Speech by SEC Staff:
Remarks to the Mississippi
by Mary N. Simpkins
Senior Counsel, Office of Municipal Securities,
U.S. Securities & Exchange Commission
June 29, 1999
The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the authors and do not necessarily reflect the views of the Commission or of the authors' colleagues on the Commission staff.
Good afternoon. Thank you for allowing me the opportunity to speak to you. Today I'd like to discuss some securities law issues of importance to issuers of municipal bonds. Before I go any further, I must remind you that my comments here today reflect my own point of view, which is not necessarily shared by my colleagues on the Securities and Exchange Commission's staff, or by the Commission.
My name is Mary Simpkins and I am a lawyer with the Office of Municipal Securities at the Securities and Exchange Commission in Washington. Like most of the folks in my office, however, I am also a bond lawyer. Actually, for most of my career, I was in private practice, helping communities like your communities borrow in the bond market.
Local governments have been issuing municipal bonds in the United States for almost two hundred years. The size of today's market may surprise you approximately $1.5 trillion of municipal bonds are currently outstanding in the United States. More than 70% of this amount is held by individual investors either directly or through mutual funds. Last year, Mississippi communities borrowed over $1 billion in the municipal bond market.
I have been looking forward to this visit since January, when Jeanie Smith and I first began to talk of our participation in today's session. I understand that most of you issue municipal bonds. Some of you may do so more frequently than others, but when you do, a few things happen that I think are good for anyone involved to keep in mind. I want to talk a bit with you today about those things and, of course, answer your questions as best I can.
The easiest way I can think of to sum these things up is that issuing bonds is like meeting new people and learning about new laws. Like meeting anyone for the first time, or renewing the acquaintance, if you're like me, you hope the meeting goes well and it's one you can look back on with satisfaction. Let me assure you, even though lawyers are involved, this can be the result. The great majority of the time, it is the result. And I hope that for you it will always be the result.
First: how is it like meeting new people? When you issue bonds, as opposed to borrowing from the bank, you meet a new group of people investors those who consider buying and those who actually buy your bonds. Who are they? They may be a young couple in Wisconsin setting aside money for a child's education. They may be a much older couple in Florida saving for retirement and minimizing the taxes they pay. Or they may be a neighbor, simply using a tax-exempt money market fund to manage their own day-to-day funds. Quite often, they are just like you and me.
You may not always know much about them, but there is a lot they want to know about you. What they do come to know about you may be from any number of sources, but the principal way will be through your official statement and the annual information you provide. This information is known as "disclosure." That information is very important to them, for it may affect their decision to invest in your bonds over some other municipality's bonds.
The folks whose money you borrow expect your disclosure to be true, just as they expect you to repay the money you borrow. Not surprisingly, so does the law. This is where we at the Securities and Exchange Commission come in. Federal securities law has protected investors for over sixty five years by requiring the information provided investors be accurate, complete and not misleading. Issuers of municipal bonds such as yourselves are generally exempt from most of the federal securities laws, but not from those sections forbidding misleading statements or omitting material facts from the disclosure you make in official statements and annual financial information. Those provisions known as the antifraud provisions apply to any person. I will come back to the antifraud provisions in a few moments, with a few things you should remember about them, but right now I ask you to remember one very important thing about them you should be sure your lawyer, and anyone else who helps you prepare your official statement, is familiar with them. If they are not, unfortunately, you may be the one to pay the price.
When you issue bonds, you also encounter another set of federal laws the tax code. The interest on most municipal bonds is exempt from federal income taxation and often from state income taxation. From an investor's point of view, tax exemption is a very important feature of municipal bonds. From your point of view, the lower borrowing rate is undoubtedly important. Of course you can imagine how unhappy an investor would be to learn that supposedly tax-exempt bonds were in fact taxable. Misleading facts in disclosure as to the tax status of municipal bonds may be fraud under the securities laws. The SEC has brought several enforcement actions based on misleading disclosure of facts affecting the tax status of municipal bonds. In several cases where bonds have been declared taxable, the Internal Revenue Service has looked first to the issuer to pay the penalty. Once again, I ask you to be sure your lawyer who gives the opinion that your bonds are tax exempt understands the tax law and is competent to advise you in such matters. If they are not, it may hurt you and your investors.
I mentioned a few moments ago that based on your disclosure, an investor may decide whether or not to buy your bonds. Some consider this decision so important that they refer to bondholders as a second constituency. If your financial operations depend upon borrowing in the bond market as well as your tax base, you may understand how they come to feel this way. Each time you return to the bond market to borrow money, you ask this constituency to vote for you again. If bondholders have a pleasant meeting in your first encounter, they are more likely to pursue additional meetings or vote for you by continuing to buy your bonds in the years ahead.
This idea that an investor may decide whether or not to buy your bonds based on the disclosure you provide that investor is at the heart of federal securities law and the antifraud provisions. That investor expects true and complete information in making an investment decision. In essence, the antifraud provisions say that any person may not make any untrue statement of a material fact or omit to state a material fact necessary to make something said not misleading in connection with the offer, purchase or sale of a security. Now, if you were paying close attention, you probably noticed the word "material" in my description. When courts apply the antifraud provisions, an omitted fact is material if there is a substantial likelihood that the disclosure of the omitted fact would have been viewed by reasonable investors as having significantly altered the "total mix" of information made available. The focus of the law is on the information given to investors to make their investment decision.
Over the years, the Commission has devoted a good portion of its resources to enforcing the antifraud provisions. If you look at our recent Annual Report, you will see that over the last five years, the Commission has brought on average approximately 475 cases each year. In those five years combined, we have brought over 75 cases against participants in municipal securities transactions.
Our cases involving the municipal securities markets include actions against underwriters, financial advisors, accountants, consultants, bond counsel, issuers and issuer officials. The securities law violations involved include misleading disclosure in use of proceeds, risks associated with the borrowing, stale and incomplete accounting information and matters affecting the tax status of the bonds.
We have compiled most of the cases involving municipal bonds the Commission has brought over the last thirty years, together with other Commission guidance, and are providing the compilation to bond lawyers at a variety of different seminars this year. While these materials have always been available to lawyers in law libraries, we want to make it even easier for them to access it. You may want to make sure the lawyers you hire to help you prepare disclosure are familiar with this information. They have little excuse not to be familiar with it. Cases within the last four years and new cases may also be accessed on our web site at www.sec.gov.
You may be particularly interested in a few of the cases involving issuers and issuer officials. Many of the more recent cases involve bond issues involving the investment pools of Orange County, California. You may recall that four years ago, Orange County filed for bankruptcy following difficulties relating to its investment pools. The Commission settled its enforcement proceedings with the County and the County Board of Supervisors, as well as the former County Treasurer and Assistant Treasurer for misleading disclosure, including failure to reveal the risks associated with investing in the pools and certain facts affecting the tax status of the notes. The Commission also issued a report critical of the conduct of the members of the Board of Supervisors. You should also know that the Commission also settled proceedings with the financial advisor and bond counsel in those cases, settled with one underwriter and sued two others, one of which subsequently settled and the other is still pending in federal court. The Commission has also initiated proceedings against several communities in California that issued notes to invest in the pool, alleging failure to disclose the purpose of the borrowing and risks associated with the investment.
The Commission has also settled proceedings with Maricopa County, Arizona and Syracuse, New York arising from stale and misleading accounting information provided to investors. I assume that many of you are also familiar with the settlement last summer involving thirty-nine communities in Mississippi. The core difficulty in these offerings was misleading disclosure. The communities all agreed to entry of the Commission's order, without admitting or denying the charges.
The respective official statements for each offering represented that the issuers intended to spend the full amount of the offering proceeds within three years on various capital projects, such as roads, parks, a courthouse, and other projects. These statements were not true. None of the bond proceeds were used for capital projects other than fees. The substantial risk to the tax exempt status of interest on the notes was not disclosed to prospective investors.
The text of the Order states as follows: "Each of the note offerings was approved by the governing board of the respective Respondent. In each case, the official statements and other documents used in connection with the offering, including arbitrage certificates, were executed by the chief executive of the respective Respondent. Those officials were either aware of the misrepresentations contained in the documents, or, in many instances, failed to read the documents closely enough to ascertain whether misrepresentations were being made as to the essential purposes of the offering, for example, the intended use of proceeds. Issuers may not blindly rely on professionals such as bond counsel, to ensure that factual representations being made by the issuers are accurate."
The bond lawyer for these offerings, Derryl Peden, was also sued in federal court. Earlier this spring, the Honorable Judge Henry T. Wingate, United States District Court Judge for the Southern District of Mississippi, issued an order of disgorgement of ill-gotten gains against Peden in the amount of $2,080,753. However, the Order waived payment of disgorgement and civil penalties based on Peden's demonstrated inability to pay. Peden submitted sworn financial statements to the Commission. Peden also filed a voluntary chapter 7 bankruptcy proceeding on September 25, 1998.
Earlier, on July 15, 1998, Judge Wingate entered a Final Judgment of Permanent Injunction against Peden, permanently enjoining him from violating the antifraud provisions of the federal securities laws and ordered Peden to comply with an earlier administrative cease-and-desist order which had been entered against Peden by the Securities and Exchange Commission on December 2, 1994.
The underwriter for these offerings, Thorn, Alvis, Welch, Inc. had previously been sued by the Commission for securities fraud and found to have violated federal securities law by an administrative law judge in 1996. John E. Thorn, Jr. and the firm, now Thorn Welch & Co., Inc. appealed that finding to the Commission and then settled that proceeding together with new proceedings based on the same offerings as the thirty-nine Mississippi communities, without admitting or denying any of the factual assertions, findings or conclusions of the Commission's Order. As part of the settlement, the broker-dealer registration of Thorn Welch & Co., Inc. was revoked, John E. Thorn, Jr. and Eugene J. Yelverton, Jr. were barred from association with any broker, dealer, municipal securities dealer, investment adviser or investment company and ordered to cease and desist from violating the antifraud provisions of the federal securities laws. The firm, Mr. Thorn and Mr. Yelverton were also ordered to disgorge their profits.
One message for issuers that rings clear through many of the cases the Commission has brought involving municipal bonds is know the professionals you hire. More than a few of the proceedings involve breach of fiduciary duty by financial advisors to issuer clients.
Several years ago, the Commission worked with the National League of Cities, the Government Finance Officers Association and other groups representing issuers to prepare a booklet called "Questions to Ask Before You Approve a Municipal Bond Issue." It contains ten questions officials should ask themselves and their staff and five questions officials should ask outside professionals. I encourage you to get it and read it before each of your offerings, and share it with your colleagues.
Don't be afraid to ask your professionals questions and demand answers you understand. When investment bankers present you with complicated financial proposals, perhaps involving advance refundings, or interest rate swaps or derivative products, if you are not sure what they are talking about, ask questions. Don't be embarrassed because you're afraid they'll think you're asking about things you should already know. That's their job. Don't assume that just because they use a lot of financial jargon and talk fast that they are very sophisticated. If they can't explain it to your satisfaction, that may be a warning sign. Maybe the reason they can't explain it to you is that it doesn't make any sense.
In recent years, we have brought actions against underwriters and financial advisors for failure to disclose payments from third parties that sold or brokered investments to municipal issuers. Last year, the Commission found O'Brien Partners in violation of investment advisory laws by failing to adequately disclose to issuers that while providing advisory services to these issuers, O'Brien Partners also was receiving payments from guaranteed investment contract brokers used by these issuers to invest their bond proceeds. Find out if somebody is getting a kickback in exchange for your business.
If somebody is trying to sell you something, find out what is in it for them. Our recent yield-burning actions are a case in point. In a recently settled yield-burning case, the Commission charged Lazard Freres & Co. with violating its fiduciary obligations to issuers by failing to disclose to them the excessive markups and profits it took from selling them securities for refunding escrows.
Municipal issuers also face a risk of misleading investors through public statements that may not be intended to be the basis of investment decisions, but nevertheless may reasonably be expected to reach the securities markets. In order to minimize the risk of misleading investors, you may wish to establish procedures to disclose material information to the trading market. If your city, town or county has a Web site, you take care that the information you provide on your Web site is not misleading. If a statement is made reaching markets or investors, the antifraud provisions apply regardless of whether the statement is on paper or delivered electronically.
In closing, I want to thank you and the members of the Mississippi Municipal Association for this opportunity. I also ask for your advice. This is the first session of a series specifically designed for small issuers that my colleagues and I plan to participate in around the country. We want your suggestions as to how we could improve it. Please call or e-mail us. Our phone is 202-942-7300 and our e-mail is email@example.com. Also, please do not hesitate to call us anytime we may be of assistance to you. Thank you.