By Matt Ehling and Mike Kaszuba
The Securities and Exchange Commission (SEC) cited the State of Minnesota last year for making “material misstatements” in the sale of municipal bonds, according to records obtained by Public Record Media (PRM).
A 2016 order issued by the SEC, a federal regulatory agency that monitors the country’s financial industry, required the state to institute a training program to ensure compliance with federal securities laws within 180 days and to update delinquent disclosures to investors, among other measures. Minnesota was one of more than seventy public entities that were cited by the SEC – but just one of two states.
“Continuing disclosures” are required by SEC rules in order to ensure that investors have accurate information about the financial condition of the bonds issued by cities, counties and states. Each year, government entities across the nation issue billions of dollars in bonds which are purchased by institutions, mutual funds, and individuals. The SEC action was part of a broader enforcement campaign to address “widespread violations” of securities laws across the nation.
SEC “cease-and-desist” order
In August of last year, the SEC issued a “cease-and-desist” order against the State of Minnesota under the Securities Act of 1933 and imposed “remedial sanctions.” The order, obtained by Saint Paul-based non-profit PRM, noted that the state made “material misstatements” in the sale of municipal securities when it reported that it had complied with continuing disclosure requirements “related to the sale of municipal bonds.”
According to the SEC order, the State of Minnesota made “materially false and/or misleading” statements in both 2011 and 2013 about being in compliance with its bond disclosure requirements. The order also indicated that the state was noncompliant prior to these times, pointing out that the “Commissioner of Management and Budget” and, before a name change, the “Commissioner of Finance” both failed to disclose required information. Minnesota’s Department of Finance changed its name to “Minnesota Management and Budget” in 2009 during the administration of former Gov. Tim Pawlenty.
The SEC order detailed several instances of non-compliance by the state. For example, the order noted that the State of Minnesota had claimed in a 2013 competitive offering that “[i]n the previous five years the Commissioner of Management and Budget has not failed to comply in any material respect” with continuing disclosure requirements relating to state bonds. “This was false and/or misleading because [the state] failed to file [a] 2008 audited financial report for certain outstanding bonds,” the SEC wrote. The SEC also noted that the state filed 2010 financial reports late, and also failed to report the late filing as required.
In a written statement to PRM, a Minnesota Management and Budget spokesman said that the SEC action needed to be put in perspective, and that state officials “agreed to neither admit nor deny findings.”
MMB Commissioner Myron Frans added in a statement that “the SEC’s initiative highlighted the importance of providing accurate and timely information to the state’s investors” and “it provided MMB with the opportunity to review and improve” the state’s continuing disclosure process. “I am glad to report that MMB had updated all required disclosures by August of 2015, almost one year in advance of the SEC’s 2016 order,” Frans wrote. “And I can report that, as part of the states’s written continuing disclosure policies, we have established a training requirement to review the state’s obligations under federal securities laws on an annual basis.”
Federal law generally prohibits dealers of municipal bonds from purchasing or selling them unless they have determined that the bond issuer has executed continuing disclosure agreements to provide annual financial information and “timely” notices about events that might impact the financial condition of the bonds. These events can range from changes in bond ratings, to events that impact budgets, to the bankruptcy of the bond issuer itself. Continuing disclosure requirements were instituted by the SEC in 1995 as a way to provide financial transparency to investors buying bonds in the municipal market. Beginning in 2009, the SEC designated the Municipal Securities Rulemaking Board (MSRB) as the recipient for continuing disclosure information. The MSRB makes the information publicly available through its EMMA website for the benefit of investors.
Self-reporting by the state under SEC program
The 2016 order notes that the State of Minnesota self-reported its violations to the SEC under the agency’s “Municipalities Continuing Disclosure Cooperation” initiative (MCDC). According to the SEC web site, the MCDC initiative was put in place to “address potentially widespread violations of the federal securities laws” relating to faulty representations in bond offering documents. The web site highlights the SEC’s concern that “many issuers have not been complying with their obligation to file continuing disclosure documents.”
The SEC’s MCDC initiative permitted noncompliant government entities to self-report during a nine-month period of 2014 in exchange for the SEC recommending favorable settlement terms – terms that included no monetary penalties for bond issuers.
In May of 2016, the State of Minnesota submitted an “offer of settlement” to the SEC relating to its disclosure violations. Both the state’s offer and the SEC’s 2016 order contain identical language regarding the terms required of the state. Minnesota’s settlement terms obligated the state to create a training program related to federal securities laws, to establish a compliance officer, to update delinquent filings, and to cooperate with future investigations into false disclosure statements. These terms matched the standard settlement terms offered under the MCDC program.
“I think it is very important for states to comply with all of the rules in connection with the issuance of municipal bonds,” said Richard Painter, a University of Minnesota corporate law professor who also specializes in reform efforts to deter securities fraud. “Remember, these are bonds that do not have to be registered with the Securities and Exchange Commission. Congress exempted them from registration and that provides, unfortunately, an enormous loophole that can be used for the issuance of municipal bonds that are a lot riskier than the issuer informs the investors,” he added.
Painter, however, said the situation needed to be viewed in context. “Minnesota,” he noted, is “a state with a good credit history,” unlike some other state and local governments. “Illinois is a disaster right now,” said Painter.
Minnesota’s continuing disclosure procedures
In August of 2017, PRM obtained a document from Minnesota Management and Budget that outlined the state’s “continuing disclosure procedures.” The document was originally dated November 22, 2014 – a date that fell within the nine-month period during which the SEC allowed delinquent bond issuers to self-report. It also lists a revision date of July 26, 2016 – one month before the SEC’s cease-and-desist order.
The state’s continuing disclosure policy establishes a compliance officer for the issuance of state bonds, and notes that they will be responsible for ensuring that all required information will be properly reported to the MSRB. For instance, a recent front-page supplement to the state’s 2016 series bonds includes notice of the 2016 cease-and-desist action.
Problems in the municipal bond market
The SEC’s 2016 order for Minnesota was part of a broader resolution stemming from the agency’s MCDC Initiative. On the same date that the SEC instituted cease-and-desist proceedings against Minnesota, similar orders were entered against seventy other government entities, including municipalities (ranging from Alameda, California to Gary, Indiana), counties, public universities, and state agencies.
Beyond Minnesota, the only other state included in the resolution effort was Hawaii.
In an SEC press release, Enforcement Division Director Andrew Ceresney stated that “the diversity among” the government entities “demonstrates that continuing disclosure failures were a widespread and pervasive problem in the municipal bond market.”
The SEC’s stepped-up enforcement efforts in 2014 came in the aftermath of a 2012 agency report that highlighted problems with municipal securities disclosures. The 2012 report noted that the SEC had, over the course of time, pursued numerous enforcement actions against municipal issuers for omissions or misleading statements in bond offering materials. Past actions had involved the city of Miami, Florida, which failed to disclose cash flow shortages, and the city of San Diego, California, which failed to disclose information about the city’s pension problems in its 2002-2003 bond offerings.
The 2012 report also highlighted the importance of regulating municipal securities. “The municipal securities market is critical to building and maintaining the infrastructure of our nation,” the report noted. “As of December 31, 2011, there were over one million different bonds outstanding, in the total aggregate principal amount of more than $3.7 trillion.”
The report added: “Despite its size and importance, the municipal securities market has not been subject to the same level of regulation as other sectors of the U.S. capital markets.”
The SEC’s MCDC initiative sought to resolve issues with a broad range of noncompliant bond issuers, and began in 2014 with proceedings instituted against a California school district that failed to include required disclosures in several bond offerings between 2008 and 2010. An SEC press release on the initiative noted that “because the issuers also voluntarily agreed to take steps to prevent future violations, both they and their investors benefitted.”