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According to a November 8, 2013 press release, the U.S. Securities and Exchange Commission (“SEC”) has appointed LeeAnn Ghazil Gaunt as head of the Municipal Securities and Public Pensions Unit of its Enforcement Division. She is credited for overseeing pay-to-play actions and investigations that range from inappropriate hedge accounting disclosures and market timing. No doubt her background will easily lend itself to continued scrutiny on the part of the SEC in questioning the extent to which pension plan economics were properly disclosed to prospective and existing bondholders of municipal debt.

A focus on pension IOU’s remains a top priority of the SEC, according to attributed comments made by the head of its Office of Municipal Securities, John Cross, during a National Association of Bond Lawyers (“NABL”) event. An article by Reuters cites Detroit, Illinois, Miami and Harrisburg, Pennsylvania as examples of SEC questioning about the adequacy and/or completeness of information that was provided to bond buyers. See “SEC Official says public pension disclosures remain under scrutiny” (September 26, 2013). A few days earlier, the SEC issued a nearly 800 page document regarding municipal advisor compliance. Click to access “Registration of Municipal Advisors,” Final Rule, Securities and Exchange Commission, September 20, 2013.

The SEC is not alone. I just wrote about the Empire State investigation of several dozen investment advisors that have offered to provide or do provide services to government pension plans such as the $160+ billion New York State Common Retirement Fund. This blog post, entitled “Probing Pension Advisers For Possible Conflicts of Interest,” addresses the New York inquiry as well as pay to play enforcement and regulations in general.

I have carried out extensive research in the area of municipal bond disclosures as relates to the use of derivatives and pension plan costs, respectively. What I found suggests that courtrooms are likely to see action in these areas for a variety of reasons. Like traveling salesman Harold Hill tells it in the famed Broadway play and movie, The Music Man, “Well, either you’re closing your eyes to a situation you do not wish to acknowledge or you are not aware of the caliber of disaster indicated…Well, ya got trouble, my friend, right here…”

  • With nearly $4 trillion at stake, the municipal bond market is comprised largely of retail investors who have direct ownership and/or exposure via mutual funds. A large number of retail investors who can be shown to have suffered economic harm is the stuff of class action drama.
  • SEC enforcement could be a catalyst for non-government attorneys to investigate the extent to which disclosure problems occur at the state, city and/or county levels. Inasmuch as countless municipal bond issuers are cutitng back their budgets, the plaintiffs’ bar could seek to sue deep pocketed municipal bond underwriters and/or advisors about what they knew or did not know before encouraging others to purchase. Moreover, if it can be shown that disclosures were insufficient or worse yet, grossly misleading, and caused damages, an action could be brought on the basis of investors buying at inflated prices. Earlier this summer, a Fox Business reporter described a possible faux pas on the part of a bank underwriter of municipal bonds. It supposedly held back bad news regarding the size of unfunded pension obligations for certain issuers rather than upsetting those same issuers and having their fees go elsewhere.
  • Several years ago, the Financial Industry Regulatory Authority (“FINRA”) cited its plans to investigate, and possibly take action, against companies that had excessive markups and markdowns of municipal securities. Since then, at least several firms have been fined and publicly chastised for charging “too much” to muni bond buyers.
  • While LIBOR investigations and lawsuits have garned much attention of late, municipal bond benchmarking is definitely showing up on the radar screen. According to “Judge OKs suit claiming banks rigged municipal derivatives market” (July 13, 2013) Reuter‘s Peter Hamner writes about a multi-district lawsuit by a state housing authority against a large bank over questionable practices.
  • Portfolio managers of mutual funds that invest in municipal bonds are likely to face scrutiny as well about the kind of due diligence they undertook (or did not carry out) before investing in a bond. Once exposed to a particular issuer, what kind of due diligence and oversight do they maintain? How does he or she attempt to mitigate risk if a muni bond fund is concentrated in a particular geographic sector? If any particular issue defaults and the fund has a significant concentration in state or city bonds, will economic “contagion” bring ruin to any or all of its mutual fund investors? These are real issues. In “Woes of Detroit Hurt Borrowing by Its Neighors” (August 8, 2013), New York Times pension reporter Mary William Walsh writes that “cities, counties and other local governments in Michigan are getting a cold shoulder in the municipal market” and have either had to postpone bond issues or incur higher costs.

The numbers are too big to ignore. In September of this year, the editor of State Budget Solutions estimated the unfunded liability for the states alone at approximately $4.1 trillion. Click to read “Promises Made, Promises Broken – The Betrayal of Pensioners and Taxpayers” by Cory Eucalitto (September 3, 2013).

Contact me if you would like to get more information about my research and insights. The municipal bond sector is destined to become a busy arena for compliance officers, regulators and legal professionals alike.