D.C. Circuit Affirms SEC Findings of Scienter Involving Underwriter of Municipal Bonds

The D.C. Circuit recently affirmed, in SEC v. Bradbury, 2008 WL 108728 (D.C. Cir. Jan. 11, 2008) an SEC order that held a broker-dealer that acted as an underwriter for a municipal bond offering was liable for securities fraud.  The only issue on appeal was whether the SEC established that defendants acted with scienter, which, in this case, was extreme recklessness.  The D.C. Circuit also discussed the role of the underwriter and noted, pithily, that the underwriter is supposed to be a "trail guide, not a mere hiking companion."

The Dauphin County General Authority issued the bonds to finance the purchase of an office building in Harrisburg, PA.  At the time of the offering, the Pennsylvania Dept. of Transportation (PennDOT) was the substantial tenant in the building; however, the lease was scheduled to expire well before the maturity date of the bonds, and, as the underwriter knew, PennDOT planned to vacate the premises when repairs to its own building were completed.  Although a state official had mentioned that the state would use the space for other purposes, it made no commitments to do so.

The disclosure document contained cautionary language (in boldface caps): The leases are scheduled to expire prior to the maturity of the bonds; there is no commitment, requirement or guarantee that the [state] will renew or extend any of the office leases."  The Court said this disclosure was deficient and materially misleading because the underwriter had actual knowledge that PennDOT planned to leave the premises.  In addition, the projections assumed that the PennDOT leases would continue on the same terms.

The Court notes that Congress directs it to apply a "substantial evidence" standard in reviewing SEC orders, which the court describes as an "extremely deferential" standard.  Otherwise, this would be a cery close case, since the scienter standard is very high.