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National Examination Risk Alert

By the Office of Compliance Inspections and Examinations1

Volume II, Issue 3 March 19, 2012 

Strengthening Practices for the 

Underwriting of Municipal Securities

Background

In the aftermath of the 2008 financial crisis and related 

economic turmoil, there is greater awareness of the financial 

vulnerabilities faced by state and local governments. Thus, a 

current focus of the Commission’s National Examination 

Program (“NEP”) is the potential risk to investors in the 

municipal securities markets. Due to these potential risks, the

staff believes it appropriate to examine a range of 

broker-dealers’ municipal securities underwriting activities. 

In 1989, the Commission adopted Rule 15c2-12 (“Rule 

15c2-12” or the “Rule”) under the Securities Exchange Act of 

1934 (“Exchange Act”), which sets forth certain broker-dealer 

obligations when participating in an underwriting.

2

 The 

Commission also provided interpretive guidance about

broker-dealers’ obligations under the anti-fraud provisions of 

the federal securities laws to form a “reasonable basis” for 

offering new issues of municipal securities.3

 1

 The Securities and Exchange Commission (“SEC”), as a matter of policy, disclaims responsibility for any 

private publication or statement by any of its employees. The views expressed herein are those of the staff of 

the Office of Compliance Inspections and Examinations, in consultation with other SEC staff, including the 

Division of Trading and Markets and the Division of Corporation Finance, and do not necessarily reflect the 

views of the Commission or the other staff members of the SEC. This document was prepared by the SEC 

staff and is not legal advice.

 Most recently, the 

2 Exchange Act Release No. 34-26985 (June 28, 1989), 54 FR 28799 (July 10, 1989) (“1989 Adopting 

Release”). 

3 The “reasonable basis” requirement is often referred to as “due diligence,” which is the term used in this Risk 

Alert. See also Exchange Act Release No. 33741 (March 9, 1994), 59 FR 12748 (March 17, 1994) (“1994 

Interpretive Release”) (reaffirming the Commission’s interpretation of the obligations of municipal 

underwriters under the antifraud provisions of the federal securities laws).

In this Alert: 

Topic: Duties of broker-dealers 

engaged in municipal underwriting.

Key Takeaways: 

Examiners have observed that some 

broker-dealers have not maintained, 

nor did they require the maintenance 

of, adequate written evidence that they 

complied with their obligations under 

Securities Exchange Act Rule 15c2-12 

and applicable Commission guidance 

regarding due diligence and 

supervision.

This Alert provides a number of 

examples of effective practices 

identified by the staff that evidence due 

diligence and supervisory review. 

These include the use of commitment 

committees; due diligence memoranda; 

outlines for due diligence calls; and 

recordkeeping checklists.
2

Commission engaged in rulemaking in 2010 to amend Rule 15c2-12 in order to further enhance the 

quality and timeliness of information about municipal securities in the marketplace, and to update 

the Commission’s interpretive guidance regarding the obligations of underwriters.

4

Failure of a firm to comply with its due diligence obligation can lead to violations of the anti-fraud 

provisions of the federal securities laws, as well as Rule 15c2-12 and MSRB rules. Given these 

legal requirements, the Commission’s NEP has been concerned about the level of due diligence 

and supervision carried out by underwriters in connection with offerings of municipal securities. 

Thus, the examination staff has engaged in, and is currently engaging in, various examinations of 

broker-dealers’ municipal securities underwriting businesses so as to assess their compliance with 

applicable laws and rules. 

 

Municipal Underwriter’s Due Diligence Obligation

By participating in an offering, an underwriter makes an implied recommendation about the 

securities it is underwriting.5

 By holding itself out as a securities professional and, especially in 

light of its relationship with the issuer, a municipal underwriter also makes a representation that it 

has a reasonable belief in the truthfulness and completeness of the key representations made in any 

disclosure documents used in the offering.

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More specifically, Rule 15c2-12 requires a municipal securities underwriter to, among other 

things, “obtain and review” a “deemed final” official statement, prior to bidding for or purchasing 

securities in connection with the offering and also to reasonably determine that an issuer, or 

obligated person, has undertaken in writing to provide the MSRB with certain specified continuing 

disclosures, prior to the time the underwriter purchases or sells municipal securities in an offering. 

In the 2010 Release, the Commission updated its interpretive guidance and emphasized that:

 Thus, if the broker-dealer fails to undertake efforts to 

form such a reasonable belief, it may violate the antifraud provisions of the securities laws.

 4 See Exchange Act Release No. 34-62184A (May 26, 2010), 75 FR 33100 (June 10, 2010) (“2010 Release”). 

The compliance date for the rule amendment was December 1, 2010. 

5 See Exchange Act Release No. 34-26100 (Sept. 22, 1988), 53 FR 37778 (Sept. 28, 1988) (“1988 Proposing

Release”) at 37786. 

6 Id. (and cases cited therein). See also 1989 Adopting Release. The Commission confirmed its interpretation 

of municipal underwriter responsibilities from the 1988 Proposing Release in the 1989 Adopting Release and 

made a few modifications, among other things, adding that “the presence of a credit enhancement does not 

foreclose the need for a reasonable investigation of the accuracy and completeness of key representations 

concerning the primary obligor.” See, 1989 Adopting Release, 1989 WL 1113459 at p.*16. In addition, a 

municipal underwriter's due diligence obligation has been held to be primary and an obligation that cannot be 

delegated away (in terms of liability) to underwriter’s counsel. See, S.C. Nat’l Bank v. Stone, 139 

F.R.D.335,345 (D.S.C. 1991). Furthermore, MSRB Rule G-19 requires that “in recommending to a customer 

any municipal security transaction, a broker, dealer, or municipal securities dealer shall have reasonable 

grounds: (1) based upon information available from the issuer of the security or otherwise, and (2) based 

upon the facts disclosed by such customer or otherwise known about such customer, for believing that the 

transaction is suitable.” See MSRB Rule G-19(c) (Suitability of Recommendations and Transactions; 

Discretionary Accounts).
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• underwriters have a duty under the antifraud provisions of the federal securities laws, in 

both negotiated and competitively bid municipal securities offerings, to review the 

issuer’s or obligated person’s disclosures in a professional manner with respect to 

accuracy and completeness of statements made in connection with an offering;7

• it is important for underwriters to carefully evaluate the likelihood that an issuer or 

obligated person will comply on a timely basis with its disclosure undertakings;8 and

• underwriters should obtain evidence reasonably sufficient to determine whether and 

when annual filings and event notices, pursuant to an issuer’s or obligated person’s 

disclosure undertakings, were in fact provided, such as by a review of the municipal 

securities information repositories and the MSRB’s Electronic Municipal Market Access

(“EMMA”) system.9

In the 2010 Release, the Commission also stated that sole reliance on an issuer will not suffice in 

meeting an underwriter’s “reasonable basis” obligations. 10

Supervisory Obligations

The responsibility of broker-dealers to supervise their employees is a critical component of the 

federal regulatory scheme. In this regard, MSRB Rule G-27 requires broker-dealers to supervise 

the conduct of their municipal securities activities to ensure compliance with the rules of the 

MSRB and the applicable provisions of the Exchange Act and the rules thereunder. This 

supervision obligation would, of course, include supervision of compliance with Rule 15c2-12. 

MSRB Rule G-27, among other things, further requires broker-dealers to establish and maintain a 

system of supervision including written policies and procedures, annual examinations or testing of 

the system of supervision and a submission of a report to senior management, no less than 

annually, with a summary of the test results, and any additional or amended supervisory 

procedures to be adopted in light of such test results. 

Section 15(b) of the Exchange Act also authorizes the Commission to impose sanctions on a firm 

or any person that fails to reasonably supervise a person subject to their supervision that violates 

the federal securities laws. Section 15(b)(4)(E) provides an affirmative defense against a charge of 

failure to supervise where reasonable procedures and systems for applying the procedures have 

been established and effectively implemented without reason to believe that such procedures are 

 7 See 2010 Release; 1988 Proposing Release, 53 FR 37778, at 37787.

8 See 2010 Release.

9 See 2010 Release. The Commission stated that an underwriter’s reasonable belief should be based on its 

independent judgment, not solely on representations of the issuer or obligated person as to the materiality of 

any failure to comply with any prior undertaking. Id. 

10 See 2010 Release at 33124.
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not being complied with.11

 To rely on the defense in Section 15(b)(4)(E), a broker-dealer must 

develop a system for implementing its procedures that could reasonably be expected to prevent 

and detect securities law violations. However, establishing policies and procedures is not 

sufficient to discharge a person’s supervisory responsibility. It is necessary to implement measures 

to monitor compliance with those policies and procedures and an appropriate system of follow-up 

and review if red flags are detected. 12

Examination Purpose and Observations

 

The examinations have generally been designed to assess, among other things, municipal 

underwriters’ compliance with their underlying due diligence and supervisory obligations, as well 

as the specific provisions of Rule 15c2-12 and MSRB Rule G-27. 

In examining for these requirements, the examination staff is also looking for evidence that 

broker-dealers have: (i) created and maintained an adequate supervisory system and written 

policies and procedures setting forth the due diligence obligations of personnel carrying out the 

firm’s responsibilities under Rule 15c2-12 (e.g., public finance bankers and their supervisory 

personnel), including their obligations consistent with Rule 15c2-12 and applicable Commission 

guidance, MSRB rules and the antifraud provisions of the federal securities laws; and (ii) created 

and maintained adequate written evidence of their performance of their obligations under Rule

15c2-12, MSRB rules and the antifraud provisions of the federal securities laws for purposes of 

their own internal reviews of compliance with these rules and regulations by internal audit and/or

the compliance departments, as well as for Commission staff examinations. 

In its examinations, the NEP staff has observed that some broker-dealers may not be engaging in 

the type or extent of due diligence activities discussed in the Commission’s guidance on the 

subject. In addition, the NEP has observed instances where municipal underwriters have not 

maintained, nor did they require the creation and maintenance of, adequate written evidence that 

they complied with their due diligence obligations, including those under Rule 15c2-12 and 

applicable Commission interpretive guidance. Indeed, some firms have asserted that it is their 

specific policy not to maintain any due diligence records and have stated that “it is not industry 

practice” or that they are following advice from outside counsel.

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 11 In addition, MSRB Rule G-27 sets forth a broker, dealer or municipal securities dealer’s obligation to 

supervise its municipal securities activities and those of its associated persons and the requirements for a 

supervisory system, written supervisory procedures, internal inspections, review of correspondence, and a 

supervisory control system.

 Such an approach, however, 

makes it difficult for firms to demonstrate that they met their due diligence obligations and their 

duty to reasonably supervise with a view to preventing and detecting violations of the federal 

12 See, e.g., Staff Legal Bulletin No. 17, Remote Office Supervision (March 19, 2004). See also, e.g., Quest 

Strategies, Inc, Exchange Act Release No. 44935 (Oct. 15, 2001), Consolidated Investment Services, Inc., 

Exchange Act Release No. 36687 (Dec. 8, 1994) at 6; Gary E. Bryant, Exchange Act Release No. 32357 

(May 24, 1993).

13 While Rule 15c2-12 itself does not have an express record-keeping requirement, a firm may not be able to 

demonstrate compliance with that rule, and its supervisory responsibilities, without having evidence of its 

due diligence process and supervisory review thereof. 
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securities laws. This approach might lead to lax due diligence practices at a time when there are 

growing concerns over the fiscal well-being of some municipalities. 

The staff reminds the industry that, separate from documentation of due diligence, the Commission 

has provided a non-exclusive list of six factors that it believes generally would be relevant in 

determining the reasonableness of an underwriter’s basis for assessing truthfulness of key 

representations in a final official statement. These factors are:

• the extent to which the underwriter relied on municipal officials and other persons 

whose duties have given them knowledge of particular facts;

• the role of the underwriter (e.g., manager, syndicate member, selling dealer);

• the type of bonds being offered (general obligation, revenue, or private activity);

• the past familiarity of the underwriter with the issuer;

• the length of time until maturity of the securities; and

• whether the bonds are competitively bid or are distributed in a negotiated offering.14

To demonstrate compliance, underwriters of municipal securities should have adequate policies 

and procedures, including those relating to the firm’s and its associated persons’ compliance with 

its obligations. 

Examples of Municipal Securities “Due Diligence” Practices, Policies and Procedures

The following are examples of practices identified by the staff that evidence some due diligence

and supervisory review. Broker-dealers may, however, identify and implement other practices or 

controls that they believe are reasonably designed to meet their obligations under the federal 

securities laws, and the staff’s observations described above.

Clear Explanation of Regulatory Requirements and Firms’ Expectations

Some firms have fairly detailed written policies and procedures addressing the nature of the due 

diligence requirements under Rule 15c2-12, including a summary of applicable Commission 

guidance, and the firm’s expectations as to how their personnel can develop a reasonable basis for 

offering any municipal new issue securities. These policies and procedures also describe 

supervisors’ obligations in determining whether the diligence performed was adequate given the 

particular facts and circumstances. These supervisory policies and procedures make clear that that 

supervisors’ determinations are most effectively made in advance of the offering, but after the 

review of the “deemed final” official statement. Some firms also develop and include in their 

written policies and procedures other processes whereby supervisors may provide business 

approval to submit materials in response to an issuer request for proposal or qualification, or make 

 14 2010 Release at 91-92.
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their initial business determination whether or not to proceed in the diligence and underwriting 

process. 

Commitment Committees

Many broker-dealers have firm-wide, senior level commitment committees that review and 

approve various underwritings, including municipal securities underwritings. These commitment 

committees are in addition to “line of business” supervisory reviews, through a business level 

committee or otherwise. In advance of a scheduled commitment committee meeting, some firms 

require their personnel to submit a deal-specific set of materials to the committee for its review, 

prepared pursuant to written guidance and a template submission form. Such deal-specific

committee submissions may consist of a due diligence memorandum describing the diligence that 

was done, including a list of the diligence calls in which firm personnel participated, and also 

certain portions of the “deemed final” official statement (e.g., the financial and risk disclosures) 

for review by supervisors and the Committee. Some firms require that business supervisors 

formally approve the commitment committee material before it is provided to the committees, or 

for business supervisors to provide the material to the committee, with the written instruction that 

such approvals, or submission of materials, is designed to evidence the supervisor’s review of the 

material and a determination that the level of diligence that was performed was adequate. 

Such senior-level commitment committees can serve as an additional step in reviewing the 

diligence that was performed, with documentation that the transaction was approved, disapproved 

or was subject to additional diligence steps being performed. An added benefit of a firm-wide 

committee may be to instill discipline and rigor to the due diligence process and its documentation.

Some firms exempt certain underwritings from a firm-wide commitment committee process (e.g., 

based on credit ratings or commitment committee approvals of issuers previously reviewed by the 

committee within a certain period of time). In such cases, some firms require personnel to prepare 

the same or a similar form of submission as would be required for non-exempt underwritings, for 

provision to a committee chairperson, member (or an individual providing administration support 

to the committee), albeit without the need for a committee meeting. In this way, these firms’ 

policies and procedures reflect that due diligence and adequate supervision is required in respect of 

the specific offering and any changed circumstances, even though the firm as a matter of risk 

management has determined it is unnecessary to hold a formal commitment committee meeting.

Diligence “Checklists”

Some firms have also developed checklists to assist their personnel in recording the various 

diligence steps taken, including their review of the final or “deemed final” official statement and 

the results of an independent review of EMMA (and other data repositories for the time period 

prior to the development of EMMA). To evidence due diligence and supervisory review, such 

checklists may require substantial narrative describing due diligence steps that were undertaken. 

Such checklists may also include narrative responses relating to any past familiarity with the 
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issuer, and other factors relevant to forming a reasonable basis for offering new issue municipal 

securities.15

Due Diligence Memoranda

Some firms require public finance bankers to prepare a memorandum describing due diligence 

calls, issues noted and how they were resolved, as well as their review of the final or “deemed 

final” official statement. Such memoranda may be used in conjunction with checklists such as 

those described above, and as part of a submission to a commitment committee or other 

supervisory diligence review process.

Outlines for Due Diligence Calls

Underwriters’ counsel or issuer’s counsel often prepare outlines of disclosure issues to be 

discussed in due diligence calls in which the underwriters participate. Such outlines, particularly 

when accompanied by documentation of the responses to and resolution of such issues, may be 

helpful in evidencing an underwriters’ due diligence.16

On-Site Examination Activities

Some firms require their personnel to engage in various on-site examination activities, including 

meetings with municipal officials, visits to facilities and an examination of an issuer’s records and 

current economic trends and forecasts that bear on the ability of the issuer to pay its debt.

Recordkeeping Checklists

Some firms have developed recordkeeping checklists to assist personnel in maintaining records 

that evidence the due diligence that was performed, as well as specifying where such records 

should be maintained. 

Conclusion

Effective policies and procedures, as well as a supervisory system reasonably designed to prevent 

and detect violations of the federal securities laws are required for a firm to meet its due diligence 

and supervisory obligations. The above examples could assist a firm in: evidencing how the firm is 

meeting its obligation to perform due diligence sufficient to support its implied representation that 

it has formed a reasonable belief as to the accuracy and completeness of the statements in the 

offering documents; and documenting its municipal underwriting efforts. 

 15 Some firms have stated that where a review of EMMA/other repositories is delegated to underwriters’ 

counsel, underwriters’ counsel will not, or customarily does not, provide any letter or other written evidence 

that it reviewed EMMA along with its findings. Other firms, however, have a review of EMMA as part of a 

diligence checklist or form of memorandum to indicate that a review was performed (through outside counsel 

or otherwise). This review includes noting any failures by the issuer to comply with its continuing disclosure 

undertakings, and suggesting how to proceed in light of any such failings. Supervisors may then be able to 

review any instance where an issuer may have failed to comply with its continuing disclosure undertakings, 

the nature of such failures and how then to proceed.

16 If the responses to the outline questions are not recorded, the staff would look to other processes for evidence 

that diligence was performed and was the subject of supervisory review.
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The staff hopes that sharing observations from recent examinations is helpful to firms in 

strengthening their compliance and risk management programs, and welcomes comments and 

suggestions about how the NEP can better fulfill its mission to promote compliance, prevent fraud, 

monitor risk, and inform SEC policy. If you suspect or observe activity that violates the federal 

securities laws or otherwise operates to harm investors, please notify us at

http://www.sec.gov/complaint/info_tipscomplaint.shtml.

This Risk Alert is intended to highlight for firms risks that the staff has indentified in the course of examinations regarding 

municipal securities offerings. In addition, this Risk Alert describes factors that firms may consider to (i) assess their 

supervisory, compliance and/or other risk management systems related to these risks, and (ii) make any changes, as may 

be appropriate, to address or strengthen such systems. These factors are not exhaustive, nor will they constitute a safe 

harbor. Other factors besides those described in this Risk Alert may be appropriate to consider, and some of the factors 

may not be applicable to a particular firm’s business. While some of the factors discussed in this Risk Alert may reflect 

existing regulatory requirements, they are not intended to alter such requirements. Moreover, future changes in laws or 

regulations may supersede some of the factors or issues raised here. The adequacy of supervisory, compliance and other 

risk management systems can be determined only with reference to the profile of each specific firm and other facts and 

circumstances.