Published on Mar 15th, 2016 | Posted in Articles

The Securities and Exchange Commission today charged Kansas-based Central States Capital Markets, its CEO, and two employees for breaching their fiduciary duty by failing to disclose a conflict of interest to a municipal client.  The case is the SEC’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’s order, while 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.  The order found that Central States CEO John Stepp and employees Mark Detter and David Malone did not inform the client, identified in the order as “the City,” of their relationship to the underwriter or the financial benefit they obtained from serving in dual roles. 

Municipal advisors advise municipal and conduit borrowers about the terms of offerings, including interest rates, the selection of underwriters, and underwriting fees.  In the three offerings, Central States collected fees from the City for the municipal advisory work and received 90 percent of the underwriting fees the City paid to the broker-dealer.  The SEC’s order found that Central States, Stepp, Detter, and Malone, breached their duty to the City 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.

“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,” said Andrew J. Ceresney, Director of the SEC’s Enforcement Division.  “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 said, “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.”

Without admitting or denying the findings, Central States, Detter, Malone, and Stepp consented to the SEC’s order that they cease and desist from similar future securities-law violations and violations of Rule G-17 of the Municipal Securities Rulemaking Board (MSRB) that requires advisors to deal fairly with their clients.  Detter, Malone, and Stepp also agreed to cease and desist from future violations of MSRB Rule G-23 that bars those acting as municipal advisors on a bond offering from underwriting that offering.

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.

The SEC’s investigation was conducted by Municipal Securities and Public Pensions Unit members Sally Hewitt, Eric Celauro, Jason Howard, Jon Wilcox, Brian Fagel, and Deputy Chief Mark Zehner, with assistance from members of the SEC’s National Exam Program in the Chicago Regional Office, including Thomas J. Meier, Stephen G. Vilim, Ambar Freyre, and Thomas F. Murphy.