SEC Charges Wachovia With Section 17(a) Generally

The SEC’s Municipal Securities and Public Pensions Unit brought a fairly significant municipal securities bid-rigging case against Wachovia on December 8th. According to the SEC’s complaint and press release, Wachovia won bids for business by “fraudulently rigg[ing] at least 58 municipal bond reinvestment transactions in 25 states and Puerto Rico.” 

The SEC says the bank did this in two primary ways. First, Wachovia obtained advance information about competing bids from bidding agents, who ostensibly worked for the municipalities. Second, Wachovia won bids through “set-ups” in which the bidding agent deliberately obtained non-winning bids from other banks in order to rig the field in Wachovia’s favor. Wachovia also at times submitted fake bids so others could win their share of rigged business. The complaint repeatedly refers to Wachovia’s “fraudulent practices”; it’s not pretty. The Commission is getting beaten up in the usual quarters for the neither-admit-nor-deny language included in the settlement papers. 

But I am mostly interested in Section 17(a) of the Securities Act of 1933, the statute the SEC says Wachovia violated.  And unfortunately, I’m going to have to quote most of it here.  It reads: It shall be unlawful for any person in the offer or sale of any securities . . . by the use of interstate commerce or . . . the mails--

(1)   to employ any device, scheme, or artifice to defraud, or (2)   to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or (3)   to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.

The courts interpreting this language have generally held that to violate subsection (1) of this statute, one’s mental state has to be quite high on the spectrum of intent. That is, one has to have defrauded another intentionally or with severe recklessness. Subsections (2) and (3), on the other hand, require only negligence. Needless to say, defendants would much rather settle to claims under the latter two subsections than the first. It can make the difference between being able to continue one’s securities business and being permanently barred from it.

Here, the complaint made no distinction between the different subsections. Wachovia is paying disgorgement, prejudgment interest and a civil money penalty for violating Section 17(a) generally. Admit, deny, or whatever, Wachovia cannot exactly say that it settled to a negligence-based charge. We only remember this happening once before, with the SEC’s fiercely contested CDO case against Goldman Sachs in 2010.  Settling to Section 17(a) generally there allowed SEC Enforcement Director Rob Khuzami to say in interviews that dropping the Rule 10b-5 claim was insignificant because that rule and Section 17(a)(1) are “virtually overlapping and co-extensive.” And that is basically true, though it's not true for Sections 17(a)(2) and (3). But because of the way the claims were pled, neither Goldman nor Wachovia can easily say they walked away with negligence-based charges only. It will be interesting to see if the SEC takes this approach more frequently in the future.