­servers have noted that un­der SEC Chair Jay Clay­ton, the com­mis­sion ap­pears to have moved away from the “bro­ken win­dows” en­force­ment pol­icy that char­ac­ter­ized en­force­ment pol­icy un­der the chair­man­ship of Mary Jo White from 20132017. The “bro­ken win­dows” phi­los­o­phy holds that by strictly en­forc­ing smaller vi­o­la­tions, en­forcers can dis­cour­age would-be law­break­ers from com­mit­ting more se­ri­ous crimes.

Bond Deal­ers of Amer­ica CEO Mike Ni­cholas said he has a sense that the “tone has changed” at the SEC un­der Clay­ton.

“It doesn’t seem like ev­ery­thing com­ing out of the SEC is driven by en­force­ment,” Ni­cholas said.

The Fi­nan­cial In­dus­try Reg­u­la­tory Au­thor­ity de­clined to dis­cuss its 2019 plans ahead of the for­mal re­lease of its pri­or­i­ties. FINRA typ­i­cally pub­lishes its pri­or­i­ties within the first sev­eral days of Jan­uary. ◽

“You can ex­pect to see en­force­ment ac­tion in the same gen­eral ar­eas as you’ve seen in re­cent years,” the SEC’s LeeAnn Gaunt said.

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