SEC settles with California MA over breach of fiduciary duty

BY SourceMedia | MUNICIPAL | 09/26/23 12:25 PM EDT By Connor Hussey

The Securities and Exchange Commission has settled an administrative proceeding with municipal advisor Fieldman Rolapp & Associates as well as one of its principals, Anna Sarabian, for an alleged breach of the legal duty of care in connection with advice provided to an unnamed California city.

The Commission found that FRA and Sarabian violated Section 15(b)(c)1 of the Exchange Act of 1934 and Municipal Securities Rulemaking Board Rules G-17 on conduct of municipal securities and municipal advisory activities, in addition to MSRB Rule G-42 on the duties of non-solicitor municipal advisors.

Without admitting or denying the findings, FRA agreed to settle the charges, agreed to a cease-and-desist, and agreed to pay a $60,000 civil penalty, plus disgorgement of $56,548.50 and prejudgment interest of $11,368.77. Sarabian agreed to pay a civil penalty of $30,000.

The period in question ranges from October 2018 to July 2019, when FRA and Sarabian made a series of presentations to the unnamed California city to discuss the potential options for financing a community project.

"The city asked FRA to analyze the costs of certain financing options that ranged from using available funds without issuing new debt, financing the project entirely with debt with various maturity dates, and multiple hybrid options consisting of both cash and new debt with various maturity dates," the Commission said.

Under federal law, municipal advisors owe issuer clients a fiduciary duty, the highest standard of professional conduct which requires the client's best interests come before that of the MA. This was codified in the Dodd-Frank Act in 2010, and by subsequent SEC and MSRB rulemaking over the next several years.

Sarabian was the lead partner on FRA's engagement with the city, and was the point woman responsible for reviewing and editing the presentations. After the initial presentation, Sarabian attended several non-public meetings with individual city council members and employees to discuss the analysis presented.

The city eventually voted to approve the community project entirely with new debt and the measure was voted on during a public meeting.

According to the Commission, FRA's model incorrectly sold the idea that issuing long-term debt would be less expensive on a net present value than paying cash.

"The problem with FRA's conclusions arises from the difference between the interest rate the city would have to pay on the debt, and the interest rate the city could earn on its unspent cash," the Commission said. "By issuing debt to fund the project, the city would save its cash and put it into an account that, according to FRA's presentation, was estimated to earn 1.9% interest. However, the interest rate for the debt would be three%."

Given this arrangement, the interest rate on the debt was greater than the estimated savings interest rate, therefore the city would be paying more in debt service interest than it would be earning in interest on savings.

"It is less expensive to pay for the project up front in cash than to issue debt and debt payments," the Commission said.

Importantly, the firm failed to disclose to the city the assumptions it made in reaching its erroneous analysis, the SEC found.

Adam Bauer, chief executive officer for Fieldman Rolapp & Associates did not immediately respond to requests for comment.

In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible.

Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.