The SEC's Office of Compliance Inspections and Examinations, or "OCIE," is taking is taking aim at broker-dealers that underwrite municipal securities.  Examiners have observed that some broker-dealers have not maintained, nor did they require the maintenance of, adequate written evidence that they complied with their obligations under Rule 15c2-12 of the Securities Exchange Act of 1934 (SEA) and applicable Commission guidance regarding due diligence and supervision. SEA's Rule 15c2-12. As adopted in 1989, 15c2-12 sets forth certain broker-dealer obligations when participating in an underwriting.  The Commission also provided interpretive guidance about broker-dealers’ obligations under the anti-fraud provisions of the federal securities laws to form a “reasonable basis” for offering new issues of municipal securities - this requirement often is referred to as “due diligence."  In 2010, the SEC further amended Rule 15c2-12 to further enhance the quality and timeliness of information about municipal securities in the marketplace, and to update the Commission’s interpretive guidance regarding the obligations of underwriters. Due Diligence Failures. Failure of a firm to comply with its due diligence obligation can lead to violations of the anti-fraud provisions of the federal securities laws, as well as Rule 15c2-12 and MSRB rules. The Commission’s National Examination Program, or "NEP", has been concerned about the level of due diligence and supervision carried out by underwriters in connection with offerings of municipal securities - which has led to various examinations of broker-dealers’ municipal securities underwriting businesses so as to assess their compliance with applicable laws and rules. National Examination Risk Alert. Based on those findings, OCIE issued on Monday a Risk Alert on compliance measures that can help broker-dealers fulfill their due-diligence duties when underwriting offerings of municipal securities.  An Investor Bulletin also was issued to help educate investors about municipal bonds.  [C-I Note: And perhaps to encourage investors to keep a watchful eye over broker-dealers to see that they're complying.] Municipal Underwriter’s Due Diligence Obligation. Rule 15c2-12 requires a municipal securities underwriter ("U/W") to, among other things, “obtain and review” a “deemed final” official statement, prior to bidding for or purchasing securities in connection with the offering and also to reasonably determine that an issuer, or obligated person, has undertaken in writing to provide the MSRB with certain specified continuing disclosures, prior to the time the underwriter purchases or sells municipal securities in an offering.  In the 2010 Release, the Commission updated its interpretive guidance and emphasized that:

• U/W's have a duty under the antifraud provisions of the federal securities laws, in both negotiated and competitively bid municipal securities offerings, to review the issuer’s or obligated person’s disclosures in a professional manner with respect to accuracy and completeness of statements made in connection with an offering;
• it's important for U/W's to carefully evaluate the likelihood that an issuer or obligated person will comply on a timely basis with its disclosure undertakings; and,
• U/W's should obtain evidence reasonably sufficient to determine whether and when annual filings and event notices, pursuant to an issuer’s or obligated person’s disclosure undertakings, were in fact provided, such as by a review of the municipal securities information repositories and the MSRB’s Electronic Municipal Market Access (“EMMA”) system.

In the 2010 Release, the Commission also stated that sole reliance on an issuer will not suffice in meeting an underwriter’s “reasonable basis” obligations. Examples of Municipal Securities “Due Diligence” Practices, Policies and Procedures. The Alert offers examples of practices identified by the staff that evidence some due diligence and supervisory review.

1.  Clear Explanation of Regulatory Requirements and Firms’ Expectations. Some firms have fairly detailed written policies and procedures addressing the nature of    the due diligence requirements under Rule 15c2-12, including a summary of applicable Commission guidance, and the firm’s expectations as to how their personnel can develop a reasonable basis for offering any municipal new issue securities. These policies and procedures also describe supervisors’ obligations in determining whether the diligence performed was adequate given the particular facts and circumstances. These supervisory policies and procedures make clear that that supervisors’ determinations are most effectively made in advance of the offering, but after the review of the “deemed final” official statement. Some firms also develop and include in their written policies and procedures other processes whereby supervisors may provide business approval to submit materials in response to an issuer request for proposal or qualification, or make their initial business determination whether or not to proceed in the diligence and underwriting process.

2.  Commitment Committees. Many broker-dealers have firm-wide, senior level commitment committees that review and approve various underwritings, including municipal securities underwritings.  These commitment committees are in addition to “line of business” supervisory reviews, through a business level committee or otherwise. In advance of a scheduled commitment committee meeting, some firms require their personnel to submit a deal-specific set of materials to the committee for its review, prepared pursuant to written guidance and a template submission form. Such deal-specific committee submissions may consist of a due diligence memorandum describing the diligence that was done, including a list of the diligence calls in which firm personnel participated, and also certain portions of the “deemed final” official statement (e.g., the financial and risk disclosures) for review by supervisors and the Committee. Some firms require that business supervisors formally approve the commitment committee material before it is provided to the committees, or for business supervisors to provide the material to the committee, with the written instruction that such approvals, or submission of materials, is designed to evidence the supervisor’s review of the material and a determination that the level of diligence that was performed was adequate.

3. Diligence “Checklists”. Some firms have also developed checklists to assist their personnel in recording the various diligence steps taken, including their review of the final or “deemed final” official statement and the results of an independent review of EMMA (and other data repositories for the time period prior to the development of EMMA). To evidence due diligence and supervisory review, such checklists may require substantial narrative describing due diligence steps that were undertaken. Such checklists may also include narrative responses relating to any past familiarity with the issuer, and other factors relevant to forming a reasonable basis for offering new issue municipal securities.

4.  Due Diligence Memoranda. Some firms require public finance bankers to prepare a memorandum describing due diligence calls, issues noted and how they were resolved, as well as their review of the final or “deemed final” official statement. Such memoranda may be used in conjunction with checklists such as those described above, and as part of a submission to a commitment committee or other supervisory diligence review process.

5. Outlines for Due Diligence Calls. Underwriters’ counsel or issuer’s counsel often prepare outlines of disclosure issues to be discussed in due diligence calls in which the underwriters participate. Such outlines, particularly when accompanied by documentation of the responses to and resolution of such issues, may be helpful in evidencing an underwriters’ due diligence.

6.  On-Site Examination Activities. Some firms require their personnel to engage in various on-site examination activities, including meetings with municipal officials, visits to facilities and an examination of an issuer’s records and current economic trends and forecasts that bear on the ability of the issuer to pay its debt.

For further details, go to:  [SEC 12-48, 3/19/12] and [NEP Risk Alert:  Strengthening Practices for the Underwriting of Municipal Securities] http://www.sec.gov/about/offices/ocie/riskalert-muniduediligence.pdf