It's not news that the Securities and Exchange Commission (SEC) is cracking down on issuers of municipal bonds. Stepped-up enforcement has come in one wave after another since at least 1996, when the Orange County, Calif., bankruptcy spurred the SEC to target issuers suspected of violating municipal-securities laws. However, the recent case brought against Harrisburg, which the Pennsylvania capital city settled with the federal regulators, represents something significantly new and different.
There were clearly misstatements in Harrisburg's 2009 budget, which reported the city's credit as being rated Aaa by Moody's Investors Service when in fact by December 2008 Moody's had downgraded Harrisburg's general-obligation credit rating to Baa1. But the SEC also cited statements by then-mayor Stephen Reed in his 2009 state-of-the-city address about debt owed by a city authority for upgrades to its resource recovery facility. As Liz Farmer reported on Governing.com, the SEC noted that Reed's address "simply referred to the authority's debt as an 'issue that can be resolved' but failed to mention that Harrisburg had already made $1.8 million in guarantee payments on the resource recovery facility bond debt." The city was already having to step up to meet debt payments on the troubled facility.
There are at least three aspects of this case which I thought would generate significant discussion but which seem to have not:
First, the SEC's press release about the case notes that the city had not released audited financial statements from January 2009 through March 2011. Investors, the SEC said, "had to seek out Harrisburg's other public statements in order to obtain current information about the city's finances" but "very little information about the city's fiscal situation was publicly available elsewhere." You'd think it would be obvious to potential investors that if there's not much current information available about a city's finances they might want to think twice about buying its securities. But investors don't always exercise proper diligence, and it wouldn't have hurt for the SEC to have driven home that point.
Second, the city as an organization was charged with fraud based in part on the statements of a single individual, Mayor Reed. The city issues disclosure documents and should have complex processes in place to assure that those documents meet the equally complex requirements of securities law. Investors are buying securities issued by the city, a legal entity, and not by the mayor, a single political player. Holding the city and its taxpayers liable for the statements of any single city official, particularly statements made outside of the financial-disclosure arena, seems an enormous expansion of legal liability for cities. This is especially true for small jurisdictions in which the position of mayor is a part-time job often filled by individuals elected more for their passion and concern for their communities than for their financial sophistication.
Finally, in seeking to regulate the speech of the mayor (or any other public official), the SEC is bringing itself into conflict with the First Amendment, which prohibits a governmental entity from regulating political speech except when there is a compelling state interest. No such interest exists here. A state-of-the-city address is pure political speech. Typically, it touts the virtues of the jurisdiction and its accomplishments and lays out the elected leader's vision of the future, aiming to inspire his or her constituents. The mayor generally says something like: "We've accomplished much, we have much more to do, and this is how I want us to do it." The best of these speeches are truly moving. The worst will bore you to tears. But in no case will a state-of-the-city speech be improved by having it written by the jurisdiction's bond counsel and its financial advisers. That's what documents such as the Comprehensive Annual Financial Report (CAFR) are for.
Left unchallenged, the likely result of the Harrisburg case is that political speeches by elected officials will have to undergo the same scrutiny by lawyers and financial advisers that official financial statements are subject to -- with the result that they will become just as opaque, hedged-in and mind-numbing as the CAFR. We might get slightly better "disclosure" but probably less actual transparency and meaning.