Public agencies of all sizes that issue bonds through a public offering are facing increased scrutiny and enforcement action by the U.S. Securities and Exchange Commission, which is charged with enforcing federal securities laws. The SEC is particularly interested in the antifraud provisions relating to the disclosure of information by a local agency to the investors who purchase its bonds.
Most local agencies are rightly focused on performing their core missions of serving their local communities and may view federal enforcement as an unwelcomed imposition or a distraction. However, every local agency can benefit by developing a disclosure policy that will guide and facilitate its compliance with applicable securities laws.
Disclosure Requirements and Recent SEC Enforcement Actions
When a local agency borrows money by issuing bonds through a public offering, it takes on certain obligations to disclose material information about the agency to help those who purchase its bonds make an informed investment decision. The federal antifraud laws apply to this disclosure of information.
In particular, Section 10(b) of the Securities Exchange Act of 1934 and the related Rule 10b5 provide that it is "unlawful for any person … to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading … in connection with the purchase or sale of any security."
These provisions apply to primary offering documents when a bond is first issued (such as an official statement or offering memorandum), as well as to other disclosures of information that issuers make after the bonds are issued, including those required by SEC Rule 15c2-12.
In recent years, the SEC has stepped up its enforcement of these antifraud laws in the municipal bond market by bringing enforcement actions against many issuers for failures to disclose material information in connection with the sale of bonds.
Several of these enforcement actions have resulted in fines imposed personally on local government managers and elected officials, sometimes even if that person didn't sign any bond documents. For example, in an ongoing enforcement case, the SEC is seeking a record $450,000 civil penalty against the former finance director of a local government for repeated violations of the federal antifraud laws. In each case, the SEC has required the local agency to adopt a disclosure policy as part of the settlement to prevent future lapses in disclosure.
SEC officials have also been vocal in encouraging all municipal bond issuers to adopt a suitable disclosure policy. A recent survey conducted by the State Treasurer's office of a large state revealed that only 50 percent of the counties and less than 25 percent of the school districts in that state had adopted any debt-related policies. Hence the need for continuing effort in this area.
Contents of a Disclosure Policy
A disclosure policy is a document that outlines a local agency's policies and procedures with respect to disclosure of material infor—rather, a policy should be drafted to fit a particular local agency. Disclosure policies generally address the following issues:
What types of communications are covered, including primary bond offering documents, continuing disclosure filings, audited financial statements, websites and other statements expected to reach the financial markets;
Who is responsible for coordinating the production and review of these disclosures, including the roles of a disclosure coordinator, disclosure working group and the agency's governing body;
What procedures will be put in place to require communication between departments and to break down internal information silos;
Periodic staff and management training;
Procedures to ensure timely and accurate continuing disclosure filings; and
Documenting compliance with the policy.
Benefits of a Disclosure Policy
If implemented and followed, a written disclosure policy can benefit a local agency by:
Increasing the quality of the information disclosed and the consistency of information between the different disclosure documents (e.g., official statement, audited financial statement and website);
Providing clear guidelines for the production of disclosure documents to enable staff to work efficiently;
Providing for regular training and for succession when staff changes;
Increasing the quality of communication within the organization and with the market; and
Providing legal protections for the issuer by showing that it wasn't negligent in drafting its disclosure documents.
Developing a Disclosure Policy
Going through the process of drafting a disclosure policy is valuable in and of itself. In several enforcement actions, the SEC noted that disclosure failures occurred because the local agency was highly departmentalized with little communication between the different divisions.
Information that needed to be disclosed to investors was confined to a "silo" within the organization and was not available to those drafting and disseminating the disclosure documents. The exercise of drafting a disclosure policy will require staff and management from each department that has critical information about the organization to come together and discuss who has the information and how that information can be communicated to those drafting the disclosure documents in a reliable, efficient and timely manner.
The drafting process will thus begin to improve communication and cooperation within the organization. When a local agency decides to draft or update a disclosure policy, it is helpful for staff to consult with its financial advisors and competent disclosure counsel to review its existing procedures for the production of disclosure documents, formalize those procedures into a written policy, and enhance those areas that need strengthening.
A policy drafted in this fashion will be more organic to the organization and will be easier to implement and follow. Several resources are available online, particularly the "Crafting Disclosure Policies" guide from the website of the National Association of Bond Lawyers (NABL). Also, working with competent disclosure counsel can assist a local agency to draft a disclosure policy that will be best suited to its circumstances and will ensure that it sets in place a reasonable process and structure for complying with the federal antifraud laws.