The Securities and Exchange Commission (SEC) recently filed an enforcement action in federal court against the City of Miami (City) and its former budget director alleging securities fraud in connection with the City’s 2007 and 2008 annual financials and subsequent 2009 bond offerings. This lawsuit follows other aggressive SEC actions against state and local governments. It also highlights the SEC's continued increased scrutiny of the substance of primary and secondary municipal market disclosures as well as the related conduct of municipal officials.
The SEC’s complaint against the City focused on alleged improper conduct—and the consequent annual financials and bond offering disclosures—involving interfund transfers by the City. The SEC alleged that from 2007 to 2009, the City made transfers from capital project funds (which comprised monies restricted to specific purposes) to a general use fund to mask deficits in the general fund. The interfund transfers totaled $37.5 million, according to the SEC. The SEC asserted that these improper transfers falsely inflated the general fund balance to meet a reserve level requirement for that fund. Bolstering the City's general fund in this manner led ultimately to more favorable ratings by credit rating agencies on the City's 2009 bonds, according to the SEC.
The SEC claimed that the City made numerous material misrepresentations and omissions about the interfund transfers in its bond offering documents and its 2007 and 2008 annual financials. This included the failure to disclose the full amount or effect of the transfers to the general fund's budget and balance; the misstatement that transferred project funds were "unexpended" or "unused" when in fact the funds were allocated to and needed for specific projects; the failure to disclose that a portion of the transferred funds were restricted from interfund transfer; and the failure to disclose that the City had not adjusted its capital projects funds budget to reflect the transfers to the general fund.
The SEC charged that the City's former budget director arranged the improper transfers, misrepresented the true nature of transfers to City officials and others (including the rating agencies), and falsified justification for transfers in the City's internal records. The SEC asserted that the improper transfers came to light when the City's Office of Independent Auditor General issued a report in 2009 after conducting an annual compliance review.
In its complaint, the SEC pleaded claims against both the City and former budget director for violations of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 (and Rule 10b-5 thereunder); a claim against the former budget director for aiding and abetting the City's violation of Section 10(b)/Rule 10b-5; and a claim against the City for violations of a 2003 cease-and-desist order due to prior violations of the anti-fraud provisions. It is the first SEC action against a state or local government alleging a violation of a cease-and-desist order. The case is pending in the U.S. District Court for the Southern District of Florida.
This lawsuit highlights that state and local governments facing difficult budget decisions must be cognizant of the SEC’s increased scrutiny of their actions, and must ensure accurate and complete public financial disclosure of their transactions and their officials’ related conduct. State and local governments should also be sure that interfund transfers are properly accounted for in remaining fund balances and properly documented.
The SEC's current focus on the municipal market disclosures of state and local governments and the related conduct of their officials is also evident in another enforcement proceeding brought against the City of Victorville, California, and other defendants in late April 2013. There, the SEC alleged fraud arising from the offer and sale of tax increment municipal bonds issued in 2006 to 2008 by a redevelopment agency controlled by Victorville. The SEC alleged that a 2008 financing was premised on an assessed value for redevelopment property that was vastly inflated, which in turn resulted in disclosure of a false tax increment and false debt service ratios in bond offering documentation.
The SEC asserted that the City's Director of Economic Development and two investment bankers who worked on the offering for the City knew that the property’s assessed value was inflated and, as a result, that the disclosures to investors about the tax increment and debt service ratios were false. The SEC further alleged that the investment banker defendants engaged in a scheme to obtain construction and management fees improperly, which also was the predicate for an alleged failure-to-disclose violation. This case also illustrates the SEC's willingness to undertake a detailed investigation into particulars of a complicated municipal financing and assert disclosure violations based on allegedly improper conduct related to the financing structure.
Earlier this year, the SEC instituted an unprecedented cease-and-desist proceeding against the City of Harrisburg, Pennsylvania, for misleading investors in public statements (an annual State of City Address, and financial and budget reports) made separately from required bond disclosure documents (addressed in a May 29, 2013, article). The SEC also recently brought an enforcement action against the City of South Miami for allegedly failing to disclose improper arrangements with the private developer of a city parking and retail project that jeopardized the tax-exempt status of bonds held by investors. These recent proceedings foretell further aggressive investigation and litigation by the SEC concerning the adequacies of disclosures in municipal market transactions and financial reporting.
Ballard Spahr's Municipal Securities Regulation and Enforcement Group helps municipal market participants navigate a rapidly evolving regulatory, investigative, and enforcement environment, enabling them to anticipate and address compliance issues and respond effectively to investigations when necessary. If you have questions about this or for more information, please contact Scott M. Himes at 212.223.0200 or firstname.lastname@example.org, Tesia N. Stanley at 801.517.6825 or email@example.com, or any other member of the Group.