Municipal disclosures:Why the SEC is investigating municipalities for fraudulent financial reporting

Fraud – a topic that always gets a lot of attention. Whether we are talking about public or private entities, fraudulent activity can be equally damaging to an organization. With the economy in distress for the past several years, state and local governments remain under tight budgetary pressure. It is no surprise that unforeseen fiscal problems have increased the risk of fraud in municipal securities. According to the Securities and Exchange Commission (SEC) Commissioner Daniel Gallagher, SEC officials are determined to clamp down on fraudulent practices by public officials, evidenced by the following events out of Pennsylvania.

On May 6, 2013 the City of Harrisburg, PA was charged by the SEC for securities fraud for presenting inaccurate data as their financial condition was beginning to deteriorate. This marked the first time a municipality has been charged by the SEC for misleading statements made outside of its securities disclosure documents.

In the case of the City of Harrisburg, the City failed to disclose required information to the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access (EMMA) system and made false public statements about its credit rating, financial condition, and timeliness of debt payments. There were two main items to note in this incident:

  • Harrisburg’s 2009 comprehensive annual financial report (CAFR) was not submitted until August 6, 2012. Additionally, their 2010 CAFR was not submitted until December 20, 2012. A delay in the release of the financial statements can open the door to investors to look for other public financial data to support their investment decisions.
  • On April 9, 2009, the former Mayor gave the State of the City Address and presented information the SEC has since deemed as false. One comment the SEC had issue with was that any financial issues were "issues that can be resolved." Investors also relied on budgets and other data that was available to the public.

The delayed presentation of the City’s CAFR caused investors to validate the quality of the bonds in an unconventional manner. They referenced the Mayor’s oral presentations to make their investment decision and as a result, relied upon data that was presented by the Mayor. This incident should serve as a wakeup call to not only the investors but to the public. The importance of accurate and timely disclosures for issuers of municipal securities is now more important than ever. Public officials need to take responsibility for their actions, especially when it comes to misstatement or omissions in connection with municipal securities. They are accountable for the information presented and reported to the public.

It is important to learn from the situation that occurred in Harrisburg. In order to avoid such occurrences, municipalities should implement additional policies to ensure that financial information being released to the public is accurate and is in compliance with Rule 15c2-12 for continuing disclosure. These policies and procedures should also be in writing and in compliance of disclosure requirements. Lastly, it is important for public officials to be aware that statements made in public could be used by investors in making decisions in the absence of other timely disclosures.