Investing

SEC Charges Municipal Advisor for Failing to Disclose Conflict of Interest

Chris Lange

Published: March 15, 2016 1:15 pm

Last Updated: January 13, 2020 11:55 am

The U.S. Securities and Exchange Commission (SEC) recently charged Kansas-based Central States Capital Markets, its chief executive officer and two employees for breaching their fiduciary duty by failing to disclose a conflict of interest to a municipal client.

Note that this case is the agency’s first to enforce the fiduciary duty for municipal advisors created by the 2010 Dodd-Frank Act, which requires these advisors to put their municipal clients’ interests ahead of their own.

According to the SEC, Central States served as a municipal advisor to a client on municipal bond offerings in 2011, two of its employees, in consultation with the CEO, arranged for the offerings to be underwritten by a broker-dealer where all three worked as registered representatives. During this time, CEO John Stepp and employees Mark Detter and David Malone did not inform the client of their relationship to the underwriter or the financial benefit they obtained from serving in dual roles.

In the three offerings, Central States collected fees from the city for the municipal advisory work and received 90% of the underwriting fees paid to the broker-dealer.

Andrew J. Ceresney, director of the SEC’s Enforcement Division, commented:

By failing to disclose their financial interest in the underwriting of the City’s offerings, Central States — the City’s municipal advisor — and its employees deprived the City of the opportunity to seek unbiased financial advice. A municipal advisor’s first duty should be to its municipal client, not its own bottom line.

Jessica Kane, director of the SEC’s Office of Municipal Securities, added:

As 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.

Central States, Stepp, Detter and Malone breached their duty to the client by failing to disclose the conflict of interest. The order found that Detter and Malone were aware of the conflict and that Detter emailed Malone that “we should resign” as municipal advisor to serve solely as underwriter on the offerings.

In the report, the SEC concluded:

Central States agreed to settle the SEC’s charges by paying $289,827.80 in disgorgement and interest and an $85,000 civil penalty. Detter agreed to settle the charges by paying a $25,000 civil penalty and agreeing to a bar from the financial services industry for a minimum of two years. Malone agreed to settle the charges by paying a $20,000 civil penalty and agreeing to a bar from the financial services industry for a one-year minimum. Stepp agreed to settle the charges by paying a $17,500 civil penalty and agreeing to a six-month suspension from acting in a supervisory capacity with any broker-dealer, investment adviser, or municipal advisor.