Former Rochester MAs, SEC battle over alleged conflict of interest

Capital Markets Advisors and its two co-principals Richard Ganci and Richard Tortora, former municipal advisors for the City of Rochester, New York, are in a legal back and forth with the Securities and Exchange Commission over whether the municipal advisor’s conduct constitutes a conflict of interest as defined in MSRB Rule G-42.

That’s the latest in the case the SEC has mounted against the City of Rochester, New York, its former finance director Rosiland Brooks-Harris, former Rochester City School District chief financial officer Everton Sewell and the municipal advisors over a $119 million bond offering in 2019. The case is in what may be the final stretch in Federal District Court for the Western District of New York.

The Commission argued in its original complaint that the defendants “misled investors with bond offering documents that included outdated financial statements for the Rochester City School District and did not indicate that the district was experiencing financial distress due to overspending on teacher salaries.” The SEC found that the district was facing at least a $25 million budget shortfall. 

The SEC’s individual complaint against the MAs alleges that CMA, Ganci and Tortora failed to disclose to its nearly 200 municipal clients that CMA had material conflicts of interest arising from its compensation arrangements. 

The Commission then moved for summary judgment on the regulatory claims, arguing that MSRB Rule G-42 on conflicts of interest sets forth a non-exhaustive list of conflicts deemed material, which includes that an MA’s compensation “is contingent on the size or closing of any transaction as to which the municipal advisor is providing advice,” the motion said.

“Per the MSRB, contingent compensation presents a material conflict of interest because the municipal advisor has a financial incentive to recommend closing on an unfavorable transaction to obtain payments; alternatively, the municipal advisor has a financial incentive to recommend a bigger-than-necessary debt issuance to increase its fee,” the motion said.

The Commission also argued that CMA admitted that it worked on several deals where CMA’s compensation depended, at least in part, on the size and/or closing of a municipal entity’s debt issuance, and that CMA also admitted that it never disclosed to clients that these contingent fee arrangements gave rise to material conflicts of interest.

“These twin admissions require summary judgment be entered in favor of the Commission,” the motion said.

In its counter motion for summary judgment to dismiss the claims, CMA argued that the Commission’s “sole basis for the alleged violation of Rule G-42 is that CMA failed to affirmatively state to its clients that the portion of CMA’s compensation that was contingent on the sale of securities by the client automatically created a material conflict of interest concerning CMA’s financial advice to those clients,” the motion said. “In other words, no CMA client suffered any financial harm in any way or was misled in any way concerning CMA’s compensation and the SEC’s complaint does not allege any such harm occurred.”

The Commission then countered, saying that these assertions were beside the point and are included to mask the absence of any colorable defense to the Commission’s claims.

CMA followed up, writing that “there is no allegation that CMA’s compensation was not fully disclosed to all of its clients or that any client misunderstood in any way the compensation to be paid to CMA,” the court filing said. 

“According to the plaintiff Securities and Exchange Commission, none of those facts matter. Instead, the SEC asks this Court to adopt an interpretation of MSRB Rule G-42 that would require registered Municipal Advisors such as CMA to lie to their clients by falsely representing that each and every time a municipal client wants to pay for municipal advisory services with a contingent fee arrangement, regardless of the actual facts concerning the fee structure, such a fee arrangement automatically creates a material conflict of interest between the advisor and the client,” the filing said. “Such an interpretation of Rule G-42 makes no sense, conflicts with the language of Rule G-42, and would violate the First Amendment to the United States Constitution by compelling speech by CMA that does not represent CMA’s point of view and is simply not true.”

The SEC then responded with another rebuttal, taking particular issue with the assertion that this interpretation violates the First Amendment by compelling speech, and arguing that CMA did not assert this defense in moving for summary judgment.

“They should not be heard on a new theory raised after the close of pleadings, after the conclusion of discovery, after the parties had stipulated to the material facts, and after the time for seeking summary judgments,” the Commission’s response said.

Lawyers for both CMA and the SEC did not respond to requests for comment for this story.

Oral arguments for this case are scheduled for Feb. 15.

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