Banks and underwriters are beginning to respond to the Securities and Exchange Commission’s recent enforcement actions on limited offering disclosures by requiring investor letters and for some, forgoing the exemption even when they qualify.

That’s according to panelists at the SEC’s Municipal Securities Disclosure Conference on Wednesday, where panelists took the time to discuss the matter and what’s been happening in the market as a result.

“In talking to some of my clients, I understand that their policies and procedures internally have definitely tightened up with respect to this matter,” said Hillary Phelps, partner at Chapman and Cutler. “We’re seeing more involvement in internal counsel and oversight with these types of deals, a very similar reaction as observed in post MCDC, where the SEC is looking very carefully at a very specific issue.”

Rule 15c2-12 includes an exemption for underwriters engaged in limited offerings, where they can mandate that issuers do not have to provide continuing disclosures if the sale of securities is in denominations of at least $100,000 and sold to no more than 35 persons who are capable of evaluating the merits and risks of the prospective investment.

The Commission charged four underwriters for violations of the limited offering exemption in Sept. 2022 and dinged two others since. Litigation with Oppenheimer & Co. remains ongoing.

But now, as a result of these enforcement actions, underwriters are beginning to tell issuers that they must comply with 15c2-12, even when an offering would qualify for the exemption.

“I think that we’re going to see a move to just fully complying with 15c2-12, in terms of the offering documents and the continuing disclosure,” said Phelps. “We’re already kind of three quarters of the way there anyway and for various reasons, we have not historically complied, we haven’t had to comply, because we have gotten an investor letter with all the representations in there.”

There is nothing in SEC guidance that says an investor letter is sufficient to clear these disclosure hurdles, but it has historically been used by issuers to create a paper trail and cement certain representations. Phelps believes that going forward, there will likely be at least a minimum requirement of an investor letter on these types of deals. 

“I would imagine a lot of the banks are requiring them anyway,” said Phelps. “And issuers are thinking, wait a second, should I really be having my securities out in the market with limited disclosure, that could end up potentially in the hands of someone they’re not supposed to end up in?”

LeeAnn Gaunt, chief of the enforcement division’s Public Finance Abuse Unit said she wasn’t at liberty to discuss what is and isn’t sufficient, given one of the six cases brought forward is still in litigation. But she did say that in all of these cases no inquiry was made and that an investor letter is a kind of inquiry, that isn’t necessarily sufficient.

“I am aware of a thing called investor letters and I’m aware of other kinds of methods that firms use,” Gaunt said. “But I don’t think we were saying that there was one way to do it. I think the reasonable belief is our standard here, it’s written right into the rule,” she added. “I think it behooves underwriters to think about what is the basis of my reasonable belief and I think some policies and procedures around that to make it clear what you’ve done, that you’ve been reasonable and diligent in informing that belief, would be beneficial.”

There has also been some concern around the fact that most of these offerings are exempt securities under the Exchange Act of 1933 and that there has to be some expectation to hold onto these securities, even though they can be traded.

“That’s exactly right, there’s no restriction on them,” Gaunt said. “That’s the concern, you’re not compelled to hold them to maturity and in certain cases, I’m sure people do so. But the point is, we’re trying to avoid an indirect general distribution undermining the concept that this is a limited offering intended to be for a small number of people. That’s why they’re getting the benefit of less or no disclosure.”

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