Introduction
This Hawkins Advisory provides an update on selected matters of interest to the municipal securities market and its participants. In particular, this Advisory reviews (i) the Municipal Disclosure Conference (the “Conference”) recently hosted by the Securities and Exchange Commission (the “SEC”); (ii) the status of certain rulemaking initiatives by the SEC and the Municipal Securities Rulemaking Board (the “MSRB”); (iii) a recent Supreme Court decision relating to matters involving federal securities laws; and (iv) the publication of a paper on risk factors by the National Association of Bond Lawyers (“NABL”).
SEC Municipal Disclosure Conference
On May 10, 2023, the SEC held the Conference, which focused on current municipal securities disclosure practices and potential opportunities for regulatory and industry improvement. Four panel sessions were held covering (i) voluntary disclosure and best practices; (ii) the Financial Data Transparency Act of 2022 (the “FDTA”)[i] (iii) risk factors (including cybersecurity, environmental, social, and governance (“ESG”) disclosure, and federal debt ceiling matters, among others); and (iv) current disclosure topics (which primarily focused on updates on municipal advisor activities and recent developments in SEC enforcement actions regarding limited offerings). The FDTA and limited offering panel discussions from the Conference are considered in more detail below.
FDTA Implementation. At the Conference, the FDTA panel provided the most spirited discussion of the day. Moderated by Mary Simpkins, Senior Special Counsel of the Office of Municipal Securities (“OMS”), the panel discussed the status of the FDTA – the rulemaking initiative requiring federal financial regulatory agencies (including the SEC) to establish new data standards for certain financial data reported to such agencies. The SEC is charged with implementing these data standards with respect to information submitted to the MSRB, including information filed by municipal issuers and obligated persons through the MSRB’s Electronic Municipal Market Access website (“EMMA”). For a detailed discussion of the FDTA, see our Hawkins Advisory, dated January 25, 2023 (the “January 2023 Hawkins Advisory”), available at https://www.hawkins.com/about/publications/2023-01-25-update-on-the-municipal-securities-market.
The FDTA panel discussion focused upon several key rulemaking concerns for municipal securities market participants:
(i) Will the scope of information to be collected or made publicly available expand under the FDTA?
There is no expectation that the FDTA will broaden the scope of information municipal securities market participants report to EMMA. The FDTA expressly stated that it may not be construed to affect the operation of existing limits upon the authority of the SEC and MSRB to require municipal issuer or obligor filings prior to the sale of municipal securities or of the MSRB to require a municipal issuer or obligors to furnish information. In addition, it is not currently expected that the FDTA will, by itself, broaden the scope of other collected municipal market information that the MSRB and SEC make publicly available.
(ii) What input will market participants have in the initial establishment of the new data standards?
The FDTA requires the SEC to consult market participants in the initial establishment of the new data standards. Each rule proposal under the FDTA will include an opportunity for public comment and market participants should follow these developments closely as rule proposals take form.
During the FDTA panel, market participants were encouraged to engage with the SEC as regulators begin to formulate FDTA-related rules and regulations. As suggested in the January 2023 Hawkins Advisory, input from market participants submitted before rule proposals are released, may guide the direction of regulations towards reducing the burden of implementing the data standards.
(iii) How will the SEC scale the data standards to reduce any unjustified burden on smaller regulated entities and minimize disruptive changes to the persons affected by the rules?
This topic generated the liveliest discussion during the FDTA panel, as conformance to uniform data standards was generally viewed by participants as likely to be costly and burdensome to issuers.
All data standards utilize taxonomies (or defined tagging and organization rules), validation rules, data quality assessments, and other tools for conducting data analyses. It is widely expected that the starting point for the development of the data standards under the FDTA will be the eXtensible Business Reporting Language, or “XBRL,” system applicable to submissions by registered companies and related regulated parties through the SEC’s Electronic Data Gathering, Analysis and Retrieval system (“EDGAR”). Under XBRL, there are standardized pieces of data that are both human and machine readable, which may be analyzed without extensive and burdensome manual processing. This is meant to promote easier navigation within documents, comparison of current and prior filings by a particular issuer or related party, or cross-market comparison of filings by different issuers or related parties.
No matter what the FDTA data standards ultimately look like, the concern is that implementation will impose financial and staffing burdens that may be difficult for many smaller municipal issuers to meet. The panelists referred to experience to date with non-federal structured data standards that have been adopted or considered in certain jurisdictions throughout the country to get a glimpse of what might be in store for municipal securities market participants. In particular, the panelists explored the data standards adopted by the State of Florida and the demonstration, trial program implemented by the City of Flint, Michigan, both of which have objectives similar to the FDTA.
The Florida program has established an interactive repository of financial statement information and standardized taxonomies for state, county, municipal, and special district financial filings. Local governments currently have the option to submit documents in XBRL format or to provide their financial data in the same manner they have utilized historically, in which case the data is now tagged and converted into XBRL format by state officials.
One panelist stated that the Florida program has been costly to implement and sluggish to get off the ground. Also, the option of having financial documents converted to the prescribed data standard by state officials seems to be one of highlights of the Florida program. If such a feature were to be included as a part of the nationwide program under the FDTA, it would alleviate some of the concerns about creating an unjustified burden or market disruptions. However, panelists noted that including a similar feature as a part of a nationwide program may not be feasible.
Two panelists familiar with the data standards and the implementation of the Florida and Flint programs expressed concerns with the cost, burden, need, and pragmatism of establishing a nationwide set of data standards for the diverse and multi-layered municipal securities market.
(iv) When can market participants expect rulemaking under the FDTA to occur and become effective?
There is still likely to be a significant amount of time before any regulations under the FDTA become effective and market participants can expect a robust comment period for any proposed FDTA-related rules and regulations. One panelist noted that the expectation is that FDTA implementation will be a long, phased-in process.
On timing specifics, certain federal financial regulatory agencies (including the SEC) are required to propose joint data standards by June 23, 2024, and to adopt these in final form by December 23, 2024. Once these efforts are completed, the SEC is expected to issue rules adopting the applicable data standards for the municipal securities market and information submitted to the MSRB within two years of their actual promulgation. It remains possible, as noted in the January 2023 Hawkins Advisory, that such rules may provide multiple effective dates, if the SEC determines this to be appropriate.
Note on Legal Entity Identifiers (“LEIs”).[ii] While not covered in any detail at the Conference, the FDTA also raises concerns about a potential requirement that municipal issuers and obligors may be required to use LEIs when submitting financial disclosures under the new data standards. Presently, the municipal securities market uses CUSIP numbers to link disclosures filed on EMMA with associated bonds and the introduction of LEIs under the FDTA would be an additional adjustment for market participants. Rulemaking around LEIs is another key area to monitor closely as rule proposals are released.
Limited Offerings. On March 7, 2023, the SEC announced a settlement with Keybanc Capital Market Inc. (“Keybanc”)[iii] in connection with offerings of municipal securities utilizing the limited offering exemption provided by Rule 15c2-12 (the “Rule” or “Rule 15c2-12”).[iv] This action represents the continuation of the SEC’s recent focus on underwriters who fail to meet the legal requirements of the “Limited Offering Exemption”[v] under the Rule. Discussions of earlier SEC enforcement activity in this area were included in the Hawkins Advisory, dated September 23, 2022 (the “September 2022 Hawkins Advisory”), available at https://www.hawkins.com/about/publications/2022-09-23-sec-actions-rule-15c2-12-limited-offering-exemption
and in the January 2023 Hawkins Advisory. The facts of the Keybanc matter are similar to those described in the initial enforcement actions. Considered together with the earlier cases, it appears that establishing the elements of the Limited Offering Exemption has consistently been overlooked or ignored by underwriters.
The Keybanc matter and the other limited offering enforcement actions were the focus of the final session at the Conference, which was moderated by Dave Sanchez, the Director of OMS. The session examined various measures taken by municipal securities market participants in response to SEC enforcement activity.
One of the panelists highlighted that in most of the subject financings, the underwriters had not taken any steps to establish the elements of the Limited Offering Exemption. It was not merely inadequate policies and procedures or poorly drafted investor letters. Rather, there were indications that no measures were taken at all.
As noted in each of the September 2022 and January 2023 Hawkins Advisories, it would be prudent for underwriters to: (i) review their written supervisory procedures (or to adopt new ones); (ii) evaluate their compliance with existing procedures; and (iii) consider the adoption of clear guidelines for requiring investor letters, and for internal approval as to their form, to assure that the elements of the Limited Offering Exemption are met.
At the Conference, the panelists noted that the underwriting community has, in fact, taken notice of these enforcement actions and started to reinforce the steps being taken to establish a reasonable basis for establishing the elements of the Limited Offering Exemption, in both their internal policies and procedures and requiring investor letters.
The panelists indicated that municipal issuers are also focusing on memorializing the elements of the Limited Offering Exemption in investor letters and requiring them if not already part of the underwriter’s transaction documents. Even though the Limited Offering Exemption and Rule 15c2-12 apply to the underwriters (and underwriters bear the risk of any regulatory actions pertaining to any failures related thereto), issuers are being proactive to ensure that their privately placed bonds are not caught up in any SEC enforcement actions.
Note on Recent Developments in Limited Offerings. The SEC continues to be active in scrutinizing limited offerings. On July 18, 2023, the SEC announced charges against a seventh underwriting firm for violating the Limited Offering Exemption. Fifth Third Securities, Inc. (“Fifth Third”) agreed to settle charges that it failed to comply with the Limited Offering Exemption and Rule 15c2-12 and the settlement order describes a familiar fact pattern.[vi]6
The SEC indicated that, while serving as sole underwriter for 79 limited offerings, Fifth Third (i) did not have a reasonable belief that the broker-dealers and investment advisers were purchasing the securities for investment purposes; (ii) did not inquire, or otherwise determine, if the broker-dealers and investment advisers were purchasing the securities for more than one account or for distribution; and (iii) failed to ascertain for whom the broker-dealers and investment advisers were purchasing the securities, preventing them from forming a reasonable belief that such buyers were purchasing the securities for investors who possessed the necessary knowledge and experience to evaluate the investments.
As with the other limited offering enforcement actions, the settlement order also described MSRB Rule G-27 violations by Fifth Third for lack of adequate supervisory procedures reasonably designed to ensure compliance with the federal securities laws.
As a result of the settlement of these matters, Fifth Third is subject to a cease and desist order, was censured by the SEC, and must pay disgorgement and prejudgment interest of approximately $500,000, as well as a civil penalty of $200,000.
Update on SEC and MSRB Rulemaking
The January 2023 Hawkins Advisory described rulemaking efforts from the SEC and potential rule amendments and interpretive releases from the MSRB (namely, rulemaking regarding cybersecurity, climate change, and ESG for the SEC and possible amendments to Rules G-3 (amendments recently filed with the SEC), G-14, and G-32 for the MSRB). While we continue to monitor such initiatives, no final regulatory actions on these topics have been released at this time.
MSRB Rules G-12 and G-15. On May 25, 2023, the SEC approved amendments to MSRB Rules G-12 and G-15,[vii] which define “regular-way settlement” for municipal securities transactions as occurring one business day after the trade date (“T+1”). Such amendments align with recently amended settlement procedures for equities and corporate bonds under Exchange Act Rule 15c6-1. According to the MSRB Notice, “shortening the settlement process can reduce operational risks that can be present between trade and settlement date, which can promote investor protection and help reduce the risk of counterparty default and the capital required to mitigate this risk.”
As amended, Rules G-12 and G-15 provide that “settlement dates” are as follows: (A) for “cash” transactions, the trade date; (B) for “regular way” transactions, the first business day following the trade date; (C) for “when, as and if issued” transactions, a date agreed upon by both parties, which date: (1) with respect to transactions required to be compared in an automated comparison system[viii] …, shall not be earlier than two business days after notification of initial settlement date for the issue is provided to the registered clearing agency by the managing underwriter for the issue…; and (2) with respect to transactions not eligible for automated comparison, shall not be earlier than the first business day following the date that the confirmation indicating the final settlement date is sent; and (D) for all other transactions, a date agreed upon by both parties, provided, however, that a broker, dealer or municipal securities dealer shall not effect or enter into a transaction for the purchase or sale of a municipal security (other than a “when, as and if issued” transaction) that provides for payment of funds and delivery of securities later than the first business day after the date of the transaction unless expressly agreed to by the parties, at the time of the transaction (e.g., for variable rate demand obligations, there may be a settlement date expressly agreed to by the parties that may occur later than regular-way settlement to coincide with the reset date (T+5, T+3, etc.)).
The compliance date for the amendments to Rules G-12 and G-15 is May 28, 2024.
Update from the Supreme Court
The federal Securities Act of 1933 (the “1933 Act”) creates a registration regimen that is applicable to corporate issuers of non-exempt securities, which generally requires such issuers to file a registration statement with the SEC prior to commencing a public offering of newly issued securities and limits the statements that the issuer may make to the market in connection with such an offering.
Section 11 of the 1933 Act provides a remedy to purchasers of registered securities against a broad range of persons who prepared or are responsible for a registration statement. A purchaser must show that the registration statement contained a material misstatement or material omission. A defendant can avoid liability by showing that the purchaser was aware of the misstatement or omission at the time of acquisition or that the defendant, after exercise of diligence, reasonably believed the statement to be true and complete.
Section 12 of the 1933 Act provides a separate remedy to purchasers of securities that are required to be subject to registration, but are offered or sold without an effective registration statement (or by means of a published or oral communication outside of the registration process) that includes a material misstatement or material omission. A defendant can avoid liability by showing that the defendant did not know and, in the exercise of reasonable care, could not have known of the misstatement or omission. The misstatement or omission clause of this Section excludes offers or sales of securities to which certain general 1933 Act registration exemptions apply, including most municipal securities.
Liability under Section 11 or 12 does not require a plaintiff to establish fraudulent intent or recklessness, as is required under Section 10(b) of the Securities Exchange Act of 1934 (the “1934 Act”) and Rule 10b-5 thereunder.
Not all securities issued by registrants are required to be subject to a registration statement. The facts of a recent Supreme Court decision contain an example of such unregistered securities. In Slack Technologies, LLC v. Pirani (598 U.S. ___ (2023), Section 11 liability and the “traceability” of how one acquires securities was at issue.
In June 2019, Slack Technologies, LLC (“Slack”) went public via a direct listing of its shares on the New York Stock Exchange. The outstanding shares represented both those registered pursuant to Slack’s registration statement and those, issued to early investors and employees, that were not subject to registration. There were 118 million registered shares and 165 million unregistered shares. All shares were available for trading at the same time. One investor purchased 30,000 shares on the initial listing date and another 220,000 shares over the next several months. In late 2019, when the stock price dropped, the investor filed a class-action lawsuit against Slack and claimed there were materially misleading statements or omissions in Slack’s registration statement. Slack moved to dismiss the complaint because the plaintiff was unable to establish that he had purchased registered shares, as opposed to unregistered shares.
The Supreme Court held that Section 11 “requires a plaintiff to plead and prove that he purchased shares traceable to the allegedly defective registration statement.” The Supreme Court unanimously reversed a Ninth Circuit Court of Appeals decision that would have permitted a plaintiff to recover under Section 11 and 12 of the 1933 Act with respect to shares that it purchased without alleging that the shares were originally issued pursuant to the allegedly deficient registration statement. The Supreme Court reversed as to the Section 11 claim on the basis of its textual analysis of that provision. However, it vacated the Ninth Circuit’s judgment as to both the Section 11 and the Section 12 claims and remanded both for reconsideration in light of its Section 11 analysis.
The SEC’s municipal securities enforcement actions in recent years have increasingly reflected the Staff’s developing view that issuer statements made outside of the formal municipal securities offering and secondary disclosure processes may result in 1934 Act Section 10(b) liability under theories that hold issuers responsible for disclosure practices that take into account the “total mix” of information that may be reasonably expected to reach investors, even though the statutory text, by its terms, only prohibits the use of a “manipulative or deceptive device or contrivance” that is “in connection with the purchase or sale of any security.” Related to this point, OMS published a Staff Legal Bulletin (the “Bulletin”) entitled “Application of Antifraud Provisions to Public Statements of Issuers and Obligated Persons of Municipal Securities in the Secondary Market” on February 7, 2020. The Bulletin summarizes certain previous SEC statements regarding the application of the antifraud provisions of the federal securities laws to, among other matters: information on issuer websites; hyperlinks; public reports containing financial information or operating data; and public statements made by public officials. The Bulletin is further described in a Hawkins Advisory, dated February 13, 2020, available at https://www.hawkins.com/about/publications/2020-02-13-sec-staff-guidance-regarding-secondary-market-disclosure.
While the Slack Technologies opinion’s restrictive reading of the scope of 1933 Act Section 11 liability may reasonably raise questions as to the view that the Court would take of the scope of other federal securities law remedies, several statements included in the opinion as dicta caution against premature conclusions. In particular, the opinion both begins and ends its substantive analysis by contrasting the scope and standard of proof applicable to actions under the 1933 Act and the 1934 Act and, with respect to 1933 Act Sections 11 and 12, ends with a footnote cautioning that the two provisions “contain distinct language that warrants careful consideration.”
NABL’s Risk Factors Project
On July 11, 2023, NABL published a paper entitled “Disclosing Risk Factors in Municipal Securities Offerings” (the “Risk Factors Project”), which “explores legal and practical considerations in (a) identifying and disclosing risk factors in primary offerings of municipal securities and, in some circumstances, related secondary market disclosure and (b) developing policies and procedures for disclosing risk factors.” The Risk Factors Project is broken down into three key sections examining the legal framework of risk factor disclosure, procedures for identifying, evaluating, and disclosing risk factors, and examples of and considerations for common risk factors (the latter of which is included in chart format as part of a separate Appendix).
The Risk Factors Project has been in development for many years and the final product has turned out to be comprehensive and quite useful. It is available for download by NABL members at its website.
[i] The FDTA was signed into law on December 23, 2022; see H. R. 7776, Title LVIII – Financial Data Transparency, available at https://www.congress.gov/117/bills/hr7776/BILLS-117hr7776enr.pdf.
[ii] See https://www.gleif.org/en/about-lei/introducing-the-legal-entity-identifier-lei. LEIs are unique global identifiers for legal entities participating in financial transactions and are used in regulatory reporting to financial regulators, among other things. LEIs are formatted as a 20-character, alpha-numeric code.
[iii] In the Matter of Keybanc Capital Market Inc., SEC Rel. No. 34-97064 (Mar. 7, 2023); https://www.sec.gov/enforce/34-97064-s.
[iv] The full text of Rule 15c2-12 can be found at 17 C.F.R. §§ 240.15c2-12; https://www.ecfr.gov/current/title-17/chapter-II/part-240/subpart-A/subject-group-ECFR541343e5c1fa459/section-240.15c2-12.
[v] Rule 15c2-12(d)(1)(i) provides that the primary disclosure and continuing disclosure elements of the Rule will not apply to offerings of municipal securities issued in denominations of $100,000 or more that are sold to no more than thirty-five (35) persons if the underwriters have a reasonable belief that each purchaser: (A) has such knowledge and experience in financial and business matters that it is capable of evaluating the merits and risks of the prospective investment; and (B) is not purchasing for more than one account or with a view to distributing the securities.
[vi] In the Matter of Fifth Third Securities, Inc., SEC Rel. No. 34-97937 (July 18, 2023); https://www.sec.gov/enforce/34-97937-s.
[vii] See MSRB Notice 2023-06 (May 30, 2023); MSRB Adopts Amendments to Rules G-12 and G-15, Shortening Regular-Way Settlement for Municipal Securities Transactions to T+1 (the “MSRB Notice”).
[viii] Such term refers to transactions where each party to the transaction is required to submit certain information to a registered clearing agency in order for automated comparison of the transaction to occur.
