Over the past two years, the Division of Enforcement of the U.S. Securities and Exchange Commission (“SEC”) has focused its efforts on underwriters and issuers of municipal securities. Their efforts have been driven by the Municipalities Continuing Disclosure Cooperation Initiative (“MCDC Initiative”) that began in March 2014. The MCDC Initiative seeks to offer underwriters and issuers an opportunity to “self-report” potential violations of Rule 15c2-12 under the Securities Exchange Act of 1934 (“Exchange Act”). Such violations include materially inaccurate statements that may have been made by the issuer related to compliance with the continuing disclosure obligations.
The MCDC Initiative has resulted in the following:
- In 2014, the SEC charged a total of 72 underwriters under the voluntary self-reporting program.
- In September 2015, an additional 22 were charged.
- By February 2016, another 14 firms settled with the SEC and paid civil penalties up to a maximum of $500,000.
The recent cases underscore the need for underwriters to confirm that due diligence reviews are conducted on the information contained in the offering documents as required per Rule 15c2-12.
In March 2012, the SEC published an alert, Strengthening Practices for the Underwriting of Municipal Securities, which addresses the Rule 15c2-12 obligations on issuers and underwriters. The guidance provided by the SEC includes the following:
- Written Procedures: The starting point is to ensure that firms prepare detailed written procedures that address the due diligence requirements under Rule 15c2-12. These procedures must describe how personnel and supervisors determine whether the diligence performed was sufficient to address the requirements of the rule.
- Commitment Committees: Many firms engage commitment committees, which review and approve the municipal securities underwritings in which the firm will participate. As part of the commitment committee meetings, materials are prepared regarding the deals. These materials include due diligence information, and often will include a memorandum that describes the diligence that was completed and the continuing disclosures that the issuers should have made.
- Checklists: Many firms use a checklist to assist their personnel in completing the due diligence steps that need to be taken. These checklists may include additional narrative information, and may also be signed-off by a supervisor.
- Memoranda: Some firms prepare a memorandum that describes the due diligence that has been performed. This would also include any identified deficiencies.
The above practices are not exhaustive, but establish a baseline of activities that should help firms comply with Rule 15c2-12. A major component of the SEC’s alert highlights the need for documentation of the due diligence process, such as checklists and memos. The deal teams of underwriters generally conduct due diligence, but do not document their efforts. Firms need to formalize a documentary process to evidence the due diligence activities that are completed and to demonstrate compliance with Rule 15c2-12.
ACA can provide assistance in performing such due diligence reviews, and can help ensure these reviews result in documentary evidence of firms’ due diligence efforts.