DODD-FRANK ACT AND ITS IMPACT ON THE MUNICIPAL ISSUERS, UNDERWRITERS, AND ADVISORS.

• Author: Melerhenry, Todd

1. INTRODUCTION

   The municipal bond attorney practice in South Dakota can be traced back to the Boyce-Greeley Building in Sioux Falls. In 1932, George J. Danforth and Holton Davenport leased the southwest corner of the fourth floor of the Boyce-Greeley Building. (1) Shortly thereafter, George J. Danforth, Jr., joined the firm and later became South Dakota's first bond attorney. Since the late 1940s, Danforth & Danforth acted as bond counsel for most South Dakota municipalities. In 1987, Mark Meierhenry and I moved into the fourth floor of the Boyce-Greeley building where we shared office space with Danforth, Danforth & Johnson. (2) Having more time than billable hours, we had great discussions with Mr. Danforth about the history of the practice of law in Sioux Falls and the history of South Dakota's municipal bond practice. (3)

   Gefke & Company was the only South Dakota investment banking firm in the state from the 1940s through the 1960s. (4) Fred Gefke, president of Gefke & Company, financed his underwriting of municipal bonds with The First National Bank in Sioux Falls. He obtained a loan, travelled the state, and underwrote city and school bonds. He returned to Sioux Falls and sold the bonds.

   Mr. Danforth, as the only South Dakota bond attorney, often would travel with Fred Gefke doing municipal bond business. Traveling across South Dakota in the 1940s was a time-consuming process. Many roads were not paved, and in wet seasons, the traveler would have to back-track to avoid various unsurpassable water holes on the road. (5) There were times that the two would hunt while traveling. One would sit on the hood and shoot pheasants, and the other would drive.

   During one of these return trips from western South Dakota, Mr. Danforth and Fred Gefke stopped in Kadoka for gas. The gas station attendant in coveralls came out to fill their car with gas. He asked what the two fellows did. Fred explained that he purchased and sold municipal bonds, and that Danforth was a bond attorney. The man said that it was a fortuitous meeting since he was the mayor, explaining that he had Kadoka bonds locked in his desk drawer for sale. (6) Gefke bought the bonds, threw them in the trunk, and continued on to Sioux Falls. The days of pheasant hunting while bond buying, however, are gone. Today, the bond market is larger, more complex, and highly regulated.

2. BACKGROUND

   1. THE MUNICIPAL BONDS

      The United States' municipal securities market had "over one million different municipal bonds outstanding" in 2011. (7) In South Dakota, there are 66 counties, (8) 310 cities and towns, (9) 149 school districts, (10) and many other governmental subdivisions. (11) These government issuers borrow money to finance capital projects and improvements when they cannot or should not be financed exclusively from current operating budgets. (12) The borrowings are evidenced by bonds, certificates, notes, and finance leases.

      The process for financing projects typically includes these events: (1) Issuer defines the project; (2) Issuer retains professionals (bond counsel, (13) municipal advisor (14) and/or underwriter (15)); (3) Issuer determines the source of payment (general obligation, revenue, tax, special assessment); (16) (4) Issuer determines type of sale (public (17) or negotiated); (5) Issuer passes resolution or ordinance calling election; (6) Issuer holds election where required; (18) (7) Issuer passes resolution setting forth terms and conditions of the bonds; (8) In public offerings, distribution of the official statement; (19) (9) Bonds (20) are sold; and (10) Bonds are issued. (21)

      Parties involved in the bonding process can be divided into two camps: (1) issuer's side, and (2) underwriter's side. The following parties could appear in a negotiated sale:

      Issuer's Side Underwriter's Side Municipal Issuer (22) Underwriter(s) (23) Bond Counsel (24) Trustee (25) Municipal Advisor (26) Credit Enhancer (27) Issuer's General Counsel Underwriter Counsel (28) Disclosure Counsel (29) Selling Group Counsel (30) Credit Enhancer Counsel (31) Feasibility Consultant (32) Auditor (33) Trustee's Counsel (34) The key difference is that on the issuer's side, the bond counsel, municipal advisor, and general counsel statutorily owe the issuer a fiduciary duty. (35)

   2. HISTORY OF MUNICIPAL BOND REGULATION

      The business of issuing municipal securities, in large part, is not regulated. Municipal securities are not subject to the statutory or regulatory requirements of the Securities Act of 1933 ("Securities Act") or the Securities Exchange Act of 1934 ("Exchange Act"). (36) Further, Con gress enacted the Tower Amendment to the Securities Act in 1975. (37) This legislation created the Municipal Securities Rulemaking Board ("MSRB"). (38) The Tower Amendment strictly prohibited the U.S. Securities and Exchange Commission ("SEC") and MSRB from regulating the issuance or sale of municipal securities. (39) The SEC and MSRB are not restricted, however, in regulating post issuance matters. (40) Municipal securities transactions are subject to the antifraud provisions of Section 77q of the Securities Act, (41) Section 78j-2 of the Securities Exchange Act of 1934, (42) and Security and Exchange Commission's Rule 10b-5. (43) These antifraud provisions prohibit any person by:

      the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) [t]o employ any device, scheme, or artifice to defraud, (b) [t]o 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) [t]o engage in any act, practice, or course of business which operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. (44) The SEC's investor protection efforts in the municipal securities market have been accomplished through back-door regulation. (45) Since the SEC has the power to broker-dealers and municipal securities dealers, they have caused back-door regulation through Exchange Act Rule 240.15c2-12, SEC interpretations, enforcement of the antifraud provisions of the federal securities laws, and Commission oversight of the MSRB. (46)

   3. DODD-FRANK ACT

      On July 21, 2010, President Obama signed the Dodd-Frank Act into law. (47) It was an act "[t]o promote the financial stability of the United States by improving accountability and transparency in the financial system, to end 'too big to fail,' to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial service practices, and for other purposes." (48) Section 975 of the Dodd-Frank Act made several changes to the oversight of the municipal securities market. (49) It also amended section 15B of the Securities Exchange Act to require municipal advisors to register with the SEC and provide for municipal advisor regulation by the MSRB. (50)

3. ANALYSIS

   1. IMPACT ON MUNICIPAL ISSUERS

      The Dodd-Frank Act "expand[ed] the MSRB's mission to include the protection of municipal entities and obligated persons." (51) The Dodd-Frank Act also required the Governmental Accountability Office ("GAO") to review several aspects of the municipal securities market, including the mechanisms for trading, price discovery, and price transparency. (52) The final GAO report "examin[cd] (1) municipal security trading in the secondary market and the factors that affect the prices investors receive, and (2) the Securities and Exchange Commission's (SEC) and self-regulatory organizations' (SRO) enforcement of rules on fair pricing and timely reporting." (53) As part of this report, GAO noted that municipal issuers' disclosures were sometimes outdated and incomplete. (54)

      The SEC followed GAO with a July 31, 2012, Report on the Municipal Securities Market. (55) The report included recommendations for potential changes to laws, regulations, and business practices. (56) The report did not recommend repeal of the Tower Amendment but provided several other legislative and regulatory recommendations. (57)

      Based on the SEC's concern that many issuers had not been complying with their obligation to file continuing disclosure documents and that federal securities law violations involving false statements concerning such compliance could be widespread, in March of 2014, the SEC initiated the Municipalities Continuing Disclosure Cooperation Initiative (the "MCDC Initiative"). (58) The MCDC Initiative suggested that issuers who may have made materially inaccurate statements in a final official statement regarding their prior compliance with their continuing obligations as described in Rule 15c2-12 should consider self-reporting to the SEC to take advantage of the MCDC Initiative. (59) In addition, underwriters of the offerings were given the option to self-report. (60)

      The MCDC Initiative provided issuers and underwriters the opportunity to self-report instances of material misstatements in bond offering documents regarding the issuer's prior compliance with its continuing disclosure obligations. (61) The Initiative "was intended to address potentially widespread federal securities laws violations by municipal issuers and underwriters of municipal securities in connection with certain representations about continuing disclosures in bond offering documents." (62) The deadline for self-reporting was December 1...