SEC's MCDC Initiative

Kelley Baker kbaker@hslegalfirm.com

Karen Haase khaase@hslegalfirm.com @KarenHaase

Steve Williams

Bobby Truhe

swilliams@hslegalfirm.com @SteveisEsteban

btruhe@hslegalfirm.com @btruhe

CONFESSION IS GOOD FOR THE SOUL, BUT IS IT GOOD FOR A SCHOOL BOARD? As parents we all have at some point told our children that if they come to us and admit when they've done something wrong, the punishment will be much less harsh. The Securities and Exchange Commission, the federal agency that is charged with protecting the public against fraudulent and manipulative practices in the securities markets, is trying a modified version of this approach with public entities that have issued bonds. If your school district has issued bonds at any time in the last 5 years, you may need to decide whether to take the SEC up on its offer.

What Have Schools Allegedly Done Wrong?

Under SEC Rule 15c2-12, an underwriter of bonds must obtain from a school district that issues bonds, a promise or “undertaking” by the district to make certain detailed disclosures every year that the bonds are outstanding. Although the exact disclosures that a school promises to make may vary, they generally include a school's audited financial reports, additional annual financial and operating data, and notices of certain specified events (such as rating changes or bond defaults). This rule also requires disclosures in offering documents of any “material” noncompliance with these promises, or undertakings, in the five years prior to the new bond issue.

The problem is that some schools did not file these disclosures at all, while other schools filed disclosures that were incomplete or in some other technical way out of compliance with the SEC's regulations. The SEC’s program is aimed at entities like school districts, that said in their offering documents that they had complied in all material respects with these promises, or undertakings, and had not done so. It is important to note that there is a big difference between complete noncompliance and a couple of minor technical departures from the requirements set forth in the continuing disclosure undertaking.

What Has Changed?

The SEC does not, however, have the regulatory authority to enforce compliance with these promises, or “undertakings” that are made for the benefit of bondholders. Instead, the SEC has decided to use its power to enforce the “antifraud” rules of the federal securities laws to threaten action against municipal issuers whose offering documents, or “official statements,” may contain misleading disclosures about prior compliance with these undertakings. The SEC has expressed its concern that issuers of municipal securities (like school boards) may not have been accurately reporting prior compliance failures in official statements. The SEC has therefore announced its "Municipalities Continuing Disclosure Cooperation Initiative." Under this Initiative, school districts that self-report possible violations of misleading disclosures in official statements about prior noncompliance with continuing disclosure undertakings are eligible to receive a prescribed set of settlement terms from the SEC. Consequences of Self-Reporting Schools who participate in the Initiative will not face financial penalties from the SEC but must agree to enter into a standardized settlement agreement, or “cease-and-desist order” with the SEC. The settlement agreement will include the following: • The school must consent to the institution of a cease-and-desist proceeding by the SEC, a legal proceeding carried out under federal securities law. The school will neither admit nor deny any findings made by the SEC. • The school must establish appropriate policies and procedures and implement training regarding continuing disclosure obligations within 180 days of the agreement.

• The school must comply with its existing continuing disclosure undertakings, including updating past delinquent filings, within 180 days of the institution of the proceedings.

• The school must cooperate with any subsequent investigation by the SEC regarding the violations disclosed in the self-report, including the roles of individuals or other parties involved. If a school enters into one of these settlement agreements with the SEC, only the school district itself is protected from subsequent enforcement action on the matter. The SEC

can still institute proceedings against school district employees or board members. • The school must disclose in a clear and conspicuous fashion its settlement terms in any final official statement for a bond offering by the issuer in the five years following the settlement agreement.

Consequences of Not Self-Reporting The SEC has indicated that it intends to seek enforcement opportunities against municipal issuers that were eligible for self-reporting pursuant to the Initiative, but did not self-report. The SEC has further indicated that it is likely to seek harsher penalties in such enforcement actions, including monetary penalties.

As part of the decision making process, it is critical that school districts contact their underwriters. Underwriters are also subject to federal disclosure rules. At the same time the SEC announced its Initiative for issuers like school districts, it announced that underwriters were also eligible to self-report pursuant to the Initiative. Underwriters’ deadline for self-reporting was September 9, 2014.

Some underwriters elected to report every possible violation in order to bring as many deals as possible under the coverage of the Initiative. The SEC has announced its intention to cross-reference the list of schools which underwriters have disclosed to it to see if the school has reported itself as well.

What to Do Next Every school district that has issued municipal bonds since December 1, 2009 should conduct a review of its prior continuing disclosure compliance and related official statement disclosures. School districts should also consider contacting underwriters to determine if the underwriter self-reported any of the school district’s bond issues. You should then consult with your school's attorney or bond counsel to determine whether your district may have a material misstatement about prior compliance with continuing disclosure undertakings in an official statement that might be appropriate for self-reporting pursuant to the Initiative. Ultimately boards of education will need to decide at their November meetings whether their school should self-report. The deadline for issuers to self-report is December 1, 2014 at 4:00 p.m. central time.

Although Nebraska schools have worked hard to comply with all of the reporting requirements, we have found in our review of client files that many schools have

minor errors or omissions in their disclosures. There is no perfect answer to the dilemma that the SEC has placed school districts in with this Initiative.

Administrators and ultimately boards of education will have to make the best decision they can with the limited information available at this time.

Securities law is a very specialized area. If you have questions about the SEC's Municipalities Continuing Disclosure Cooperation Initiative, you should contact one of the H & S school lawyers, your school's attorney, or bond counsel.

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