Wednesday, March 16, 2016

SEC Brings First Charges Under Dodd-Frank Municipal Advisor Fiduciary Duty Provision

By Amanda Maine, J.D.

In the first enforcement action brought by the SEC under the Dodd-Frank Act’s statutory creation of a fiduciary duty for municipal advisors, the SEC charged a municipal advisory firm and three associated persons with failing to disclose a conflict of interest in breach of that duty. The SEC alleged that the associated persons were registered representatives for the broker-dealer that served as the underwriter for several municipal debt securities offerings for which the firm served as advisor (In the Matter of Central States Capital Markets, LLC, Mark R. Detter, David K. Malone, and John D. Stepp, Release No. 34-77369, March 15, 2016).

Dodd-Frank provision. The Dodd-Frank Act amended the Exchange Act to impose a fiduciary duty on municipal advisors and their associated persons. This fiduciary duty, owed to their municipal entity clients, requires that conflicts of interest be fully and fairly disclosed.

Central States. Central States Capital Markets is a Kansas-based municipal advisor, broker-dealer, and investment adviser. Central States’ CEO and two of its vice presidents were registered representatives of an unnamed broker-dealer (the “Broker-Dealer”).

Offerings. An unnamed municipal entity (the “City”) hired Central States to serve as its municipal advisor for municipal debt offerings in 2011. According to the SEC, Central State advised the City on three municipal debt offerings in 2011, totaling nearly $14.7 million. The two vice presidents were assigned by Central States to work with the City. The vice presidents, in consultation with the CEO, arranged to have the debt offerings underwritten by the Broker-Dealer. All three were registered representatives with the Broker-Dealer during the three debt offerings by the City.

Central States collected over $130,000 in municipal advisor fees from their work with the municipal debt offerings. The Broker-Dealer collected over $120,000 in underwriting fees, 90 percent of which were remitted to Central States, according to the SEC.

Failure to disclose conflict of interest. The SEC alleged that despite this obvious conflict of interest, Central States, its CEO, and the vice presidents failed to disclose to the City that Central State employees also worked for the Broker-Dealer. They also failed to disclose that these employees were performing both municipal advisor services and underwriting services for the municipal debt offerings. In addition, the SEC alleged that the respondents should have disclosed the conflict of interest because they were receiving a direct financial benefit from the underwriting services.

By not disclosing this conflict of interest, “Central States…and its employees deprived the City of the opportunity to seek unbiased financial advice,” said SEC Enforcement Director Andrew Ceresney.

Charges and settlement. The SEC charged Central States, the former CEO, and the former vice presidents with violating the municipal advisor fiduciary rule, as well as violating Municipal Securities Rulemaking Board (MSRB) Rule G-17, which requires advisors to deal fairly with their clients, and Rule G-23, which prohibits municipal securities advisors from underwriting issuances which they are advising.

All respondents settled the matter, agreeing to cease and desist from future violations of MSRB Rule G-17. The three former executives also agreed to cease and desist from future violations of MSRB Rule G-23. In addition, Central States agreed to pay nearly $300,000 in disgorgement and prejudgment interest, as well as a civil penalty of $85,000. The former executives agreed to pay penalties totaling $625,000, plus one- and two- year bars from the financial industry for the former vice presidents and a six-month suspension from acting in a supervisory capacity for the former CEO. Ten percent of the funds obtained from the penalties will be transferred to the MSRB. The respondents did not admit or deny the SEC’s findings.

The release is No. 34-77369.

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