Scott Manning Kortmeyer and Fredric A. Weber
January 27, 2011 view as PDF
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), as proposed to be interpreted by the Securities and Exchange Commission (the “SEC”) in its December 20, 2010 release (the “SEC Release”), could (1) make it unlawful for non-profit healthcare providers, universities, or other entities involved in conduit municipal securities offerings, or their officers, directors, trustees, or employees, to make recommendations to the entity or the municipal issuer concerning the structure, timing, or other aspects of the offering without first registering with the SEC as a “municipal advisor” and (2) impose a fiduciary duty on them when making any such recommendations to a municipal entity.
The Dodd-Frank Act also authorizes the SEC to impose civil penalties for recklessly aiding and abetting another’s material misstatement or omission in connection of the sale of municipal securities, such could expose officers, directors, and trustees who approve disclosure statements to monetary penalties if they fail to take or require reasonable measures to vet the accuracy and completeness of the statements.
Registration Required. The Dodd-Frank Act amends the Securities Exchange Act of 1934 (the “Exchange Act”) to make it unlawful for a “municipal advisor” to provide advice to or on behalf of a municipal entity or an “obligated person,” unless the municipal advisor is registered with the SEC. The Dodd-Frank Act defines “municipal advisor” as a person (other than a municipal entity or its employee) that provides advice to a municipal entity or obligated person with respect to municipal derivatives, guaranteed investment contracts, or investment strategies or the issuance of municipal securities, including advice with respect to the structure, timing, and other similar matters concerning the financial products or issues, or undertakes a solicitation of a municipal advisory engagement from a municipal entity. Neither the Dodd-Frank Act nor the SEC’s proposed rule excludes from the definition of “municipal advisor” any non-profit entities that engage in municipal securities offerings through municipal entities or their officers, directors, trustees, or employees. In fact, the Release makes clear that the SEC interprets “municipal advisor” to include non-employee, non-elected municipal officials when they give advice to a municipal entity on its municipal securities offerings. Moreover, the proposed rules provide that a person can be considered a municipal advisor whether or not a contract exists or whether or not such person is compensated for the advice.
Fiduciary Duties. The Dodd-Frank Act also provides that a municipal advisory and any associated person (including its officers and directors and any employee providing the advice) is deemed to have a fiduciary duty to any municipal entity that it advises and may not engage in any act that is inconsistent with that duty or any rule of the Municipal Securities Rulemaking Board.
Practical Consequences. Unless the SEC is persuaded to exercise its exemptive authority, the Dodd-Frank Act and the proposed rules would appear to require that all non-profit healthcare organizations and universities that seek to engage in an offering of conduit municipal securities through a municipal entity, and their officers, directors, trustees and employees, must register with the SEC as a “municipal advisor” before giving advice to their organizations or to municipal entity regarding the issuance of municipal securities, or on swap transactions, investment strategies or guaranteed investments contracts. Unless clarified or exempted, the advice could consist of deliberating about a proposed bond issue at a board meeting, or submitting an application to a conduit municipal issuer, or appearing at its board meeting to speak in favor of the application.
Rule Comments. The SEC has requested comments regarding the proposed rules by February 22, 2011.Comments may be submitted electronically on the SEC’s internet comment form (http://sec.gov/news/press/2010/2010-253.htm), or by email to email@example.com (including File No. S7-45-10 in the subject line), or by the Federal eRulemaking Portal (http://www.regulations.gov), or in paper form in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090.
SEC Enforcement Action for Recklessly Aiding and Abetting
The Dodd-Frank Act also amends the Securities Act of 1933 (the “Securities Act”) to make it unlawful to recklessly provide substantial assistance to another person in violation of the Securities Act, including inadequate or misleading material statements by an issuer in connection with the sale of securities. Although there is no private action for any such aiding and abetting, the SEC may bring an enforcement action. The Dodd-Frank Act increases the penalties that the SEC may impose against individuals in an enforcement action to $75,000 per person ($150,000 where substantial losses could occur). Recklessness has been defined as “an extreme departure from the standards of ordinary care, and which presents a danger of misleading [investors] that is either known to the defendant or is so obvious that the actor must have been aware of it.”
Recent Enforcement. In August 2010, the SEC entered a consent decree ordering the State of New Jersey to cease actions and desist from violating the securities laws. It found the State to have inadequately disclosed its pension obligations, thus violating the antifraud provisions of the Securities Act. In its consent decree, the SEC implied that the State’s failure to maintain proper disclosure procedures made its violation of the antifraud provisions negligent, stating that the State’s violations were “due to a lack of disclosure training and inadequate procedures relating to the drafting and review of bond disclosure documents.” It also accepted the State’s settlement offer in part because the State had made corrections to its disclosure procedures, which included hiring disclosure counsel on an on-going basis,” enhancing its disclosure process “by instituting formal, written policies and procedures,” and implementing annual mandatory training by disclosure counsel of state employees involved in the disclosure process, mitigated the settlement offer that the SEC would accept.
In October 2010, the SEC settled charges involving four officials of the City of San Diego for violations of the Securities Act for knowing or recklessly assisting in the preparation of offering and continuing disclosure documents that contained material misstatements and misleading statements. The settlements imposed civil penalties on the four officials ranging from $5,000 to $25,000.
Practical Consequences. If a director or trustee of a non-profit healthcare organization or university votes to authorize a disclosure document in an offering of conduit municipal securities (or as part of its continuing disclosure undertaking) without assurance that the organization followed reasonable procedures in vetting the disclosure, and the document is later found to be legally deficient, the director or trustee could be exposed to civil penalties for recklessly aiding and abetting the organization’s violation of the Securities Acts or the Exchange Act. In light of recent SEC enforcement actions, it may be prudent for a non-profit healthcare organization or university to proactively adopt mandatory organizational procedures for preparing and approving disclosure documents before they are released into the municipal securities marketplace.
This article was prepared by Scott M. Kortmeyer (firstname.lastname@example.org or 214 855 7459) and Fredric A. Weber (email@example.com or 713 651 3628) from Fulbright's Public Finance Practice Group. If you have questions concerning this article, or would like assistance in submitting comments on the SEC Release, please contact one of the authors.
 Pub. L. No. 111-203, 124 Stat. 1376 (2010).
 S.E.C. Release No. 34-63576 (Dec. 20, 2010). The Release (including the proposed rule and commentary) is available at the SEC’s website: http://sec.gov/rules/proposed/2010/34-63576.pdf . On January 6, 2011, the proposed rules were published in the Federal Register: Volume 76, No. 4, p. 824.
 Pub. L. No. 111-203, § 975(c)(1), 124 Stat. 1920, amending 15 U.S.C. § 78o-4(c)(1).
 Pub. L. No. 111-203, § 975(c)(2), 124 Stat. 1920, amending 15 U.S.C. § 78o-4(c)(1).
 Pub L. No. 111-203, §§ 929M, 929P, 124 Stat. 1861-1863, amending 15 U.S.C. §§78o, 78h-1.
 A “municipal entity” is defined to include States, their political subdivisions and municipal corporate instrumentalities, and any agency, authority, or instrumentality of any of them. Pub. L. 111-203, §975(e), 124 Stat. 1922, adding paragraph (e)(8) to 15 U.S.C. §78o-4
 The term “obligated person” means any person, including an issuer of municipal securities, who is either generally or through an enterprise, fund, or account of such person, committed by contract or other arrangement to support the payment of all or part of the obligations on the municipal securities to be sold in an offering of municipal securities.” Pub. L. No. 111-203, §975(e), 124 Stat. 1923, adding paragraph (e)(10) to 15 U.S.C. §78o-4.
 Pub. L. No. 111-203, §975(a)(1), 124 Stat. 1916, adding paragraph (B) to 15 U.S.C. §78o-4(a)(1).
 “’[S]olicitation of a municipal entity or obligated person’ means a direct or indirect communication with a municipal entity or obligated person made by a person, for direct or indirect compensation, on behalf of a broker, dealer, municipal securities dealer, municipal advisor, or investment adviser . . . that does not control, is not controlled by, or is not under common control with the person undertaking such solicitation for the purpose of obtaining or retaining an engagement by a municipal entity or obligated person of a broker, dealer, municipal securities dealer, or municipal advisor for or in connection with municipal financial products, the issuance of municipal securities, or of an investment adviser to provide investment advisory services to or on behalf of a municipal entity . . . .” Pub. L. No. 111-203, §975(e), 124 Stat. 1922-23, adding paragraph (e)(9) to 15 U.S.C. §78o-4.
 Pub. L. No. 111-203, §975(e), 124 Stat. 1921-22, adding paragraph (e)(4) to 15 U.S.C. §78o-4.
 S.E.C. Release No. 34-63576 (Dec. 20, 2010) at 41.
 S.E.C. Release No. 34-63576 (Dec. 20, 2010) at 32.
 Pub. L. No. 111-203, § 975(c)(2), 124 Stat. 1920, amending 15 U.S.C. § 78o-4(c)(1).
 Pub. L. No. 111-203, § 929M, 124 Stat. 1861, amending 15 U.S.C. § 77o.
 Pub. L. No. 111-203, § 929P, 124 Stat. 1862 and 1863, amending 15 U.S.C. § 77h-1.
 Hollinger v. Titan Capital Corp., 914 F.2d 1564 (9th Cir. 1990) (en banc), at 1569, cert. denied, 499 U.S. 976 (1991).
 In the Matter of State of New Jersey, Securities Act Release No. 9135, August 18, 2010.
 Id. at para 51.
 Id. at para 50.
 Id. at paras 44 and 45.
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Scott Manning Kortmeyer
Fredric A. Weber