Avoiding Securities Law Liability in Conduit Bond Offerings
Pennington, Oliver, Weber, Fredric A., Government Finance Review
Antifraud provisions of law apply to offerings of state and local government securities that are issued by or on behalf of a governmental entity for a private business, health, or educational enterprise.
The federal securities laws' antifraud provisions(1) apply to offerings made by or on behalf of state and local governments. The recent litigation over Denver International Airport financing is one example of the application of these provisions.(2) If the antifraud provisions are violated, the Securities and Exchange Commission (SEC) can bring enforcement actions, and investors can bring action for damages, against both issuers and issuer officials. Accordingly, when state and local governments issue bonds or other securities to borrow money for their own governmental purposes, they must exercise care in making disclosure to investors.
The antifraud provisions also apply to offerings of state and local government "conduit securities," i.e., securities that are issued by or on behalf of a governmental entity for a private business, health, or educational enterprise and are payable from loan, lease, or installment sale payments to be made by the private enterprise. Conduit securities offerings pose a special challenge for issuers: they typically are offered by means of an issuer official statement, since it is the issuer's securities that are sold in the offering, but the official statement discloses information about the private enterprise benefited by the offering, since the private enterprise is responsible for payment of the securities. In conduit securities offerings, governmental issuers are therefore called upon to make disclosure to investors about private enterprises with which the issuer and its officials are not familiar.
Despite this challenge, in offering conduit securities, issuers (and their officials) can fulfill their duties under the antifraud provisions, and thereby avoid securities law liability, by becoming knowledgeable about the relevant provisions of federal securities laws and adopting strategies for compliance based on a few basic precepts, which are discussed in this article.
The Federal Securities Laws
Before participating in a conduit securities offering, issuer officials should become familiar with the following three provisions of federal securities laws.
1. Learn the duties of issuers and issuer officials under the antifraud provisions. Under the antifraud provisions, it is illegal for any person (including a state or local government) to make untrue statements of material facts or materially misleading statements of fact in connection with the purchase or sale of securities.
The antifraud provisions apply to conduit securities in two phases. First, when an issuer offers conduit securities for sale, it has a duty to exercise reasonable care to avoid material misstatements of fact and materially misleading statements, e.g., statements that omit material negative facts. Likewise, when issuer officials, e.g., members of the governing body and executive officials, participate in preparing or authorize offering documents for conduit securities, they must exercise care to determine that the offering documents do not contain material misstatements or materially misleading statements. Second, if issuers or issuer officials communicate with investors in conduit securities after the securities are issued, they must exercise some care that the communication is not materially untrue or misleading.
These principles are illustrated by recent SEC enforcement actions against two counties and by an SEC report concerning county officials: In administrative proceedings against Orange County, California,(3) and Maricopa County, Arizona,(4) the SEC ordered two counties to cease and desist from violating the antifraud provisions.
* Orange County had offered its securities by means of official statements that omitted allegedly material investment risks. …