A federal statute setting out the requirements for trust indentures in connection with publicly traded corporate securities.
Federal Securities Law
This section is meant to provide an overview of the federal securities laws that apply to Bonds, specifically highlighting the following areas:
- Registration requirements under the Securities Act of 1933 (the “1933 Act” or the “Securities Act”);
- “Antifraud” provisions of the 1933 Act and the Securities Exchange Act of 1934 (the “1934 Act” or the “Exchange Act”) and SEC Rule 10b-5, focusing on important Securities and Exchange Commission (“SEC” or the “Commission”) enforcement actions in the municipal Securities market;
- SEC Rule 15c2-12, which regulates the receipt, content and distribution of Offering Documents by brokers, dealers and Underwriters of Bonds, the ongoing provision of information to the secondary market by Issuers and obligated parties and related broker-dealer procedures;
- SEC rules requiring the registration of Municipal Advisors;
- The MSRB rules governing the conduct of municipal Securities brokers, dealers and Advisors; and
- The regulatory bodies in the municipal Securities market, such as the SEC, the MSRB and the Financial Industry Regulatory Authority (“FINRA”).
The 1933 Act is designed to ensure that investors are provided with material information about New Issues of Securities offered for sale to the public. The 1933 Act requires that New Issues of Securities offered or sold by use of the mails or interstate commerce be registered with the SEC and that a prospectus be furnished to the purchaser prior to the sale. Registration statements must contain detailed information about the business, management and financial condition of the entity issuing the Securities and must include financial statements of the entity issuing the Securities audited by independent accountants. They must also disclose information relating to the method of offering, the Securities and other matters. However, Section 3(a)(2) of the 1933 Act exempts state and local government obligations, including Conduit Bonds, from these registration requirements. Both the SEC and the MSRB are prohibited from directly or indirectly requiring municipal Issuers to disclose information prior to the sale of Securities.
Although municipal Securities are exempt from federal registration requirements, municipal Securities must be closely analyzed to determine whether underlying arrangements commonly used in connection with such financings involve “separate securities” which require registration. Rule 131 of the 1933 Act and Rule 3b-5 of the 1934 Act provide that separate securities are “any part of an obligation evidenced by any bond . . . which is payable from payments to be made in respect of property or money . . . under a lease, sale or loan arrangement by or for an industrial or commercial enterprise.” In certain circumstances, a particular financing arrangement involves a separate Security but comes within an independent statutory exemption under the 1933 Act. In other circumstances, there is no independent statutory exemption for a particular financing arrangement, but the SEC staff has concluded that registration is not warranted because the arrangement provides additional security for the underlying municipal Security.
The following types of underlying obligations do not need to be registered as separate securities: (1) Guaranties; (2) Guaranties by the United States; (3) bank Guaranties; (4) put options; (5) Letters of Credit; (6) Participation Certificates; (7) Insurance; or (8) Guaranteed Investment Contract payments.
Registration by Transaction
- Subsequent Sale: The subsequent sale by the holder of the Securities of federal, municipal and corporate Securities does not render the seller an Issuer subject to registration requirements.
- Transactional Exemptions: Municipal Securities that are not exempt from registration under Section 3(a)(2) or some other “exempt security” provision of the 1933 Act may still be exempt if they are offered and sold in a manner that complies with certain transactional exemptions available under the 1933 Act. In particular, Section 4(a)(2) of the 1933 Act provides an exemption from registration for “transactions by an issuer not involving any public offering” – so-called “private placements.” The SEC has promulgated regulations establishing several “safe harbors” under Section 4(a)(2) for Private Placements, as discussed below in more detail.
Regulation D, which is available only to the Issuer of a Security, provides three different safe harbors, the conditions of which vary with the size of the offering. As a general rule, transactions under Regulation D may not involve any form of general solicitation or advertising, sales are restricted to Accredited Investors and a limited number of non-accredited investors, and the Issuer must exercise reasonable care to ensure that the purchasers are not Underwriters within the meaning of the 1933 Act. Securities purchased in a Regulation D transaction generally are “restricted securities” that cannot be resold without registering them under the 1933 Act or an exemption therefrom. This task would fall to the original purchaser of the Security.
In such a case, the purchasers in a Private Placement who wish to resell their restricted Securities originally sold in a transaction that benefitted from Regulation D may avail themselves of safe harbors, such as those provided under Rule 144 and Rule 144A. Under the general provisions of Rule 144, restricted Securities of a reporting Issuer may be sold after a six-month holding period, provided that certain current financial information about the Issuer is available, the amount sold during any three-month period does not exceed certain prescribed amounts, the sale is effectuated in an unsolicited brokers’ transaction or to a market maker and, in the case of sales meeting a minimum size threshold, a notice of the proposed sale is filed with the SEC and the appropriate national securities exchange, if applicable. The holding period for resales of restricted Securities of non-reporting Issuers is one year. Rule 144A provides an alternative safe harbor available in transactions involving sales or resales to purchasers meeting the definition of a Qualified Institutional Buyer.
Qualification for the Rule 144A exemption requires that the seller and seller’s agent take reasonable steps to ensure that purchaser is aware that the seller may rely on the Rule 144A exemption. In addition, in the case of Securities of an Issuer, such as a municipal Issuer, not subject to the reporting requirements of the 1934 Act, the holder of the Securities and the prospective purchaser must have the right to obtain from the Issuer certain financial information.
Because the safe harbors provided by Regulation D, Rule 144 and 144A are non-exclusive, are merely safe harbors, and were promulgated by an administrative agency as interpretations of Section 4(a)(2), transactions that do not meet their requirements nonetheless may, under certain circumstances, qualify for the general Section 4(a)(2) statutory exemption provided by Congress.
State securities laws, which regulate the offering of securities. Although these laws vary from state to state, most contain provisions concerning (a) prohibitions against fraud; (b) regulation of brokers and dealers doing business in the state; and (c) registration of Securities.
The Antifraud Provisions
Among the primary objectives of the 1933 Act and the 1934 Act are: (1) requiring disclosure of material information about Securities to allow investors to make informed decisions; and (2) prohibiting misrepresentation or other fraudulent conduct in connection with the purchase and sale of Securities. These objectives are accomplished largely through two “antifraud” provisions: Section 17(a) of the 1933 Act and Section 10(b) of the 1934 Act (and Rule 10b-5 promulgated thereunder).
The antifraud provisions not only apply to statements made in, and omissions from, an Offering Document, but also to statements and omissions that occur outside the “four corners” of an Offering Document, including statements made using electronic media and information posted on an Issuer’s website. In addition, in its Staff Legal Bulletin No. 21 published by the SEC’s Office of Municipal Securities (“OMS”), the office opined that “[t]he statements of municipal Issuer officials are also subject to the antifraud provisions if their statements are reasonably expected to reach investors or the Securities markets. Notably, statements by municipal Issuer officials ‘who may be viewed as having knowledge regarding the financial condition and operation of a municipal Issuer’ could be a principal source of significant, current information about the Issuer of the Security and thus be reasonably expected to influence investors and the secondary market. Accordingly, depending on the facts and circumstances, the statements of municipal Issuer officials that may be subject to the antifraud provisions could include verbal statements made by municipal Issuer officials, such as speeches, public announcements, and interviews with media representatives, as well as statements disseminated through other avenues such as, in the staff’s view, social media.”
Section 10(b) of the 1934 Act & Rule 10b-5
Section 10(b) of the 1934 Act makes it unlawful to use manipulative or deceptive devices in connection with the purchase or sale of Securities. The SEC adopted Rule 10b-5 to implement this provision. Rule 10b-5 makes it unlawful for any person:
“(a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”
Municipal Securities were brought within the scope of the 1934 Act and Rule 10b-5 by virtue of the Securities Acts Amendments of 1975. As a result, Rule 10b-5 imposes antifraud provisions on Issuers, Underwriters, Bond Counsel, Issuer’s Counsel, Borrower’s Counsel, Disclosure Counsel and Underwriter’s Counsel in the context of municipal Securities.
Section 17(a) of the 1933 Act
Section 17(a) of the 1933 Act provides:
Municipal Issuers are subject to Section 17(a) because the definition of “person” under the 1933 Act includes “a government or political subdivision thereof.” The language of Section 17(a) is almost identical to that of Rule 10b-5. Despite the similarity, however, Section 17(a) and Rule 10b-5 are not entirely co-extensive. Most notably, whereas Rule 10b-5 protects purchasers and sellers, but only in the sale of Securities, Section 17(a) protects only purchasers of Securities, but does so in the context of both offers and sales. Thus, in some respects, Section 17(a) is both narrower and broader than Rule 10b-5 and vice versa.
Common Elements to SEC Enforcement Actions
The SEC has broad authority to bring civil enforcement actions under Rule 10b-5 and Section 17(a). In order to establish liability under Rule 10b-5, the SEC must prove by a preponderance of the evidence that: (i) the defendant made an untrue statement of material fact or omitted to state a material fact needed to make any statements made not misleading, (ii) such statement or omission was made with the requisite mental state and (iii) the misstatement or omission was “in connection with” the purchase or sale of Securities. Rule 10b-5 also imposes liability on persons who were not the maker of an untrue or misleading statement. This secondary liability – or “aiding and abetting” liability – extends liability to individuals who do not directly violate the federal securities laws themselves or who may not be directly involved in Securities transactions (e.g., lawyers and accountants). In order to establish liability under Section 17(a), the SEC must prove by a preponderance of the evidence that: (i) the defendant made an untrue statement of material fact or omitted to state a material fact needed to make any statements made not misleading, (ii) with the requisite mental state and (iii) the misstatement or omission was “in” the offer or sale of Securities.
Private Causes of Action
Rule 10b-5 and Section 17(a) do not expressly permit plaintiffs to bring private causes of action against defendants. Rather, in the context of Rule 10b-5, the ability for private litigants to allege federal securities law violations is judicially created. In addition to the three elements that the government must establish in SEC enforcement actions, private plaintiffs pursuing Rule 10b-5 claims must also prove the following elements by a preponderance of the evidence: (1) reliance on the untrue or misleading statement; (2) loss causation; and (3) damages. Although the United States Supreme Court has not definitively answered whether Section 17(a) also affords a private remedy, most federal circuit courts that have considered the issue have concluded that it does not.
The SEC may bring enforcement actions under either Section 17(a) of the 1933 Act or Section 10(b) of the 1934 Act (including Rule 10b-5) against Issuers and obligated persons (collectively, “offerors”) for inaccurately stating or implying in a final Official Statement that they have substantially complied with their obligations under prior Continuing Disclosure Undertakings or Agreements. In such instances, the Underwriters in these transactions may also have violated the anti-fraud provisions to the extent they failed to exercise adequate diligence in determining whether the offerors of the Securities have complied with their obligations under such prior Continuing Disclosure Undertakings or Agreements, and as a result, failed to form a reasonable basis for believing the truthfulness of what the SEC believes to be a material representation in the offerors’ Official Statement.
Other Regulatory Provisions
Rule promulgated under the 1934 Exchange Act and adopted by the SEC in 1989 to establish standards for the procurement and dissemination of disclosure documents by underwriters as a means of enhancing the accuracy and timeliness of disclosure to municipal securities investors.
Law designed to ensure that investors are provided with material information about new issues of securities offered for sale to the public.
Law designed to govern the trading of securities in the secondary market.
Statute passed in the wake of the 2008-2009 financial meltdown that enacted sweeping changes in the regulation of financial institutions, municipal advisors, and the financial markets.
Regulatory Bodies in the Municipal Securities Market
Federal agency that oversees and regulates the securities industry and aims “to protect investors, maintain fair, orderly and efficient markets and facilitate capital formation.”
A self-regulatory organization charged with rulemaking authority over municipal securities dealers and municipal advisors.
A non-governmental entity that oversees and regulates a portion of the federal securities industry.