SEC Action re Fiduciary Duties Relating to Municipal Bonds

A recent action by the Securities and Exchange Commission (SEC) against the city of Harvey, IL, a poor city of 30,000 just south of Chicago, deals with a different sort of fiduciary duty than the usual government ethics case. In a complaint dated June 24, 2014 (attached; see below), the SEC alleges that the city's comptroller acted as financial adviser in three bond issues for a hotel development, diverted some of the funds to himself, and also diverted funds to the city's general fund. The comptroller is acting as financial adviser for a 2014 bond offering, which the SEC is trying to prevent through a court restraining order.

The action is based on the city's fiduciary duty to disclose to investors how bond proceeds will be used, as well as the risks associated with investing in the city's bonds (but the term "fiduciary duty" is not actually used in the complaint). This is part of the SEC's promised crackdown on disclosure failures related to municipal bonds. Alternatively, the complaint alleges fraud and the making of false and misleading statements.

According to a document written by the comptroller himself, Harvey is in a financial crisis and will soon be unable to make payments to bondholders. This situation was not apparently disclosed to investors.

This is a classic example of how an official's self-dealing can cause damage far beyond his own "ill-gotten gains," as the SEC calls them. Self-dealing can lead to transactions that are damaging to the city government, to its residents, and to those involved in the transactions.

However, although this action was brought against both the city and the comptroller, according to a recent Reuters article the SEC has been settling similar cases it has brought, demanding promises of change from the municipalities and individuals it has charged. It is most important that the processes change and that officials who do not fulfill their fiduciary duties are discharged. But it is also important that the message be sent that such officials will have to disgorge their gains as well as pay substantial fines.

It appears, however, that most of the cases so far have not involved self-dealing. Hopefully, the SEC will treat this aspect of the matter differently.

According to an article in Governing, the SEC's Enforcement Division has announced a self-reporting offer, encouraging “issuers and underwriters of municipal securities to self-report certain violations of the federal securities laws rather than wait for their violations to be detected.” In exchange, the SEC is promising “standardized, favorable settlement terms,” but the SEC did not specify what those terms might be.

Robert Wechsler
Director of Research-Retired, City Ethics

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