Disclose! Disclose! Disclose! Says the S.E.C. to a Municipal Advisor


y: Ze’eva Kushner Banks and John Goselin, II

Earlier this month, the Securities and Exchange Commission announced its first ever enforcement proceeding for breach of fiduciary duty for municipal advisors created by the Dodd-Frank Act of 2010. On March 15, 2016, the Securities and Exchange Commission publicized a settlement with Central States Capital Markets, LLC, its CEO and two employees arising from a failure to disclose a conflict of interest created by the role of Central States’ employees in providing both municipal advisor services and underwriting services for the municipal entity client.

The problematic arrangement started when Central States was hired by a city as its municipal advisor. Central States then arranged for the City’s offerings to be underwritten by a broker-dealer.  However, rather than engage in a negotiation or bidding process to secure the services of a non-conflicted broker-dealer, Central States unilaterally selected the broker-dealer at which Central States’ CEO and two employees were still working as registered representatives.  This arrangement resulted in Central States receiving from the City not only $130,117 in municipal advisory fees but also 90% of the $121,530 paid by the City in underwriting fees, pursuant to an agreement between Central States and the Broker-Dealer.

The S.E.C. found Central States, its CEO and two employees failed to make three specific disclosures to the City: (i) the fact that certain Central States employees worked for the Broker-Dealer; (ii) the fact that certain Central States employees were engaged in dual roles by performing both municipal advisor services and underwriting services for the City’s offerings; and (iii) these Central States employees had a conflict of interest due to their direct financial benefit from the underwriting services. The failure to make these disclosures constituted a breach of fiduciary duty.

Not only did they fail to disclose the conflict of interest as required under the Dodd-Frank Act, Central States and the individuals also violated Municipal Securities Rulemaking Board Rule G-17, which prohibits municipal advisors from engaging in any “deceptive, dishonest or unfair practice.” Meanwhile the individuals violated Rule G-23 as well, which prohibits brokers from acting as advisors on municipal securities they are underwriting. According to the settlement, Central States is paying a total of $374,827.80, and the three individuals are separately paying civil penalties ranging from $17,500 to $25,000.

Under the Dodd-Frank Act, municipal advisors, such as Central States, have a duty to put their clients’ interests ahead of their own. As stated by the S.E.C. in its press release, “[a]s fiduciaries, municipal advisors must identify and address all material conflicts of interest by eliminating or disclosing such conflicts.  Municipal entities rely on the advice of their municipal advisors and must feel confident that those advisors are working in the municipal entity’s best interests.”

The moral of the story is that municipal advisors are not immune from enforcement of the fiduciary duty provisions of the Dodd-Frank Act. As stated in an earlier post in the context of a conflict of interest stemming from outside business activities, the best practice is to err on the side of disclosure when there is any potential for a conflict of interest.



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