The Securities and Exchange Commission (SEC) released a National Examination Risk Alert on March 19, 2012 (the "Alert") that highlighted a number of failures in the due diligence and disclosure process for municipal securities offerings. The Alert highlights the SEC's increasing emphasis on due diligence and disclosure in the municipal securities markets and states the SEC's belief in the importance of a documented due diligence process for municipal securities as well as the need for continuing disclosure under Securities Exchange Act Rule 15c2-12 (Rule 15c2-12). The Alert recognizes that many underwriters have not established adequate procedures to ensure due diligence and disclosure compliance in accordance with Rule 15c2-12, MSRB Rule G-27 and other federal securities laws. The Alert urges underwriters as well as issuers of municipal securities to implement these types of procedures and comply with the requirements of the securities laws.
Underwriters' Due Diligence Obligations and Compliance
When an underwriter participates in an offering or sale of municipal securities, it is making an implied recommendation about the quality of the security involved in the transaction. The SEC believes that one component of the recommendation is that the underwriter has a reasonable belief in the truthfulness and completeness of the key representations made in the disclosure documents associated with the security. Failure on the part of an underwriter to demonstrate that it has formed a reasonable belief could be grounds for a violation of the antifraud provisions of the federal securities laws. Further, Rule 15c2-12 requires that underwriters review the "deemed final official statement" for accuracy and completeness and that the underwriter has reasonably determined that an issuer will comply with its continuing disclosure obligations under Rule 15c2-12. Finally, MSRB Rule G-27 requires that an underwriter have supervisory procedures in place to ensure compliance with the securities laws (including the antifraud provisions, Rule 15c2-12 and MSRB Rule G-27). While the securities laws have no explicit requirement that an underwriter maintain written evidence, the SEC has stated that maintaining proper records of due diligence activities can be the basis of an affirmative defense when the SEC charges the firm with failing to comply with its obligations.
In the Alert, the SEC rejects many current industry-held beliefs concerning due diligence and...