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.<br>
<br>
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.<br>
<br>

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.<br>
<br>
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.<br>
<br>
However, although this action was brought against both the city and
the comptroller, according to <a href="http://www.reuters.com/article/2014/06/24/usa-municipals-harvey-idUSL2N…; target="”_blank”">a
recent Reuters article</a> the SEC has
been settling similar cases it has brought, demanding promises of
change from the municipalities and individuals it has charged.</span>
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.<br>
<br>
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.<br>
<br>
According to <a>an article in <i>Governing,</i></a> 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.<br>
<br>
Robert Wechsler<br>
Director of Research-Retired, City Ethics<br>
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