The SEC Says Cities (and City Officials!) Must Obey Securities Laws, Too

Yesterday the SEC filed an Order Instituting Cease and Desist Proceedings against the City of Harrisburg, Pennsylvania for violations of Rule 10b-5. The City consented to entry of a Cease and Desist Order. The SEC also issued a Report of Investigation under Section 21(a) discussing “Potential Liability of Public Officials With Regard to Disclosure Obligations in the Secondary Market.”

The headline message from this proceeding is that the SEC found that the City had violated the securities laws through public statements made by public officials, as well as budget documents released during a certain time period, which allegedly failed to disclose material information about the City’s dire financial condition (primarily related to its obligations on certain waste-to-energy project bonds which the City had guaranteed). The reason these statements were deemed so significant is that during this period the City had fallen far behind in releasing its Comprehensive Annual Financial Reports (“CAFRs”), so that investors had no other available current financial information. The SEC used this proceeding and its Report of Investigation to re-emphasize the statements made in its 1994 Interpretive Guidance on the obligations of participants in the municipal securities markets, and its 1996 Report following the bankruptcy of Orange County, California, that statements made by public officials which might be “reasonably expected to reach investors and the trading markets” can be subject to antifraud rules, even when such statements are not part of a specific securities offering.

While this is the “headline,” it should be noted that the SEC also charged the City with violating Rule 10b-5 in connection with CAFRs which were eventually filed (a more conventional application of the Rule). It is also noteworthy that the underlying premise for much of the SEC case is that over a period of two years or so the City had repeatedly violated its contractual continuing disclosure obligations entered into pursuant to SEC Rule 15c2-12, relating to outstanding debt, to file annual financial reports within a certain time period, to file a notice that annual reports were not being filed on time, and to make certain other “material event” filings. As noted above, in that context, other statements made by City officials took on much greater importance. One could view this case, as well, as one of the first which seeks to punish an issuer (though indirectly) for repeated failures to comply with continuing disclosure obligations.