SEC Settles Anti-Fraud Violations With Municipal Bond Issuer

Earlier this month the SEC, in the first case of its kind against a municipality, ordered the City of Harrisburg, Pennsylvania to cease and desist from violating the anti-fraud provisions of the federal securities laws. While the circumstances surrounding this order are somewhat unique to the City of Harrisburg’s situation, in today’s economic climate, it is not only possible, but likely that such a scenario, or one similar to that of Harrisburg, could recur.

The City of Harrisburg, as is the case for many municipalities throughout the country, has been facing a debt crisis for a number of years leaving it in a very poor financial condition. During the years 2008 and 2009, when the City’s financial condition first took a turn for the worse, the City failed to comply with its requirements to provide certain ongoing financial information for the benefit of investors holding bonds issued by the City.

As a result of the City’s failure to file, the City created what the SEC has described as an “information vacuum.” According to George S. Canellos, co-director of the SEC’s Division of Enforcement, “municipal investors had to rely on other public statements misrepresenting City finances.” For a City needing to put on a good front for the public during an otherwise tough time, this “information vacuum” put the City in a bind.

According to the SEC’s order, it found that at a time of increased interest in the City’s finances due to its deteriorating financial condition, investors were more likely to pursue relevant information relating to their investments from other places, such as statements of public officials and the City’s own website.

One such public statement was made when then City posted on its website its 2009 budget which, as adopted, did not include funds for debt guarantee payments, “raising questions as to whether it would fulfill its obligations under those guarantees.” That budget also misrepresented the City’s credit rating.

To add to matters, in April of 2009, the City’s mayor gave a State of the City address in which he referred to these debt payments as an “additional challenge” and an “issue that can be resolved.” According to the SEC, these statements were misleading because they omitted to state the amount of the debt that the City would likely have to repay from its general fund and the impact that repayment obligation was already having on Harrisburg’s finances.

The SEC conducted its investigation into the matter and ultimately entered into a settlement agreement in which the City neither admitted nor denied wrongdoing but agreed to cease and desist from any further violations. In accepting the settlement, the SEC indicated that it took into consideration the City’s cooperation during the investigation and the steps that it has taken to improve its disclosure process.

While this may be the first such case of its kind against a municipality, this case certainly puts all other municipalities on notice that statements made by public officials, whether oral or in writing, can expose the municipality to liability under the anti-fraud provisions of the federal securities laws. This is particularly so where a municipality may have gaps or lapses in meeting its compliance obligations relating to its municipal bond obligations, causing statements made by public officials, even politically guarded statements such as those made by the City of Harrisburg’s mayor, to be significantly more material to a potential investor.

Additionally, this case stresses the importance of cooperation during the course of an SEC investigation as well as the implementation of a compliance plan that will effectively avoid such disclosure gaps. After all, had such a plan been in place to apply greater oversight of those required filings, these statements made on the City’s website or by the City’s mayor at his State of the City address would not have received the scrutiny that they did in this case. Furthermore, such a plan would have demonstrated to the SEC the City’s ongoing efforts to remain compliant with its disclosure obligations and would have effectively mitigated the damages to its reputation caused by this very public SEC settlement.