Municipal Bond Participants:
The Issuer
Injunctive Proceedings
Securities and Exchange Commission v. Robert D. Gersh, Boston Municipal Securities, Inc., and Devonshire Escrow and Transfer Corp., Civ. Action No. 95-12580 (RCL) (D. Mass.), Litigation Release No. 14742 (November 30, 1995) (complaint).
The Securities and Exchange Commission announced the filing of a complaint in the United States District Court for the District of Massachusetts, seeking a temporary restraining order, preliminary and permanent injunctions, disgorgement, civil monetary penalties and an asset freeze and other equitable relief against Defendants Robert D. Gersh ("Gersh"), of Burlington, Massachusetts, Boston Municipal Securities ("BMS"), and Devonshire Escrow and Transfer Corp. ("Devonshire") and Relief Defendants Ma'Ayan Book Company, Charles River Landing, Ltd., CRL Group, Inc., Culinary Classics of Chestnut Hill, Inc., Culinary Classics of Burlington, Inc., The Kitchen Shelf, Inc. and the Compu-Bill Co., Inc. ("Relief Defendants"). The complaint alleges violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and Section 17(a) of the Securities Act of 1933.
On November 30, 1995, the Honorable Reginald C. Lindsay granted the Commission's request for an ex parte Temporary Restraining Order, and an order freezing assets of the Defendants and Relief Defendants, requiring an accounting of these assets and granting other relief. A Hearing on the Commission's application for a Preliminary Injunction has been set for December 12, 1995.
The complaint alleges that from early 1990 to the present, Defendant Gersh and two of his wholly-owned corporate entities, Defendants BMS and Devonshire, offered and sold securities in the form of Certificates of Participation ("COPs") in 34 securities offerings which raised approximately $14 million from investors in at least six states. In connection with the offer and sale of these securities, the complaint alleges that the Defendants have engaged in continuing fraudulent acts which include the misappropriation of over $7 million in investor funds.
The complaint alleges that, to induce public investors to invest in these COPs, the Defendants marketed the offerings as tax-exempt municipal securities, collateralized by equipment leases entered into by state and local governments. The Defendants made multiple false statements and omissions of material fact. These included falsely promising that investments were fully-secured by state and municipal obligations, that Gersh would merely pass-through the collateral payments to investors and that a trustee would protect the interests of investors. In fact, however, Gersh only used a portion of the proceeds to invest in state and local government leases. Gersh commingled the proceeds of the investments and misappropriated the monies to invest in a variety of personal business ventures. The complaint further alleges that Gersh's failure to use investor proceeds as represented deprived investors of information material to an assessment of the tax-exempt status of the COPs.
The complaint further alleges that Gersh falsely represented that a portion of investor monies would be set aside in a debt service reserve account, failed to disclose that he exercised control over the trustee, and falsely represented that the COPs were issued pursuant to the authority of state or local government agencies. On July 1 and September 1, 1995, Gersh defaulted on two COPs issues, the State of Washington Series 1990A ($380,000) and the State of Wisconsin Series 1990A ($380,000), respectively, and those funds have not been repaid to investors.
According to the complaint, additional COPs defaults are imminent. Approximately $2,220,000 of the COPs securities, consisting of the State of Florida Series 1990A ($1,250,000), the State of Wisconsin Series 1990B ($270,000) and the City of Providence, Rhode Island Series 1990B ($700,000), mature on December 1, 1995. Three other Gersh COPs issues, consisting of the Westchester County, NY 1981 G Lane ($415,000), Livingston County, NY ($400,000) and Onondaga County, NY ($805,000), mature on December 31, 1995, January 31, 1996 and December 15, 1996, respectively. Gersh-controlled bank accounts currently contain only $319,000 and nearly all of the leases securing the outstanding COPs have been prepaid. Gersh has no other apparent source of funds available to repay COPs investors. Accordingly, the complaint alleges that expedited action is necessary to preserve remaining assets and assure an equitable distribution of any remaining funds to all investors.
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Securities and Exchange Commission v. Robert D. Gersh, Boston Municipal Securities, Inc., and Devonshire Escrow and Transfer Corp., Litigation Release No. 15310 (March 31, 1997) (settled final order).
The Commission announced that, on March 20, 1997, the Honorable Reginald C. Lindsay of the U.S. District Court for the District of Massachusetts enjoined Robert D. Gersh ("Gersh"), Boston Municipal Securities, Inc. ("BMS") and Devonshire Escrow and Transfer Corp. ("Devonshire") from further violations of certain antifraud provisions of the securities laws. The complaint, filed on November 29, 1995, alleged that the defendants had conducted a fraudulent offering of $14 million in securities in the form of certificates of participation ("COPs").
Gersh, BMS and Devonshire consented to the injunctive orders without admitting or denying the complaint's allegations. Gersh was also ordered to disgorge $7,451,935, plus prejudgment interest thereon, provided, however, that payment of $5,949,185 of such amount, plus the prejudgment interest, was waived based on his demonstrated inability to pay.
The complaint alleged that from early 1990 to the present, Defendant Gersh and two of his wholly-owned corporate entities, Defendants BMS and Devonshire, offered and sold COPs in 34 securities offerings which raised approximately $14 million from investors in at least six states. In connection with the offer and sale of these securities, the complaint alleged that the defendants made numerous misrepresentations and omissions of material facts and misappropriated over $7 million in investor funds.
The complaint alleged violations of the antifraud provisions of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and Section 17(a) of the Securities Act of 1933 and sought a temporary restraining order, preliminary and permanent injunctions, disgorgement, civil monetary penalties and an asset freeze and other equitable relief. On November 30, 1995, the Court issued a temporary restraining order and asset freeze against the defendants. In addition, on December 11, 1995, the Court granted the Commission's motion for appointment of a receiver to take control of the assets of the corporate and relief defendants, and those assets are being operated by the receiver for the benefit of investors. On January 12, 1996, after a hearing, Judge Lindsay granted the Commission's request for a preliminary injunction against the defendants. (For further information, See Litigation Release Nos. 14742 and 14785).
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SEC v. San Antonio Municipal Utility District No. 1, et al., Civ. Action No. H-77-1868 (S.D. Tex.), Litigation Release No. 8195 (November 18, 1977) (settled final order).
The Securities and Exchange Commission announced the filing of a complaint in the U.S. District Court in Houston seeking to enjoin San Antonio Municipal Utility District No. 1 ("District"), San Antonio Ranch Ltd., No. 1 ("Developer") and Surety Savings Association ("Surety") from further 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 arising from the offer to sell, sale and purchase of municipal securities namely, $2.5 million Unlimited Tax Bonds Series 1976 bearing a coupon interest rate of 9.03% issued by the District.
The District is a raw land district in Bexas County, Texas. The Developer owns 99% of the land within the District, which was formed in connection with a real estate development. Surety, a savings and loan association, purchased the Bonds pursuant to a commitment to bid and later resold $1.575 million of the Bonds.
The Complaint alleges that the disclosure documents used in connection with the offering and sale to the public of the District's Bonds omitted to disclose a multifaceted financing agreement entered into in April, 1976, by the Developer and Surety and omitted to disclose financial information about the Developer.
The financing agreement included commitments by Surety to bid and purchase the Bonds, to make land refinancing ($6.5 million) and development ($2.5 million) loans to the Developer and affiliates, and to purchase $3,000,000 in notes or securities from the Developer or its designees; and commitments by the Developer to purchase $5.5 million of real estate paper from Surety, $20 to $25 million in whole life insurance from a mutually acceptable life insurance company and to participate in a joint venture to purchase $1 million of real estate from Surety. Large portions of the proceeds of the land refinancing and development loans were used to fund the cost of the purchase of the real estate paper.
The District, the Developer and Surety, without admitting or denying the allegations of the Complaint, consented to the entry of orders of permanent injunction enjoining them from further violating the aforementioned provisions of the Federal Securities laws.
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SEC v. Whatcom County Water District No. 13, et al., Civ. Action No. C77-103, (W.D. Wash.), Litigation Release No. 7810 (March 7, 1977) (complaint).
Jack H. Bookey, Administrator of the Seattle Regional Office of the Securities and Exchange Commission, announced today that a complaint was filed in the United States District Court for the Western District of Washington at Seattle, Washington on February 10, 1977 seeking an injunction against Whatcom County Water District No. 13, County of Whatcom, Washington (the District), Steven J. Isenhart (S. Isenhart), Thomas E. Isenhart (T. Isenhart), Kristine L. Isenhart (K. Isenhart), all of Sumas, Washington, Harold E. Isenhart (H. Isenhart) of Lynden, Washington and James E. Isenhart, Jr. (J. Isenhart) of Maple Falls, Washington to enjoin them from further violations of the anti-fraud provisions of the federal securities laws in connection with the offer and sale of the District's water and sewer revenue bonds. As to the defendant District, the complaint also seeks an order requiring it to disclose the injunction to existing and future investors and to issue a disclosure statement to existing investors setting forth the substantive and material elements of the bond issue including a correction of the material misrepresentations and omissions alleged in the complaint.
The complaint alleges that the defendants, directly or indirectly, sold $1,200,000 of Whatcom County Water District No. 13, Water and Sewer Revenue bonds, Series A, the principal and interest on which are repayable from assessments against real estate lots, to be sold in a real estate development called Peaceful Valley Subdivision which is being developed and promoted by the individual defendants. The District was formed by a petition signed by S. Isenhart, T. Isenhart and K. Isenhart to local authorities resulting in the appointment of the petitioners as commissioners of the District. The commissioners Isenhart resolved that the District Place on the ballot, during the state general elections in November, 1975, a proposition for a bond issue by the District of $4,500,000. The proposition received an unanimous vote by the residents of the District, namely, S. Isenhart, T. Isenhart, K. Isenhart and the wife of S. Isenhart.
The allegations state that the sales of Series A of the approved bond issue were made through the use of material misrepresentations and omissions in that investors were led to believe: that real estate lots in Peaceful Valley Subdivision were available for sale or had been sold when, in fact, no lots had been sold; that the defendants would be responsible for repayment of the bond principal and interest in event of defaults on the assessments or if the real estate lots are not sold when, in fact, such assurances were not part of the bond issue and the defendants did not disclose any capability of fulfilling such financial responsibility; that the defendants owned the real property free and clear when, in fact, there were substantial underlying real estate contracts, mortgages, deeds of trust and security interests; that the District was offering the bonds at a discount because of savings through not having an underwriter or by not having the bonds rated when, in fact, the District had been unable to acquire an underwriter because of the high degree of risk in the bonds and that the bonds could not be rated by recognized national rating services; that the District's Commissioners were independent from the developers when, in fact, the commissioners of the District had an interest, directly or indirectly, in the development of Peaceful Valley Subdivision and are related to each other through birth or marriage; and, investors received no financial information for either the District, or the individual defendants.
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SEC v. Whatcom County Water District No. 13, et al., Litigation Release No. 7592 (May 10, 1977) (settled final order).
Jack H. Bookey, Administrator of the Seattle Regional Office of the Securities and Exchange Commission, announced today that Decrees of Permanent Injunction were entered on April 27, 1977, by the Honorable Walter T. McGovern, Chief Judge, United States District Court for the Western District of Washington at Seattle, Washington, against Whatcom County Water District #13, County of Whatcom, Washington (District), Steven J. Isenhart, Thomas E. Isenhart, Kristine L. Isenhart, all of Sumas, Washington, Harold E. Isenhart of Lynden, Washington and James E. Isenhart, Jr. of Maple Falls, Washington enjoining them from further violations of the anti-fraud provisions of the federal securities laws in connection with the offer and sale of the District's water and sewer revenue bonds. As to the defendant District, the decree orders it to disclose the injunction to existing and future investors and to issue a disclosure statement to existing investors setting forth the substantive and material elements of the bond issue including a correction of the material misrepresentations and omission alleged in the complaint within 120 days of the date of the decree.
The defendants consented to the Decrees of Permanent Injunction without admitting or denying the allegations of the complaint. For further information, see Litigation Release No. 7810.
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SEC v. Washington County Utility District, et al., Civ. Action No. 2-77-15 (E.D. Tenn.), Litigation Release No. 7782 (February 15, 1977) (complaint).
Jule B. Greene, Administrator of the Atlanta Regional Office, announced that on February 1, 1977, a complaint was filed in the U.S. District Court at Greeneville, Tennessee, against Washington County Utility District ("WCUD"), of Washington County, Tennessee, Wade H. Patrick, Paul G. Puckett, Henry C. Miller, and Stella B. Harwood, all of Johnson City, Tennessee, Diversified Securities, Inc., a New York corporation, Thomas R. Alcock, of Hingham, Massachusetts, and Hertz N. Henkoff, of Boston, Massachusetts, alleging violations of the anti-fraud provisions of the federal securities laws in connection with the offer for sale and sale of revenue bonds of WCUD.
The complaint alleges that the defendants have made numerous untrue statements of material facts with respect to the use of the proceeds obtained from the sale of the securities; the purposes for which the bonds were issued; the priority of liens on property owned by WCUD or its divisions; the sufficiency of revenues from WCUD projects to meet operating expenses and to pay interest and principal on the bonds as due; and other matters. Furthermore, the complaint alleges that the defendants have omitted to state numerous material facts, specifically including the fact that WCUD bonds were sold at very substantial discounts to the fiscal agent, Alcock; that proceeds from the sale of the bonds were being utilized for unauthorized purposes such as loans to Patrick, the manager of WCUD, and to companies controlled by him or his relatives, and to pay interest on prior bond issues; and that Patrick was receiving from Alcock portions of the fiscal agent's fees.
In addition to injunctive relief, the complaint seeks an accounting, impressment of a trust upon the assets of the individual defendants, and disgorgement of illegally obtained benefits.
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SEC v. Washington County Utility District, et al., Litigation Release No. 7868 (April 14, 1977) (default entered).
Jule B. Greene, Administrator of the Atlanta Regional Office of the Securities and Exchange Commission, announced that on March 30, 1977, the Honorable Charles G. Neese, Judge of the United States District Court for the Eastern District of Tennessee, Northeastern Division in Greeneville, issued orders of preliminary and permanent injunction from further violations of the anti-fraud provisions of the federal securities laws against Washington County Utility District ("WCUD"), of Washington County, Tennessee, a "municipality or public corporation", Commissioners Paul G. Puckett of Johnson City, Tennessee, and Stella B. Harwood of Jonesboro, Tennessee and Hertz N. Henkoff of Boston, Massachusetts, an attorney who served as bond counsel for several issues of revenue bonds of WCUD.
WCUD was further directed to make an accounting of the receipt and disbursement of all funds received in connection with all revenue bonds it has issued.
Puckett and Harwood were ordered to disgorge certain bonds of WCUD in their possession and to pay over to the Clerk of the Court for the benefit of bondholders the proceeds from the sale of certain other bonds of WCUD.
In addition, Judge Neese signed an order of preliminary injunction with respect to Wade H. Patrick of Johnson City, Tennessee, the manager of WCUD and ordered that a trust be impressed upon all of his assets and that he make an accounting of all income, property or other assets received by him from WCUD or from another source as a result of activities involving WCUD.
Between 1965 and 1975 WCUD had made seven different bond offerings; four for its garbage division ($2,175,000) and three for its cable antenna television division ($1,500,000).
The complaint alleged numerous untrue statements of material facts concerning, among other things, the use of the proceeds obtained from the sale of revenue bonds issued by WCUD; the purposes for which the bonds were issued; the priority of liens of the bondholders on property owned by WCUD or its divisions; and the sufficiency of revenues in each division of WCUD to meet expenses including debt service. The complaint also alleged numerous omissions to state material facts including the following: that WCUD bonds were sold at substantial discounts, ranging from 10 to 42 percent; that WCUD prior to 1975 failed to have audited financial statements prepared; that WCUD was not making payments into a sinking fund to retire the bonds outstanding; that proceeds from the sale of bonds were used for purposes other than represented in prospectuses or authorized in the bond resolutions, such as loans to Patrick and companies controlled by Patrick or his relatives, payment of interest on prior issues of bonds, and loans or advances to other divisions of WCUD.
The individual defendants consented to the relief requested; the decree against WCUD was entered by default. For further information, see Litigation Release No. 7782.
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SEC v. Reclamation District No. 2090, et al., Civ. Action No. 76-1231-SAW (N.D. Cal.), Litigation Release No. 7460 (June 22, 1976) (complaint).
Gerald E. Boltz, Regional Administrator of the Los Angeles Regional Office, and Michael J. Stewart, Acting Associate Regional Administrator of the San Francisco Branch Office, announced the filing of a complaint in the United States District Court for the Northern District of California on June 17, 1976, against Reclamation District No. 2090 [County of Contra Costa, California] ("the District") a quasi-governmental agency of the State of California; Max H. Mortensen ("Mortenson") of Oakland, California; John B. Schoenfeld ("Schoenfeld") and Lowell C. Lundell ("Lundell") of Atherton, California; Robert D. Lewis ("Lewis") and Urban J. Schreiner ("Schreiner") of Palo Alto, California; James H. Dondich ("Dondich"), also known as James Harold, of Santa Ana, California; Louis M. Mayo ("Mayo") of Havertown, Pennsylvania; National Municipal Bond C., Inc ("National") and Roger W. Osness ("Osness") of St. George, Utah; Roy J. Jackson ("Jackson") of Ogden, Utah; MFAI Associates ("MFAI") of Inglewood, California; Lawrence A. Luebbe ("Luebbe") of Los Angeles, California; Benchmark Securities, Inc. ("Benchmark") and Sheldon Fidler ("Fidler") of Beverly Hills, California; Arnold Phillips ("Phillips") of Sherman Oaks, California; All-States Tax exempt Securities, Inc. ("All-States"), Pasquale A. Tamburri ("Tamburri"), also known as Pat Tamburri, and Jules L. Steele ("Steele") of Clearwater, Florida; George E. Grills ("Grills") of Dunedin, Florida; and Norton McGiffin ("McGiffin) of North Largo, Florida, Alleging violations and aiding and abetting of violations of the anti-fraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934, in connection with the offer and sale of approximately $2.2 million in debt securities of the District 161 persons residing in 12 states.
The Complaint alleges that Schoenfeld, Lundell and Lewis are each members of a group which, in 1971, privately purchased approximately 80 per cent of the land encompassed by the District. Subsequently, in 1973, acting in their capacity as Trustees of the District, they jointly authorized the District to purchase that land at a profit to the owning group of approximately $395,000. Thereafter, they voted to authorize the issuance by the District of the bond anticipation notes and promissory notes for the purpose of raising revenues, in part to be used to repay the District's obligation to the selling group. Defendants Schoenfeld, Lundell and Lewis each received a portion of the proceeds from the sale of the said promissory notes.
The Commission's Complaint also alleges that the District, its Trustees Schoenfeld, Lundell and Lewis, its general manager Mortensen, its bond counsel Schreiner, and Dondich, Mayo, National, Osness, Jackson, MFAI, Luebbe, Benchmark, Phillips and Fidler, variously, prepared, authorized, offered, sold and delivered general obligation bond anticipation notes ("bond anticipation notes") issued by the District in violation of the anti-fraud provisions of the general securities laws.
The Complaint charges that the face of the bond anticipation note itself contains misrepresentations of material facts and omits to state material facts concerning among other things: (1) the revenues available to repay the bond anticipation notes; (2) the availability of sources of funds other than revenues to repay the bond anticipation notes; (3) the insufficiency of the District's tax base to generate enough funds to repay the bond anticipation notes; and (4) the absence of any liability of the State of California and the County of Contra Costa to repay the bond anticipation notes.
The Complaint further alleges that the District, Mortensen, Mayo, National, Osness, Jackson, MFAI and Luebbe variously prepared and delivered false and misleading offering circulars and that Benchmark, Phillips and Fidler caused to be prepared and prepared television advertisements purporting to describe the District's bond anticipation notes. The Complaint asserts that these offering circulars and television advertisements contained false and misleading statements and omitted to state material facts concerning, among other things: (1) the use of proceeds derived from the note sales; (2) the underwriting discounts and commissions received by the sellers of the bond anticipation notes; (3) the financial condition of the District; (4) the operating history of the District; (5) the debt structure of the District; (6) the absence of approval by the Treasurer of the State of California for the issuance by the District of general obligation bonds; and (7) the risk factors involved in a purchase of the District's bond anticipation notes.
The Complaint also alleges that Mortensen made misrepresentations and omitted to state material facts regarding the productive capability and financial prospects of the District, and the ability of the District to repay the bond anticipation notes; that Schreiner made misrepresentations and omitted to state material facts regarding his investigation into the legality and validity of the issue and the value purportedly received by the District in exchange for the bond anticipation notes; and that National, Jackson, MFAI, Luebbe, Benchmark and Fidler made misrepresentations and omitted to state material facts concerning the basis for their recommendations to buy the District's bond anticipation notes. Finally, in connection with the bond anticipation note sales, Dondich, Mayo and Osness are alleged to have made misrepresentations and omitted to state material facts to a purchaser regarding the marketability and security of the District's bond anticipation notes.
The Complaint further alleges that the District, its Trustees Schoenfeld, Lundell and Lewis, its general manager Mortensen, its bond counsel Schreinger, and All-States, Tamburri, Grills, McGriffin and Steele authorized, prepared, offered, sold and delivered general obligation negotiable promissory notes ("promissory notes") issued by the District. The Complaint asserts that these promissory notes on their face made the same misrepresentations and omitted the same material facts as the bond anticipation notes.
The Complaint further charges that All-States, Tamburri, Grills, McGriffin and Steele variously prepared and delivered offering circulars purporting to describe the District's promissory notes. The Complaint alleges that the offering circular contained false and misleading statements and omitted to state material facts to investors concerning, among other things: (1) the use of proceeds derived from the note sales; (2) the underwriting discounts and commissions received by the sellers of the promissory notes; (3) the financial condition of the District; (4) the operating history of the District; (5) the debt structure of the District; and (6) the risk factors involved in a purchase of the District's promissory notes.
In addition, the Complaint charges that: Mortensen made misrepresentations and omitted to state material facts concerning: (1) the financial condition and (2) productive capability and financial prospects of the District, and (3) the existence of funds to repay the promissory notes; that Schreiner made misrepresentations and omitted to state material facts concerning: (1) the use of proceeds of the note issue; (2) the failure of the District to generate revenues from operations; and (3) the basis upon which he rendered his legal opinion with respect to the promissory notes; and that All-States, Tamburri, Grills, McGriffin and Steele Variously made misrepresentations and omitted to state material facts concerning: (1) the bases for their recommendations to purchase the District's promissory notes; (2) the risk factors involved in purchasing the District's promissory notes; (3) the nature of the security being offered for sale; and (4) the financial condition of the District.
The Complaint seeks preliminary and permanent injunctive relief against all defendants, including the District, which filed a bankruptcy petition under Chapter IX of the Bankruptcy Act in San Francisco on June 15, 1976.
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SEC v. Reclamation District No. 2090, et al., Litigation Release No. 7551 (September 8, 1976) (settled final order).
Gerald E. Boltz, Regional Administrator of the Los Angeles Regional Office, and Michael J. Stewart, Acting Associate Regional Administrator of the San Francisco Branch Office, announced that the Honorable Robert H. Schnacke, United States District Judge for the Northern District of California, entered Final Judgment of Permanent Injunction against Reclamation District No. 2090 [County of Contra Costa, California], a public agency of the state of California, Arnold Phillips and Benchmark Securities, Inc., both of Los Angeles, California, on August 27, 1976, and against Roy J. Jackson of Ogden, Utah, on August 30, 1976. The injunctions proscribe violations of the anti-fraud provisions of the federal securities laws in connection with offers and sales of securities issued by Reclamation District No. 2090 ("the District") and any other security of any other issuer.
The Commission's complaint alleged that the defendants' conduct in violation of the anti-fraud provision of the federal securities laws resulted in the sales of approximately $2.2 million of bond anticipation notes and negotiable promissory notes issued by the District to approximately 161 persons residing in at least twelve states. For more information see Litigation Release No. 7460.
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Commission Orders - Settled Administrative Proceedings
In re Newport-Mesa Unified School District, Securities Act Release No. 7589, A. P. File No. 3-9738 (September 29, 1998).
I. The Securities and Exchange Commission ("Commission") deems it appropriate that a public administrative cease-and-desist proceeding be and hereby is instituted pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") against Newport-Mesa Unified School District ("Newport-Mesa USD" or the "District").
II. In anticipation of the institution of this proceeding, Newport-Mesa USD has submitted an Offer of Settlement, which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceedings brought by or on behalf of the Commission or to which the Commission is a party, and without admitting or denying the findings contained herein, except that the District admits the jurisdiction of the Commission over it and over the subject matter of this proceeding, Newport-Mesa USD by its Offer of Settlement, consents to the entry of this Order Instituting a Public Administrative Cease-and-Desist Proceeding Pursuant to Section 8A of the Securities Act of 1933, Making Findings, and Imposing Cease-and-Desist Order ("Order") and to the entry of the findings and the cease-and-desist order set forth below.
Accordingly, IT IS HEREBY ORDERED that a proceeding pursuant to Section 8A of the Securities Act be, and hereby is, instituted.
III. On the basis of this Order and the Offer of Settlement submitted by Newport-Mesa USD, the Commission finds that:1
A. Summary
In 1994, Newport-Mesa USD, a school district located in the County of Orange, California ("Orange County" or the "County"), offered and sold over $45 million in taxable municipal securities through an Official Statement that was materially misleading. These securities were issued for the purpose of earning interest income by investing the proceeds in the Orange County Investment Pools (the "Pools"), with the expectation of earning a higher yield than the interest rate at which they borrowed. The Official Statement for this offering was materially misleading because it failed to disclose: the intended investment in the Pools for profit, the risks of the Pools' investment strategy, and the Pools' declining investment results.
Newport-Mesa USD knew of the intended investment in the Pools for profit, certain facts concerning the Pools' investment strategy, and the Pools' investment results. Newport-Mesa USD should have known of the risks of the Pools' investment strategy. In light of such knowledge, Newport-Mesa USD, in authorizing the issuance of securities and approving related disclosure documents, should have known that the Official Statement was materially misleading by omitting to disclose such information. The District thus violated Sections 17(a)(2) and (3) of the Securities Act by offering and selling securities through an Official Statement that was materially misleading.
B. The Respondent
Newport-Mesa Unified School District operates public schools in and around the cities of Newport Beach and Costa Mesa, California. During the relevant time period, Newport-Mesa USD served over 17,500 students and had an annual budget exceeding $88 million. Newport-Mesa USD conducted the offering that is the subject of this Order.
C. Facts
1. The Orange County Investment Pools
The Pools operated as an investment fund managed by the Orange County Treasurer-Tax Collector ("County Treasurer" or "Treasurer"), Robert L. Citron ("Citron"), assisted by Matthew L. Raabe ("Raabe"). The Pools consisted of the Commingled Pool, the Bond Pool and certain specific investments, in which the County and various local governments or districts (the "Pool Participants" or the "Participants") deposited public funds. As an Orange County school district, the District was a mandatory Pool Participant because state law required it to deposit its funds with the County Treasurer. As of December 6, 1994 (the date the County and the Pools filed bankruptcy petitions), the Pools held approximately $7.6 billion in Participant deposits, which the Treasurer had leveraged to an investment portfolio with a book value of over $20.6 billion.
The Commingled Pool was the principal investment pool and consisted of $6.126 billion in Participant deposits. The proceeds from the subject offering were deposited into the Commingled Pool.
a) The Pools' Investment Strategy
The Pools' investment policy as stated by the Treasurer's Office to the Pool Participants was, in order of importance: 1) preservation of investment capital; 2) liquidity; and 3) investment yield. Contrary to that policy, the Treasurer caused the Pools to engage in a risky investment strategy. This strategy involved using a high degree of leverage by obtaining funds through reverse repurchase agreements on a short-term basis (less than 180 days), and investing in securities with a longer maturity (generally two to five years), many of which were derivative securities known as inverse floaters.
The Pools' investment return was to result principally from the interest received on the securities in the Pools. Leverage enabled the Pools to purchase more securities to generate increased interest income. This strategy was profitable as long as the Pools were able to maintain a positive spread between the long-term interest rate received on the securities and the short-term interest rate paid on the funds obtained through reverse repurchase agreements.
b) The Pools' Portfolio
During 1993 and 1994, the Treasurer, using reverse repurchase agreements, leveraged the Participants' deposits to amounts ranging from 158% to over 292%. The Treasurer then typically invested the Participants' deposits and the funds obtained through reverse repurchase agreements in debt securities issued by the United States Treasury or United States government sponsored enterprises.
Many of the Pools' securities were derivative securities, comprising from 27.6% to 42.2% of the Pools' portfolio and from 31% to 53% of the Commingled Pool's portfolio. In particular, the Pools were heavily invested in derivative instruments known as inverse floaters which paid interest rates inversely related to the prevailing market interest rate. Inverse floaters are negatively affected by a rise in interest rates.
c) The Rise in Interest Rates During 1994 and its Effect on the Pools
The composition of the Pools' portfolio made it highly sensitive to interest rate changes. As interest rates rose, the market value of the Pools' securities fell, and the interest received on the Pools' inverse floaters also dropped. Thus, the treasurer's investment strategy was profitable so long as interest rates, including the cost of borrowing through reverse repurchase agreements, remained low and the market value of the Pools' securities remained stable. Indeed, the Treasurer's 1992-93 Financial Statement for the Pools stated that the investment strategy was "predicated on interest rates to continue to remain low for a minimum of the next three years."
During 1993, interest rates remained low and relatively stable. Due to the low interest rates and the Pools' investment strategy, the Pools earned a relatively high yield of approximately 8% during 1993. Beginning in February 1994, interest rates began to rise. This rise in interest rates caused the Pools' yield to decrease, the reverse repurchase costs to increase, the Pools' interest income on inverse floaters to decrease, and the market value of the Pools' debt securities to decline. Month-end reports generated by the Treasurer reflected that the securities marked-to-market experienced a sharp drop in value, ranging from over $26 million in January 1994 (or .45% loss in value), to over $443 million in June 1994 (or 5.24% loss in value).
The rising interest rates and the declining value of the Pools' securities caused the Pools to suffer corresponding losses through collateral calls and reductions in the amounts loaned under reverse repurchase agreements. From January through June 1994, the Pools suffered collateral calls and reductions in loan amounts totaling over $873 million.
2. Orange County's Bankruptcy
On December 6, 1994, Orange County and the Pools each filed a petition for Chapter 9 bankruptcy. The petitions followed the County's public disclosure on December 1, 1994, that the Pools had suffered a "paper" loss of approximately $1.5 billion on an investment portfolio of $20.6 billion. Between mid-December 1994 and January 20, 1995, the County liquidated the Pools' securities portfolio. Ultimately, the Pools realized a loss of about $1.7 billion on Participants' deposits of $7.6 billion, a loss of approximately 22.3%.2
3. The Municipal Securities Offering
In 1994, Newport-Mesa USD conducted a taxable note offering.3 The purpose of this offering was to invest the proceeds in the Pools for profit.
Newport-Mesa USD issued its taxable notes simultaneously with three other Orange County school districts, Irvine Unified School District, North Orange County Community College District, and the Orange County Board of Education (collectively, the "Four Districts").4
The Four Districts issued a total of $200 million in taxable notes on June 14, 1994, the proceeds of which were deposited directly into the Commingled Pool.5 Newport-Mesa USD issued $46.96 million of this total amount.
4. Misleading Disclosure Regarding Investment of the Proceeds
The Official Statement for the subject offering contained misleading disclosure.6 In the section entitled "Purpose of Issue," this document described the purpose of the offering as providing funds to meet the District's current fiscal year expenditures, including current expenses, capital expenditures, investment and reinvestment and the discharge of other obligations or indebtedness of the issuer. In addition, a separate section of the Official Statement, entitled "Security for the Notes and Available Sources of Repayment," represented that the offering proceeds would be deposited into a repayment account. A third section, "Deposit and Investment of Repayment Fund," stated that the repayment account would be invested as permitted by state law.
This disclosure was materially misleading because it failed to disclose the issuer's intention to invest the note proceeds into the Pools for profit. Instead, the Official Statement merely recited general language of the applicable state borrowing statute, listing a series of permissible uses of the offering proceeds. This language is typically used in tax and revenue anticipation note ("TRAN") offering disclosure documents; its use in the taxable note Official Statement may have created the misleading impression that the subject offering was a TRAN offering.
This characterization is material because the source of repayment, and therefore the risks of repayment, differ for these transactions. Repayment accounts for TRAN offerings are funded by the issuer's anticipated taxes and revenues. In contrast, the repayment account for the subject offering was funded by the note proceeds themselves, which were invested in the Pools. Whereas in TRAN offerings the risks relate to whether the issuer will receive sufficient taxes and anticipated revenues, in the subject offering, the source of repayment is subject to the risks of the underlying investment, which in this case were the risks of investing in the Pools. Despite the importance of this information, the Official Statement failed to disclose both the intended investment in the Pools and the risks of that investment.
Specifically, the Official Statement failed to disclose that the Pools' investment strategy: 1) was predicated upon the assumption that prevailing interest rates would remain at relatively low levels; 2) involved a high degree of leverage through the use of reverse repurchase agreements; 3) involved a substantial investment in derivative securities, including inverse floaters, that are negatively affected by a rise in interest rates; 4) was very sensitive to changes in the prevailing interest rate because of the combined effect of the derivative securities and leverage; and 5) as a result, the investment strategy was speculative and risky.
The Official Statement also failed to disclose the risks of the investment strategy. In particular, the Official Statement failed to disclose that rising interest rates would have a substantial negative impact on the Pools in several respects: 1) the Pools' cost of borrowing on the substantial reverse repurchase position would increase; 2) the interest income on the Pools' substantial investment in inverse floaters would decrease; 3) the Pools' securities would decline in market value; 4) as the value of the securities fell, the Pools would suffer collateral calls and reductions in loan amounts on the reverse repurchase agreements; 5) as a result of the above effects of a rise in interest rates, the Pools' earnings would decrease; and 6) the Pools would suffer losses of principal at certain interest rate levels.
In addition, the Official Statement omitted to disclose certain material information concerning the Pools' investment results. In particular, the Official Statement omitted to disclose that as a result of rising interest rates in 1994: 1) the Pools' cost of borrowing had increased while the income earned from inverse floaters had decreased; 2) the Pools had suffered market losses in the overall value of the portfolio; and 3) the Pools had suffered losses on the reverse repurchase transactions through collateral calls and reductions in loan amounts, which in turn, had a negative impact on liquidity.
5. Conduct of Newport-Mesa USD
In connection with this offering, the District was represented by senior officials who, among other things, were responsible for debt issuance. These officials met with the various financing participants and reviewed and approved the Official Statement to be submitted to the approving body of the District. Before the offer and sale of the securities, the District Board voted to approve the Official Statement and issue the notes.
Before the offering, Newport-Mesa USD knew that the purpose of the offering was to invest the proceeds in the Pools. Also, in September 1993, the District received the Treasurer's 1992-93 Financial Statement. In this report, the Treasurer stated that the Pools' investment strategy involved the use of leverage of approximately two to one and structured or floating rate securities, including inverse floaters, and was predicated on interest rates remaining low over the next three years. The Treasurer further advised that the County's investment returns were higher than other local investment pools because of the use of reverse repurchase agreements, which added an additional two and one-half percent to the yield.
Around June 1993, a community member notified Newport-Mesa USD officials that he believed the Treasurer was being "overly aggressive in certain areas of the investment portfolio" and in using reverse repurchase agreements. The community member informed the District that, because of the "highly risky" reverse repurchase agreements, "it wouldn't take much for the whole thing to come crashing down."
In 1994, the Four Districts' offering occurred while the County Treasurer was engaged in the re-election campaign that focused significant attention on the Pools' holdings and risky investment strategy. During two meetings in April 1994, which Raabe also attended, the Four Districts' representatives discussed the upcoming taxable offerings and the campaign allegations. The district representatives questioned Raabe about the Pools, including the Pools' liquidity demands. He told them that within the previous two weeks, the Pools had suffered $140 million in "margin" calls (i.e., collateral calls), but had liquidity of $1 billion. Raabe informed the participants that the Pools' earnings would be lower in 1994 and that the "situation had reversed from a year ago" because interest rates were rising. The Districts' financial adviser predicted that interest rates would probably go up and most of the participants agreed with her assessment, although Raabe believed interest rates would decline in July. The participants discussed the fact that increasing interest rates would decrease their arbitrage earnings, but did not discuss the potential negative effect of an interest rate increase on principal.
In April 1994, Newport-Mesa USD became aware that a magazine reporter was planning to do a story on the risks and problems associated with the Pools. Furthermore, in addition to attending the two April 1994 meetings (discussed above), before the 1994 offering, the board and senior administrators of Newport-Mesa USD held additional public and private meetings, some of which were attended by a Rauscher Pierce investment banker. At one of these meetings, Rauscher Pierce's representative noted that the national rating agencies had recently reviewed the Pools without expressing concern about Citron's investments. Even though two board members opposed issuing the 1994 notes based on their evaluation of the risks involved in investing in the Pools and the volatility of interest rates,7 the issuance was approved without any disclosure in the Official Statement of these debated risks.
Raabe also attended a Newport-Mesa USD board meeting in April 1994 to address concerns about the Pools' safety raised by a community member. Raabe told the District officials that the Pools were safe.
D. Newport-Mesa USD Violated Sections 17(a)(2) and (3) of the Securities Act in the Offer and Sale of the Taxable Notes
Sections 17(a)(2) and (3) of the Securities Act make it unlawful for any person, through the means or instruments of interstate commerce or the mails, in the offer or sale of any security:
(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.
Scienter is not required to prove violations of Sections 17(a)(2) and (3) of the Securities Act. Aaron v. SEC, 446 U.S. 680, 697 (1980). Violations of these sections may be established by a showing of negligence. SEC v. Hughes Capital Corp., 124 F.3d 449, 453-54 (3d Cir. 1997); SEC v. Steadman, 967 F.2d 636, 643 n. 5 (D.C. Cir. 1992).
Newport-Mesa USD violated Sections 17(a)(2) and (3) of the Securities Act as the issuer of the securities. See In re CitiSource, Inc. Sec. Litig., 694 F. Supp. 1069, 1072-75 (S.D.N.Y. 1988) (antifraud provisions apply to municipal securities issuers); see also Adoption of Exchange Act Rule 15c2-12, Exchange Act Release No. 26985 n.84, 4 Fed. Sec. L. Rep. (CCH) _ 25,098 (June 28, 1989) ("(I)issuers are primarily responsible for the content of their disclosure documents and may be held liable under the federal securities laws for misleading disclosure." (citations omitted)).
1. The Disclosure in the Official Statement Was Materially Misleading
The Official Statement for the offering omitted to disclose material information concerning the intended investment of the note proceeds in the Pools for profit, the Pools' investment strategy and the risks of that strategy, material information concerning the risks of the Pools' strategy in a rising interest rate environment, and the Pools' declining investment results. Information is material if there is a substantial likelihood that a reasonable investor in making an investment decision would consider it as having significantly altered the total mix of information made available. See Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976).
Information concerning the Pools' investment strategy and the risks of that strategy was material to this securities offering. The Pools' investment strategy and the risks of that strategy were directly related to the safety of the funds pledged to repay the securities.
2. Newport-Mesa USD Should Have Known That the Official Statements Were Materially Misleading Given Newport-Mesa USD's knowledge regarding the investment purpose of the offerings and facts relating to the Pools' investment strategy, the District should have known that the Official Statement that it authorized was materially misleading as to the matters discussed above.
For purposes of the District's violations, the statements and omissions of its representatives may be imputed to the District. See Manor Nursing Ctrs., Inc., 458 F.2d 1082, 1089 n.3 (2d Cir. 1972).
The District knew of the intended investment purpose and certain facts regarding the Pools' investment strategy. Newport-Mesa USD should have known of the related risks of the Pools' investment strategy. In light of this knowledge, Newport-Mesa USD, in authorizing the issuance of securities and approving related disclosure documents, should have known that the Official Statement was materially misleading by omitting to disclose such information.
E. Conclusion
Accordingly, based on the foregoing, the Commission finds that Newport-Mesa USD violated Sections 17(a)(2) and (3) of the Securities Act.
IV. Newport-Mesa USD has submitted an Offer of Settlement in which, without admitting or denying the findings herein, it consents to the Commission's entry of this Order, which makes findings, as set forth above, and orders Newport-Mesa USD to cease and desist from committing or causing any violations and any future violations of Sections 17(a)(2) and (3) of the Securities Act. As set forth in the District's Offer of Settlement, Newport-Mesa USD undertakes to cooperate with Commission staff in preparing for and presenting any civil litigation or administrative proceedings concerning the transaction that is the subject
of this Order.
V. In view of the foregoing, the Commission deems it appropriate to accept the Offer of Settlement submitted by Newport-Mesa USD and impose the cease-and-desist order specified in the Offer of Settlement.
Accordingly, IT IS HEREBY ORDERED that, pursuant to Section 8A of the Securities Act: 1. Newport-Mesa USD shall cease and desist from committing or causing any violation and any future violation of Sections 17(a)(2) and (3) of the Securities Act.
2. Newport-Mesa USD shall comply with its undertakings described in Section IV. above.
Footnotes
-[1]-: The findings herein are made pursuant to the Offer of Settlement of the District and are not binding on any other person or entity named as a respondent in this or any other proceeding.
-[2]-: Orange County was charged, in a settled cease-and-desist proceeding, with disclosure violations concerning eight offerings of municipal securities, the Official Statements for which contained false and misleading information about the Pools. See In re County of Orange, California, Securities Act Release No. 33-7260 (Jan. 24, 1996).
-[3]-: Although the national rating agencies downgraded these notes prior to maturity, Newport-Mesa USD paid these notes in full and on time.
-[4]-: These entities are the respondents in a separate proceeding. See In re the City of Anaheim, City of Irvine, Irvine Unified School District, North Orange County Community College District, and Orange County Board of Education, Securities Act Release No. 7590 (September 29, 1998).
-[5]-: Pursuant to Section 53853 of the California Government Code (West 1983), the notes of each District were issued in the name of and on behalf of the District by the County Board of Supervisors. Each District requested that the County Board of Supervisors authorize the issuance of the taxable notes in its name and on its behalf, which the County Board of Supervisors did without discussion.
-[6]-: In addition to officials at the District, bond counsel, counsel to the underwriter, and the underwriter participated in the preparation of the Official Statement, which Newport-Mesa USD reviewed and approved before issuing the notes.
-[7]-: During the meeting at which the issuance was discussed and voted upon, one of these board members expressed concerns about the direction of interest rates, the sale of a security held by the Pools at a loss of $4.8 million and the Pools' derivative holdings, including inverse floaters. He stated, "My primary concern is that what's happening at our County is very risky with regard to taxpayers' money." The other board member referred to the City of Irvine's decision not to issue taxable notes in May 1994 due to its requirement to earn a specified arbitrage profit.
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In re City of Moorhead, Mississippi, Securities Act Release No. 7585, Exchange Act Release No. 40478, A.P. File No. 3-9724 (September 24, 1998); Securities Act Release No. 7616, Exchange Act Release No. 40770, A.P. File No. 3-9724 (December 10, 1998).
I. On September 24, 1998, the Commission instituted public cease-and-desist proceedings pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against the City of Moorhead, Mississippi ("Moorhead" or "Respondent") to determine whether Moorhead committed or caused violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
The Respondent has submitted an Offer of Settlement ("Offer") which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceeding brought by or on behalf of the Commission or to which the Commission is a party, the Respondent, without admitting or denying the findings set forth herein, except as contained in Section II. 1., below, and as to the jurisdiction of the Commission over the Respondent and over the subject matter of these proceedings, which are admitted, consents to the entry of this Order Making Findings And Imposing Cease-And-Desist Order ("Order").
II. Based on this Order, the Order Instituting Public Cease-and-Desist Proceedings and the Respondent's Offer, the Commission finds1 the following:
1. The City of Moorhead, Mississippi is a political and legal subdivision of the State of Mississippi and a body corporate and politic.
2. On or about November 8, 1995, Moorhead issued and sold urban renewal revenue notes ("notes") to the public in the face amount of $4.5 million.
3. The notes were issued pursuant to the Mississippi Urban Renewal Law, Miss. Code Ann. Section 43-35-21, and were sold based upon a representation that bond counsel had concluded that interest on the notes would be excludable from gross income for federal income tax purposes. The disclosure documents used in connection with the note offering represented that the note proceeds would be utilized within three years on various public projects. In fact, Moorhead had no intention of spending more than $45,000 on public projects. The $45,000 was received by the Respondent as a "premium" or "fee" for issuing the notes. The remaining proceeds were invested in a guaranteed investment contract ("GIC") yielding a higher rate of return than the notes. The GIC provided the cash flows to pay the debt service required by the notes. This financing structure resulted in a significant and undisclosed risk to the tax exempt status of interest on the notes.
4. Internal Revenue Code ("IRC") Section 103(b) provides that gross income includes interest on any state or local bond which is an "arbitrage bond" as that term is defined by IRC Section 148. IRC Section 148 (a) defines an arbitrage bond as "any bond issued as part of an issue any portion of the proceeds of which are reasonably expected (at the time of issuance of the bond) to be used directly or indirectly (1) to acquire higher yielding investments...."
5. IRC Section 148(c)(1) allows the proceeds of certain issues to be invested in higher yielding investments for a reasonable temporary period until such proceeds are needed for the purpose for which the bonds were issued. This provision is known as the "temporary period exception." It provides that the bonds will not be treated as taxable arbitrage bonds if the net sale proceeds and investment proceeds of an issue are reasonably expected to be allocated to expenditures for capital projects within specified time periods. Treas. Reg. Sec. 1.148-2(b)(1) and 2(e)(2)(i)(1993); Treas. Reg. Sec. 1.103-13(a)(2) (1979). When statements regarding reasonable expectations with respect to the amount and use of the proceeds are not made in good faith, the notes are deemed to be taxable arbitrage bonds. Revenue Ruling 85-182, 1985-2 C.B. 39.
6. Although the note offering issued by Moorhead was purportedly structured to comply with the requirements of the temporary period exception, at the time of the offering, Moorhead did not have the resources, intent or expectation to utilize any proceeds from the offering, other than the $45,000 premium or fee, for capital projects. Subsequent to the offering, Moorhead did not utilize any of the offering proceeds, other than the $45,000 premium or fee, for any capital project. The lack of a reasonable expectation to utilize more than a small portion of the proceeds for capital projects would violate the reasonable expectation requirements of IRC Section 148(c)(1) and Treas. Reg. 1.148-2(e)(2). Therefore, a substantial risk existed that the issuer would not be able to rely on the temporary period exception, making the structure of this transaction a prohibited arbitrage device in violation of IRC Sections 103(b) and 148(a)(1). The violation of these sections could cause the IRS to declare interest on the notes subject to the federal income tax.
7. The substantial risk to the tax exempt status of interest on the notes was not disclosed to investors or prospective investors in the offering. The official statement and arbitrage certificate, among other documents, without exception, represented that Moorhead intended to spend the full amount of the offering proceeds within three years on various capital projects. The official statement also represented that the respondent was negotiating with a specified firm for "architectural services." These statements were not true. An official of the City of Moorhead, with the approval of the city council, reviewed and signed the documents.
8. Based on the foregoing, in November 1995, Moorhead violated Section 17(a)(1) of the Securities Act by, directly and indirectly, using the means and instruments of transportation and communication in interstate commerce and the mails to employ devices, schemes, and artifices to defraud purchasers in the offer and sale of securities.
9. Based on the foregoing, in November 1995, Moorhead violated Sections 17(a)(2) and 17(a)(3) of the Securities Act by, directly and indirectly, using the means and instruments of transportation and communication in interstate commerce and the mails to obtain money and property by means of untrue statements of material facts and omissions to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, and to engage in transactions, practices, and a course of business which operated or would have operated as a fraud and deceit upon purchasers, in the offer and sale of securities.
10. Based on the foregoing, in November 1995, Moorhead violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder by, directly and indirectly, using the means and instrumentalities of interstate commerce and the mails: (1) to employ devices, schemes and artifices to defraud, (2) to make untrue statements of material facts and to omit to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, and (3) to engage in acts, practices, and a course of business which operated or would have operated as a fraud and deceit upon persons, in connection with the purchase and sale of securities.
III. In view of the foregoing, the Commission deems it appropriate and in the public interest to impose the sanctions set forth in Moorehead's Offer of Settlement.
ACCORDINGLY, IT IS HEREBY ORDERED, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act that the Respondent cease and desist from committing or causing any violation and any future violation of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
Footnotes
-[1]- The findings herein are made pursuant to the Offer of Settlement of the Respondent and are not binding on any other person or entity in this or any other proceeding.
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In re City of Carthage, MS., et al., Securities Act Release No. 40194, A. P. File No. 3-9650 (July 13, 1998) (administrative cease and desist proceedings against 38 municipalities and settled administrative orders).
I. The Commission deems it appropriate and in the public interest that public cease-and-desist proceedings pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") be, and they hereby are, instituted against 38 Mississippi counties, cities and towns ("the Respondents") identified in the caption to this Order.
II. In anticipation of the institution of these cease-and-desist proceedings, the Respondents have each submitted Offers of Settlement which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceeding brought by or on behalf of the Commission or to which the Commission is a party, the Respondents, without admitting or denying the findings set forth herein, except as contained in Section III. B., below, and as to the jurisdiction of the Commission over the Respondents and over the subject matter of these proceedings, which are admitted, consent to the entry of this Order Instituting Public Cease-and-Desist Proceedings Pursuant to Section 8A of the Securities Act of 1933 and Section 21C of the Securities Exchange Act of 1934, Making Findings, and Imposing Cease-and-Desist Order ("Order").
III. Based on this Order and the Respondents' Offers, the Commission finds the following.1
A. Summary
This matter involves 38 Mississippi political subdivisions, including Counties, Cities and Towns, which issued and sold urban renewal revenue notes ("notes") to the public in 73 separate offerings. The offerings occurred from 1987 through April 1996, and raised a total of approximately $282,800,000; however, while each offering produced arbitrage profit to the respective Respondent involved and others, the Respondents did not intend to use the offering proceeds, other than the arbitrage, on public projects.
In each offering, the notes were sold based upon a representation that bond counsel had concluded that interest on the notes would be excludable from gross income for federal income tax purposes. The disclosure documents used in connection with the note offerings presented that the note proceeds would be utilized within three years on various public projects. In fact, the Respondents had no intention of spending more than a small percentage of the proceeds on public projects. That percentage, generally close to one percent of the proceeds, was received by the Respondent as a "premium" or "fee" for issuing the notes. The remaining proceeds were invested in instruments yielding a higher rate of return than the notes. Those instruments provided the cash flows to pay the debt service required by the notes. This financing structure resulted in a significant and undisclosed risk to the tax exempt status of interest on the notes.
B. Respondents
Each of the Respondents is a political and legal subdivision of the State of Mississippi and a body corporate and politic. Each Respondent conducted one or more note offerings as individually specified in the Appendix to this order.
C. The Urban Renewal Revenue Note
Between 1987 and April, 1996, the Respondents individually issued, offered and sold 73 separate urban renewal revenue note issues in amounts ranging from $2 million to $5 million, totaling approximately $282,800,000. The notes were issued pursuant to the Mississippi Urban Renewal Law, Miss. Code Ann. 43-35-21. The notes were sold based upon unqualified opinions from bond counsel which concluded that interest on the notes would be exempt from federal income tax.
The Respondents were approached and asked to issue the notes by bond counsel or by representatives of the underwriter. The same bond counsel and underwriter were involved in all of the offerings. Following the initial contact, bond counsel or a representative of the underwriter would meet with an individual Respondent's governing body and describe the proposed offering. The proposed offering was generally described to the Respondents' representatives as a mechanism by which the Respondent could receive a modest amount of funds, generally $30,000 to $50,000, as a "premium" or "fee" in exchange for serving as the issuer, without impairing the Respondent's tax base or creating a pay-back obligation. The Respondents considered this premium or fee a substantial benefit.
After issuance, the bulk of the offering proceeds from each offering was used to purchase a certificate of deposit ("CD") or a guaranteed investment contract ("GIC") through the underwriter. The CD or GIC had a three year term and a sufficient rate of interest to pay both periodic interest and the principal on the notes at the end of a three year period. The remaining proceeds were used to pay the premium or fee paid to the issuer, the fees and expenses of bond counsel, the underwriter, the trustee, and other miscellaneous costs of issuance, including the fees and expenses of various third party professionals.
The CDs and GICs provided a higher yield than the notes sold in the offerings. Internal Revenue Code ("IRC") Section 103(b) provides that gross income includes interest on any state or local bond which is an "arbitrage bond" as that term is defined by IRC Section 148. IRC Section 148 (a) defines an arbitrage bond as "any bond issued as part of an issue any portion of the proceeds of which are reasonably expected (at the time of issuance of the bond) to be used directly or indirectly (1) to acquire higher yielding investments..."
IRC Section 148(c)(1) allows the proceeds of certain issues to be invested in higher yielding investments for a reasonable temporary period until such proceeds are needed for the purpose for which the bonds were issued. This provision is known as the "temporary period exception." It provides that the bonds will not be treated as taxable arbitrage bonds if the net sale proceeds and investment proceeds of an issue are reasonably expected to be allocated to expenditures for capital projects within specified time periods. Treas. Reg. Sec. 1.148-2(b)(1) and (e)(2)(i)(1993); Treas. Reg. Sec. 1.103-13(a)(2) (1979). When statements regarding reasonable expectations with respect to the amount and use of the proceeds are not made in good faith, the notes are deemed to be taxable arbitrage bonds. Revenue Ruling 85-182, 1985-2 C.B. 39.
Although all the note offerings issued by the Respondents were purportedly structured to comply with the requirements of the temporary period exception, at the time of the offerings, none of the Respondents had the resources, intent or expectation to utilize any proceeds from the offerings, other than the premium or fee, for capital projects. Subsequent to the offerings, none of the Respondents has utilized any of the offering proceeds, other than the premium or fee, for any capital project. The lack of a reasonable expectation to utilize more than a small portion of the proceeds for capital projects would violate the reasonable expectation requirements of IRC Section 148(c)(1) and Treas. Reg. 1.148-2(e)(2).
Therefore, a substantial risk exists that the issuers would not be able to rely on the temporary period exception, making the structure of these transactions a prohibited arbitrage device that violates IRC Sections 103(b) and 148(a)(1). The violation of these sections could cause the IRS to declare interest on the notes subject to the federal income tax.
The substantial risk to the tax exempt status of interest on the notes was not disclosed to investors or prospective investors in any of the offerings. The respective official statements and arbitrage certificates for each offering, among other documents, without exception, represented that the issuers intended to spend the full amount of the offering proceeds within three years on various capital projects, such as roads, parks, a courthouse, and other projects. Each official statement also represented that the issuer/respondent was negotiating with a specified firm for "architectural services." These statements were not true. Although the investors were under no duty to independently evaluate the degree of risk to the tax exemption, the false representations dealing with the municipalities' intentions to spend the proceeds and their current negotiations for services in that regard, would have made it difficult for investors, even those with access to tax advice, to ascertain the risk to the tax exemption.
Bond counsel provided the respective issuers with all of the necessary documents, including, but not limited to resolutions, official statements, and arbitrage certificates. These documents were signed by the chief executives of the respective issuers. Those chief executives signed the various documents, when they knew or were reckless in not knowing that the documents contained misrepresentations regarding the municipalities' intention to utilize the note proceeds for capital projects. Certain of the respective chief executives and other officials failed to read the documents before signing or authorizing them, relying on bond counsel to ensure that the factual representations being made by the respondent were accurate.
D. Legal Discussion
Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder make it unlawful for any person, in the offer or sale or in connection with the purchase or sale of any security, by use of the means and instrumentalities of interstate commerce, the means and instruments of transportation and communication in interstate commerce or the mails: (a) to employ devices, schemes or artifices to defraud, (b) to make untrue statements of material facts or omit to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; (c) to engage in acts, practices or a course of business which operate as a fraud and deceit; and (d) to obtain money and property by means of untrue statements of material facts and omissions to state material facts necessary to make the statements made, in light of the circumstances under which they were made, not misleading.
The notes issued by the Respondents are securities under Section 2(1) of the Securities Act and Section 3(a)(10) of the Exchange Act.
Information is material if there is a substantial likelihood that a reasonable investor would consider it important to an investment decision. See Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). The official statements used as offering documents in connection with the sale of the notes represented that an unqualified opinion from bond counsel had concluded that interest on the notes would be exempt from gross income for federal income tax purposes, assuming continuing compliance with certain covenants made by the issuer. Although such an opinion was obtained, the offering documents failed to disclose a substantial risk to the tax exempt status of interest payments on the notes. The Respondents made it difficult for investors independently to analyze the tax exemption in that the Respondents misrepresented that they intended to use the proceeds from the note offerings on capital projects within a three year period, and that they were negotiating for architectural services in that regard. These misrepresentations and omissions were material. See In re County of Orange, California; Orange County Flood Control Dist.; and County of Orange, California Bd. of Supervisors, Exchange Act Release No. 36760, 61 S.E.C. Docket 0395 (January 24, 1996).
The Respondents acted with Scienter in making the above misrepresentations and omissions of material fact. For purposes of the Respondents' liability, the Scienter of various officials of the Respondents may be imputed to the Respondents. See SEC v. Manor Nursing Centers, Inc., 458 F. 2d 1082, 1089 n.3 (2d Cir. 1972). Each of the note offerings was approved by the governing board of the respective Respondent. In each case, the official statements and other documents used in connection with the offering, including arbitrage certificates, were executed by the chief executive of the respective Respondent. Those officials were either aware of the misrepresentations contained in the documents, or, in many instances, failed to read the documents closely enough to ascertain whether misrepresentations were being made as to the essential purposes of the offering, for example, the intended use of proceeds. Issuers may not blindly rely on professionals such as bond counsel, to ensure that factual representations being made by the issuers are accurate. In this case, the practice of executing offering documents containing factual misrepresentations, without first reading the documents to ascertain whether they were accurate as to the essential purposes of the offering, was at least reckless and therefore sufficient to establish Scienter.
Based on the foregoing, during the period from November 1987 through at least April 1996, the Respondents violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
IV. ACCORDINGLY, IT IS HEREBY ORDERED, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act that the Respondents cease and desist from committing or causing any violation and any future violation of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
Appendix: List of Respondents' Urban Renewal Revenue Note Issues
| |
Date |
Issuer |
Amount |
| 1. |
November 24, 1987 |
Jefferson County |
$3.0 million |
| 2. |
December 10, 1987 |
Panola County |
$4.8 million |
| 3. |
March 8, 1988 |
Greene County |
$3.4 million |
| 4. |
June 13, 1988 |
Hancock County |
$4.8 million |
| 5. |
July 14, 1988 |
Simpson County |
$3.0 million |
| 6. |
October 6, 1988 |
Coahoma County |
$5.0 million |
| 7. |
October 20, 1988 |
Wayne County |
$5.0 million |
| 8. |
November 3, 1988 |
Pearl River County |
$4.9 million |
| 9. |
December 22, 1988 |
Smith County |
$4.9 million |
| 10. |
March 13, 1989 |
City of Picayune |
$4.1 million |
| 11. |
April 6, 1989 |
Jefferson Davis County |
$4.8 million |
| 12. |
April 13, 1989 |
City of Clarksdale |
$3.2 million |
| 13. |
June 15, 1989 |
Leake County |
$4.6 million |
| 14. |
April 18, 1990 |
Stone County |
$4.0 million |
| 15. |
July 31, 1990 |
Quitman County |
$4.4 million |
| 16. |
August 2, 1990 |
Clarke County |
$4.8 million |
| 17. |
December 27, 1990 |
City of Magee |
$2.0 million |
| 18. |
February 13, 1991 |
Jefferson County |
$3.0 million |
| 19. |
February 27, 1991 |
City of Carthage |
$2.0 million |
| 20. |
February 27, 1991 |
Leake County |
$4.6 million |
| 21. |
March 7, 1991 |
Panola County |
$4.75 million |
| 22. |
March 28, 1991 |
Greene County |
$4.2 million |
| 23. |
May 16, 1991 |
City of Mendenhall |
$3.5 million |
| 24. |
July 2, 1991 |
Coahoma County |
$4.8 million |
| 25. |
November 18, 1991 |
Town of Bay Springs |
$4.0 million |
| 26. |
December 18, 1991 |
Town of Marks |
$5.0 million |
| 27. |
January 23, 1992 |
Town of Raleigh - A |
$2.0 million |
| 28. |
April 1, 1992 |
Town of Raleigh - B |
$2.0 million |
| 29. |
August 3, 1992 |
Town of Crenshaw |
$4.5 million |
| 30. |
August 27, 1992 |
City of Carthage |
$2.0 million |
| 31. |
August 27, 1992 |
Leake County |
$4.6 million |
| 32. |
September 7, 1992 |
Panola County |
$4.75 million |
| 33. |
September 28, 1992 |
Greene County |
$4.2 million |
| 34. |
October 12, 1992 |
Stone County |
$4.0 million |
| 35. |
November 16, 1992 |
City of Mendenhall |
$3.5 million |
| 36. |
December 15, 1992 |
Town of Leakesville |
$3.5 million |
| 37. |
December 27, 1992 |
City of Magee |
$2.0 million |
| 38. |
December 30, 1992 |
Jefferson Davis County |
$5.0 million |
| 39. |
February 1, 1993 |
Quitman County |
$4.4 million |
| 40. |
February 14, 1993 |
Jefferson County |
$3.0 million |
| 41. |
March 1, 1993 |
Coahoma County |
$4.8 million |
| 42. |
June 18, 1993 |
Town of Marks |
$5.0 million |
| 43. |
September 23, 1993 |
Town of Raleigh - A |
$2.0 million |
| 44. |
October 1, 1993 |
Town of Raleigh - B |
$2.0 million |
| 45. |
December 7, 1993 |
City of Magee |
$4.0 million |
| 46. |
December 8, 1993 |
Panola County |
$4.0 million |
| 47. |
December 8, 1993 |
Stone County |
$2.0 million |
| 48. |
February 1, 1994 |
Leake County |
$4.0 million |
| 49. |
February 15, 1994 |
Jefferson County |
$3.6 million |
| 50. |
March 1, 1994 |
City of Carthage |
$3.0 million |
| 51. |
March 1, 1994 |
Quitman County |
$4.0 million |
| 52. |
April 1, 1994 |
Greene County |
$4.5 million |
| 53. |
June 25, 1994 |
City of Mendenhall |
$4.0 million |
| 54. |
August 10, 1994 |
City of Winona |
$3.0 million |
| 55. |
August 24, 1994 |
Montgomery County |
$4.0 million |
| 56. |
September 1, 1994 |
Town of Marks |
$4.0 million |
| 57. |
November 1, 1994 |
City of Purvis |
$4.0 million |
| 58. |
December 5, 1994 |
Town of Raleigh |
$4.4 million |
| 59. |
December 29, 1994 |
Town of Leakesville |
$3.6 million |
| 60. |
December 29, 1994 |
Town of Crenshaw |
$3.4 million |
| 61. |
March 7, 1995 |
Town of Como |
$3.6 million |
| 62. |
March 7, 1995 |
Town of Coldwater |
$3.9 million |
| 63. |
April 24, 1995 |
Town of Lambert |
$4.0 million |
| 64. |
May 11, 1995 |
City of Sardis |
$4.3 million |
| 65. |
June 27, 1995 |
Town of Friars Point |
$4.2 million |
| 66. |
July 6, 1995 |
Town of Coffeeville |
$3.9 million |
| 67. |
July 20, 1995 |
Town of Tchula |
$3.9 million |
| 68. |
September 21, 1995 |
Town of Edwards |
$4.0 million |
| 69. |
September 28, 1995 |
Town of Jonestown |
$3.9 million |
| 70. |
November 30, 1995 |
City of Itta Bena |
$4.9 million |
| 71. |
December 28, 1995 |
City of Shaw |
$4.9 million |
| 72. |
February 15, 1996 |
Town of Leakesville |
$4.0 million |
| 73. |
April 15, 1996 |
Stone County |
$4.0 million |
Footnotes
-[1]- The findings herein are made pursuant to the Offers of Settlement of the Respondents and are not binding on any other person or entity named as a respondent in this or any other proceeding.
To Contents
In re County of Nevada, City of Ione, Wasco Public Financing Authority, Virginia Horler and William McKay, Securities Act Release No. 7503, Exchange Act Release No. 39612, A.P. File No. 3-9542 (February 2, 1998).
On February 2, 1998, the Securities and Exchange Commission ("Commission") issued an Order Instituting Public Administrative Proceedings against three central California municipalities and two professionals for causing or committing securities fraud in connection with the sale of $58 million in municipal bonds. The Order names the County of Nevada ("Nevada County"), the City of Ione ("Ione"), the Wasco Public Financing Authority ("Wasco"), Virginia Horler ("Horler"), of Dain Rauscher Incorporated (formerly known as Rauscher Pierce Refsnes), and William McKay ("McKay"), a real estate appraiser. The Order alleges that the municipalities and individuals created and approved written materials, used in selling the bonds, that fraudulently misstated or omitted important information.
Last July, the Commission sued the underwriter of the offerings, First California Capital Markets Group, and two of its executives, H. Michael Richardson and Derrick Dumont, in the United States District Court for the Northern District of California. See Lit. Rel. No. 15423. That litigation is pending.
Nevada County raised $9.07 million through the sale of "Mello-Roos" bonds, which are used to finance real estate development. The Order alleges that the Official Statement for the Nevada County offering contained misrepresentations and omissions concerning: (1) the value of the property to be developed; (2) the developer's ownership interest in the property; (3) the developer's experience and financial condition; (4) cost estimates to complete the project; and (5) how the project would be financed by the developer and Nevada County. The Order further alleges that Horler, Nevada County's financial advisor, drafted the Official Statement, which was reviewed by Nevada County staff and officials, and approved for distribution by resolution of the County Board of Supervisors.
Ione raised $14 million in two "Mello-Roos" bond offerings. The Order alleges that the Official Statements for the Ione offerings contained misrepresentations and omissions concerning: (1) the ability to complete all of the listed improvements with the offering proceeds; (2) the value of the property to be developed, and (3) the sufficiency of the developer's capital to complete the project.
The Order further alleges that McKay prepared the appraisals for both Nevada County and Ione, as well as summaries of each which he knew were to be included in the Official Statements for the offerings.
The misrepresentations and omissions in the Nevada County and Ione Offering Statements were important to investors because they made the projects and the bonds appear to be less risky than they actually were.
The Wasco offering, which raised $35 million, involved the sale of "Marks-Roos" municipal bonds, which are issued to form pools of money to finance a number of local projects. The Order alleges that the Official Statement for this offering failed to disclose that nearly all of the projects listed were highly contingent, if not speculative. These misrepresentations were important to investors because they falsely created the impression that the pools were fully allocated to particular projects. Because the projects were speculative, there was a greater risk to investors that the bonds would not be repaid with interest.
The Order alleges that Nevada County, Ione, Wasco, Horler and McKay violated the antifraud provisions of the federal securities laws, including Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 issued thereunder.
An administrative hearing will be scheduled to litigate the allegations and determine whether the Commission should order any remedial action.
To Contents
In re County of Nevada, Securities Act Release No.7535, A.P. File No. 3-9542 (May 5, 1998).
I. The Securities and Exchange Commission ("Commission") has previously instituted a cease-and-desist proceeding pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against the County of Nevada ("Nevada County"). 1 Nevada County subsequently has submitted an Offer of Settlement ("Offer"), which the Commission has determined to accept.
II. Solely for the purpose of this proceeding and any other proceedings brought by or on behalf of the Commission or in which the Commission is a party, and without admitting or denying the findings contained herein, except that Nevada County admits the jurisdiction of the Commission over it and over the subject matter of this proceeding, Nevada County consents to the issuance of this Order Making Findings and Imposing a Cease-and-Desist Order ("Order") and to the entry of the findings and the imposition of the relief set forth below.
III. On the basis of this Order and Nevada County's Offer, the Commission finds2 the following:
A. Respondent
County of Nevada is a political division and legal subdivision of the St
ate of California invested with corporate powers, and acting through the Nevada County Board of Supervisors. When the term "Nevada County Board of Supervisors" is used herein, it refers to the Board as it was constituted in 1990; none of the current members of the Board of Supervisors was a member of the Board at any time relevant to this proceeding.
B. The Nevada County Bond Offering
The Mello-Roos Bond Act
The California Mello-Roos Community Facilities Act of 1982 (the "Mello-Roos Act")3] authorizes municipalities to organize community facilities districts ("CFDs") to finance the building of infrastructure. Mello-Roos bonds are paid off through special taxes levied on the property being developed. The bonds are not personal debts of the landowners or general obligations of the issuing municipality. Because they are paid off using future real property tax levies, the bonds' financial attractiveness depends upon the underlying value of the land being developed, the contemplated improvements to the land and the developer's ability to carry out the contemplated improvements.
Nevada County's Infrastructure Finance Committee Procedure
On February 20, 1990, the Nevada County Board of Supervisors adopted a public resolution setting out a procedure for considering and approving land-based public financings (the "Procedure"). Under the Procedure, each proposal was to be forwarded to the Board of Supervisors with a report from the Infrastructure Finance Committee (comprising County officials and staff) and its recommendation to proceed. The purpose of the Procedure was to guard against unwise public financings including the bonds for the Wildwood Estates public improvements described below.
The Procedure specified a value-to-lien ratio of "at least" 4-to-1 "after the installation of the public improvements to be financed" in order to undertake a Mello-Roos bond offering. Although the Procedure permitted the County Board to consider a lesser value-to-lien ratio on a case-by-case basis, there must first be a "compelling justification" offered by the Financial Adviser or lead underwriter in order to deviate from the 4-to-1 ratio.
Formation of the Wildwood Estates District
Located within Nevada County is a contiguous, undeveloped, 286-acre parcel which became known as "Wildwood Estates" and which had been owned by a bankrupt entity. In early 1990, G. Michael Montross ("Montross") purchased -- subject to final bankruptcy court approval -- Wildwood Estates for $1.98 million using funds raised through four limited partnerships. During early 1990, Montross placed title to the 286 acres into his wholly-owned corporation, Wildwood Estates, Inc. ("Wildwood Corp."), even though he had promised the investors in the four limited partnerships ("Wildwood Partners") that those entities would receive title to some of the property.
In February 1990, Nevada County initiated the process to issue Mello-Roos bonds to finance the construction of the public improvements for Wildwood Estates. On March 20, 1990, the Nevada County Board of Supervisors ("Board") considered an application by Montross to form the Wildwood Estates Community Facilities District ("Nevada County CFD") in accordance with the Mello-Roos Act. The Nevada County Board of Supervisors voted to form the Nevada County CFD and to retain Derrick Dumont ("Dumont") and First California Capital Markets Group, Inc. ("First California") to underwrite its Mello-Roos bonds.
Horler is Retained as a Financial Adviser
Nevada County had limited experience in municipal bond offerings, and none of those offerings involved Mello-Roos bonds. In view of its lack of experience with Mello-Roos bonds, Nevada County believed that it was appropriate to retain independent professionals to advise it on the bond issue and the proper preparation of the Official Statement. Nevada County relied upon the professionals' work and recommendations in connection with the Mello-Roos offering.
Consequently, in May 1990, Nevada County retained Virginia Horler ("Horler"), Senior Vice President of Rauscher Pierce Refsnes, Inc. ("Rauscher"), a San Francisco investment banking firm, as Financial Adviser for the bond offering. On July 2, 1990, Nevada County and Rauscher formally executed a financial advisory contract in which Rauscher represented that "it (was) skilled in making the studies and analyses described in the contract and represent(ed) that it is qualified by training and experience to perform the work required by the county."
Horler accepted the responsibility of carrying out Rauscher's performance under the contract. Rauscher agreed to "prepare the preliminary and final official statements describing ... the economic and financial background of the property owner in accordance with the disclosure required by the Securities and Exchange Commission Rule 15c2-12." Rauscher also agreed to "review and analyze all data and information which have a bearing on the program to finance the County's Community Facilities District, including but not limited to ... the value of the appraisal, coverage ratios and debt capacity (and) projected special taxes." In addition, Rauscher agreed to confer and consult with county staff and elected officials, architects, contractors, property owners, bond counsel and the underwriter "to assist the county in developing a financing plan that meets the county's specific needs for funds and the property owners ability and willingness to pay." Nevada County agreed to pay Rauscher $30,000, but only if and when its bond offering closed.
McKay is Retained to Appraise Wildwood Estates
On March 23, 1990, the underwriter solicited proposals for the appraisal of Wildwood Estates. Of the five appraisers solicited, two did not respond, one replied that it could not submit a bid within the time allowed, one bid $20,000 and William McKay ("McKay") bid $4,000.
On June 6, 1990, McKay prepared a "preliminary" appraisal which was discussed at a June 8, 1990 meeting involving the Infrastructure Finance Committee and Horler. None of McKay's appraised values satisfied Nevada County's 4-to-1 value-to-lien guidelines. However, Horler stated that 3-to-1 was the industry standard and focused on the two highest values in McKay's appraisal -- the only two which satisfied the 3-to-1 ratio.
McKay then prepared a 60-page appraisal which was circulated to Horler and Nevada County. McKay found values ranging from $2.98 million to $38 million. McKay also prepared a 14-page summary to be included in the Official Statement to be provided to investors. McKay, Nevada County and Horler knew the summary would be included in the Official Statement and relied upon by investors to measure the security of the bonds. The summary appraisal only contained the three highest values, ranging from approximately $32 million to $38 million.
Nevada County Issues $9.07 Million in Mello-Roos Bonds
On December 20, 1990, First California underwrote $9.07 million in tax-exempt Mello-Roos bonds for the Nevada County CFD. At the time, the County also intended to issue an additional $2 million in taxable Mello-Roos bonds to finance the remaining public infrastructure which did not qualify for tax-exempt treatment. When its Mello-Roos bond offering closed, Nevada County used over $500,000 of the proceeds to retire a special sewer assessment against the property. That, in turn, allowed the County to recover approximately $160,000 that it had deposited to secure pay-off of the assessment. Additionally, $30,000 of the bond proceeds were used to pay Rauscher for Horler's activities.
Some of the Nevada County Bonds matured between September 1, 1993 and September 1, 2003 and bore an interest rate of between 6.75% and 8.00%, depending upon the maturity date. Most of the Bonds, about $7,370,000, matured on September 1, 2019 and bore a 8.40% interest rate. Those Nevada County Bonds maturing on or after September 1, 2001 could not be redeemed before September 1, 2000. Additionally, if such early redemption for those Bonds occurred before March 1, 2002, a prepayment penalty, along with accrued interest, would have to be paid to the bond holders.
The Official Statement Contains Material Misrepresentations and Omissions Horler drafted the Official Statement for the Nevada County bonds. The Official Statement was also reviewed by Nevada County staff and officials, and it was approved by resolution of the County Board of Supervisors.
Misleading Valuations
The Nevada County Official Statement represented that the build-out value of Wildwood Estates (the estimated value for all the lots after completion of the infrastructure if sold individually to builders or homeowners) was $35,280,000. This figure was materially overstated by at least $4 million because it was based on the inclusion of 45 single family lots to be located on a 22-acre parcel in Wildwood Estates when, in fact, Montross had not sought -- and never received -- approval to develop that parcel into 45 single family lots. McKay also assigned a per lot value almost $10,000 higher for these 45 lots than the average value for the approved 384 lots. Without the additional $4 million, the Nevada County Bonds would not have met a 3-to-1 value-to-lien ratio (after the County issued the additional $2 million in taxable bonds necessary to complete the project). Additionally, without a clear and viable plan to develop the 22-acre parcel, the Mello-Roos tax liens against that parcel would go unpaid unless Wildwood Corp. was willing and able to pay the taxes.
Furthermore, the Nevada County Official Statement failed to disclose that, in addition to the appraised build-out value of $35,280,000 represented in the Official Statement, the land had also been appraised using other methods of valuation which resulted in substantially lower appraised values which did not meet the 3-to-1 ratio.
Misleading Owner and Developer Information
According to the Official Statement, "(a)ll of the taxable land within the District is currently owned by G. Michael Montross of Montross Barber Investments, Inc." In fact, Nevada County knew since the March 20, 1990 Board meeting that Wildwood Corp. owned the property because Montross signed the election ballot on behalf of that entity and provided a title report disclosing Wildwood Corp.'s ownership.
The Official Statement represented the experience of Montross and Montross Barber Investments, Inc. as follows:
"(Montross Barber Investments) now holds more than $250 million worth of Northern California property for more than 3,000 investors.
". . . Montross has invested in and developed commercial and residential properties for the past 18 years. He has purchased over $200 million worth of residential units and created over 1,200 subdivision lots in the last eight years."
In fact, Montross was not an experienced developer. His real estate experience consisted of managing apartment buildings and forming limited partnerships to syndicate the purchase of apartment buildings and commercial properties. In these syndication's, Montross and his firm retained a minority interest as general partner, usually no more than 6 percent. Montross did not have 18 years of experience developing vacant land into subdivisions, and he had not created 1,200 subdivision lots. Additionally, the reference to "over $200 million worth of residential units" suggested that Montross Barber Investments, Inc. had enormous financial resources when, in fact, the Montross Barber firm had, as of March 1989, a purported tangible net worth of only $300,000 and was experiencing a negative cash flow from its business operations.
Misleading Financing Description
The Official Statement represented that the "portion of the subdivision improvements that will be financed directly by the Developer includes recreational facilities, drainage facilities, roads and certain fees. The remaining subdivision improvements will be financed from proceeds of the Aggregate Bonds." The Official Statement also stated that $6,900,579.41 in improvements would be financed with public Series E-1990 bonds, $1,392,371.71 in improvements would be financed with public Series T-1990 bonds and $5,089,756.76 would be privately financed. In fact, Nevada County was -- at Horler's recommendation -- requiring the property owner and developer to obtain all of the construction financing from private lending institutions because Nevada County would release the Mello-Roos bond proceeds only after each phase of the project was completed. Nevada County therefore used the Mello-Roos bond proceeds to provide "take out" or "permanent" financing for the public improvements, rather than using the proceeds -- as represented in the Official Statement -- for the construction financing as well. This increased the amounts of liens that would be placed against the property, increased the amount of financing that the owner or developer would have to provide and made the obtaining of financing more difficult.
C. Legal Analysis
Section 17(a) of the Securities Act generally prohibits misrepresentations or omissions of material facts in the offer or sale of securities. Scienter is not required to establish a violation of Section 17(a)(2) or Section 17(a)(3) of the Securities Act. Aaron v. SEC, 446 U.S. 680, 702 (1980).
The misrepresentations contained in the Nevada County Official Statements were material to investors because they directly addressed the security of the bonds. These misrepresentations significantly altered the total mix of information available to the investors.
The misrepresentations contained in the Nevada County Official Statements were "in the offer or sale" of the bonds. All were designed to induce investors to purchase the bonds. There was a causal nexus between the statements made and the investors' decisions to buy the bonds.
Despite its retention of professional advisers and appraisers, Nevada County remained legally responsible for any misrepresentations and/or omissions in the Nevada County Official Statement. The Nevada County Board of Supervisors approved the Nevada County Official Statement.
IV. Based on the foregoing, the Commission finds that Nevada County committed violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act.
V. Accordingly, IT IS HEREBY ORDERED, pursuant to Section 8A of the Securities Act, that Nevada County cease and desist from committing or causing any violation and any future violation of Sections 17(a)(2) and 17(a)(3) of the Securities Act.
Footnotes
-[1]- The Commission instituted the cease-and-desist proceeding on February 2, 1998. See Securities Act Rel. No. 7503; Securities Exchange Act Rel. No. 39612
-[2]- The findings herein are made pursuant to Nevada County's Offer and are not binding on any other person or entity in this or any other proceeding
-[3]- See Article 1, Chapter 2.5, Division 2, Title 5 of the California Government Code (§§ 53311, et seq.).
To Contents
In re Wasco Public Financing Authority, Securities Act Release No. 7536, A.P. File No. 3-9542 (May 5, 1998).
I. The Securities and Exchange Commission ("Commission") has previously instituted a cease-and-desist proceeding pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against the Wasco Public Financing Authority ("Wasco PFA").1 The Wasco PFA subsequently has submitted an Offer of Settlement ("Offer"), which the Commission has determined to accept.
II. Solely for the purpose of this proceeding and any other proceeding brought by or on behalf of the Commission or in which the Commission is a party, and without admitting or denying the findings contained herein, except that the Wasco PFA admits the jurisdiction of the Commission over it and over the subject matter of this proceeding, the Wasco PFA consents to the issuance of this Order Making Findings and Imposing a Cease-and-Desist Order ("Order") and to the entry of the findings and the imposition of the relief set forth below.
III. On the basis of this Order and the Wasco PFA's Offer, the Commission finds2 the following:
A. Respondent
Wasco Public Financing Authority is a public financing authority formed by a joint powers agreement between the City of Wasco and the Wasco Redevelopment Agency. The City of Wasco is a political division and legal subdivision of the State of California invested with corporate powers. It is located in California's Central Valley, 275 miles south of San Francisco, and has a non-prisoner population of approximately 10,000. The City of Wasco is governed by an elected City Council whose members also serve as the directors of the Wasco PFA Authority and the Wasco Redevelopment Agency.
B. Background
The California Marks-Roos Local Bond Pool Act of 1985 ("Marks-Roos Act")3 permits municipalities to organize "public financing authorities" ("PFAs") that sell bonds to the general public in order to create pools of moneys which are, in turn, used to buy bonds, notes and other obligations of other public entities ("local obligations").
Marks-Roos bonds are payable from the principal and interest of the local obligations purchased with the pool's proceeds.
Funds raised in a Marks-Roos offering must be used within a certain amount of time to purchase local obligations. Under Section 149(f) of the Internal Revenue Code, a pooled financing is tax exempt only if the issuer reasonably expects that 95 percent of the net proceeds of the bond pool will be used within three years of the date of issuance. For this reason, bond pools generally require that all funds not applied within three years of issuance be returned to investors. The Wasco PFA Indenture of Trust ("Indenture") contained a three-year limitation ("the origination period") on the placement of funds and required that all funds not used within the origination period be repaid to investors.
C. Facts
On September 20, 1989, the Wasco PFA issued $35 million of its 1989 Local Agency Bonds pursuant to the Marks-Roos Act. The Wasco PFA offered and sold its bonds by means of an Official Statement. The Board of Directors for the Wasco PFA approved the Official Statement. The Official Statement (which contained a summary of the Indenture and advised investors to refer to the full Indenture) represented that the Wasco PFA anticipated using the offering's proceeds to purchase certain local obligations described in the Official Statement. These local obligations were typically identified as proposed development projects to be undertaken by area developers. However, the Official Statement failed to disclose the tentative nature of certain projects identified in the Official Statement.
The Official Statement represented that the Wasco PFA intended to finance the purchase by the Delano Regional Medical Center ("the Delano RMC") of an existing facility in Wasco with $1.2 million in bond funds. The Official Statement failed to disclose that while the Delano RMC and the city were engaged in negotiations, no agreement had yet been reached to purchase the facility. Negotiations broke off after the bonds were issued. The Delano RMC did not purchase the facility.
The Official Statement represented that $1.125 million of funds were intended to be used to finance the "Johnson Housing Project Infrastructure" and that construction of the infrastructure for a mobile home park was expected to commence in late 1989. At the time the Official Statement was disseminated, however, no maps, permits or financing for the mobile home park existed. The park was not constructed.
The Official Statement listed the $2.075 million "Wasco Civic/Recreation Center" as a project the Wasco PFA intended to finance. While the city had considered the idea of building a civic center for many years, it had completed virtually none of the planning required to proceed with such a development. For example, no site had been selected for the project. The civic center was not constructed.
The Official Statement also disclosed that $4.0 million of funds were intended to finance the construction of 100 units of low-income housing, called the "Housing Authority Multi-family Housing Project. "While the Official Statement represented that the Housing Authority "is in the process of taking the necessary steps to start construction," no approvals, sites, plans or matching funds had yet been obtained. The project was not constructed.
The Wasco PFA created the appearance that the bond proceeds would be fully subscribed within the origination period. In fact, by the end of the origination period, the Wasco PFA had applied only about fifteen percent of the funds to the local obligations described in the Official Statement. Instead of funding other local projects over that three-year period, the Wasco PFA purchased more than $9 million in bonds from the underwriter for various projects not related to the Wasco community.
D. Legal Analysis
Section 17(a) of the Securities Act generally prohibits misrepresentations or omissions of material facts in the offer or sale of securities. Scienter is not required to establish a violation of Section 17(a)(2) or Section 17(a)(3) of the Securities Act. Aaron v. SEC, 446 U.S. 680, 702 (1980).
While offering and selling its bonds to the public, the Wasco PFA represented that it intended and reasonably expected to finance twelve specific local obligations with the proceeds of its offering. These statements were false and misleading in light of the tentative nature of certain projects.
These misrepresentations were material to investors because they directly addressed the use of the offering's proceeds. The misrepresentations significantly altered the total mix of information available to the investors.
The misrepresentations were "in the offer or sale" of the Wasco PFA bonds. All were designed to induce investors to purchase the bonds. There was a causal nexus between the statements made and the investors' decisions to buy the bonds.
Despite its retention of professional advisers, the Wasco PFA remained legally responsible for any misrepresentations and/or omissions in the Official Statement. The Wasco PFA Board of Directors, who also sat on the City of Wasco City Council, approved the Official Statement.
IV. Based on the foregoing, the Commission finds that the Wasco PFA committed violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act.
V. Accordingly, IT IS HEREBY ORDERED, pursuant to Section 8A of the Securities Act, that the Wasco PFA cease and desist from committing or causing any violation and any future violation of Sections 17(a)(2) and 17(a)(3) of the Securities Act.
Footnotes
-[1]-The Commission instituted the cease-and-desist proceeding on February 2, 1998. See Securities Act Rel. No. 7503; Securities Exchange Act Rel. No. 39612.
-[2]-The findings herein are made pursuant to Ione's Offer and are not binding on any other person or entity in this or any other proceeding.
-[3]-See Article 4, Chapter 5, Division 7, Title 1 of the California Government Code (§§ 6500, et seq .).
To Contents
In re City of Ione, Securities Act Release No. 7537, A.P. File No. 3-9542 (May 5, 1998).
I. The Securities and Exchange Commission ("Commission") has previously instituted a cease-and-desist proceeding pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against the City of Ione ("City of Ione"). 1 Ione subsequently has submitted an Offer of Settlement ("Offer"), which the Commission has determined to accept.
II. Solely for the purpose of this proceeding and any other proceeding brought by or on behalf of the Commission or in which the Commission is a party, and without admitting or denying the findings contained herein, except that Ione admits the jurisdiction of the Commission over it and over the subject matter of this proceeding, Ione consents to the issuance of this Order Making Findings and Imposing a Cease-and-Desist Order ("Order") and to the entry of the findings and the imposition of the relief set forth below.
III. On the basis of this Order and Ione's Offer, the Commission finds2 the following:
A. Respondent
City of Ione is a political subdivision and legal subdivision of the State of California invested with corporate powers.
B. The Two City of Ione Bond Offerings
The Mello-Roos Bond Act
The California Mello-Roos Community Facilities Act of 1982 (the "Mello-Roos Act")3 authorizes municipalities to organize community facilities districts ("CFDs") to finance the building of infrastructure. Mello-Roos bonds are paid off through special taxes levied on the property being developed. The bonds are not personal debts of the landowners or general obligations of the issuing municipality. Because they are paid off using future real property tax levies, the bonds' financial attractiveness depends upon the underlying value of the land being developed, the contemplated improvements to the land and the developer's ability to carry out the contemplated improvements.
Ione wanted to finance the infrastructure for a 460-acre real estate development project called Castle Oaks Country Club Estates ("Castle Oaks"), consisting of a residential subdivision, a golf course, and other recreational and commercial uses
Ione wanted to finance the infrastructure for a 460-acre real estate development project called Castle Oaks Country Club Estates ("Castle Oaks"), consisting of a residential subdivision, a golf course, and other recreational and commercial uses. The underwriter, First California Capital Markets Group, Inc. ("First California"), recommended that Ione issue two series of Mello-Roos bonds to finance the infrastructure. The first series, Ione CFD-1, was initially designed to be used to finance the development of the Castle Oaks golf course, which was to be owned by Ione, but leased to a private, for-profit operator. Because that lease arrangement would have prevented that series of Mello-Roos bonds from being tax free, the Ione CFD-1 offering was delayed for several months, and its purpose was changed to provide financing for certain infrastructure. The second series, Ione CFD-2, was to be used to develop certain other infrastructure at Castle Oaks. Because of the delay in issuing the Ione CFD-1 bonds, the Ione CFD-2 bonds were actually issued first.
The Ione CFD-2 Offering in February 1991
On February 14, 1991, First California underwrote $7.5 million in Ione CFD-2 bonds under the Mello-Roos Act. The Ione CFD-2 Official Statement described public and private improvements that would be made at the Castle Oaks project through bond financing and private financing. That description was false and misleading because there was a significant shortfall in financing for the proposed project that was not disclosed in the CFD-2 Official Statement.
After the Ione CFD-2 bonds were issued, Ione noticed that the tentative map had not been drawn in conformity with the minimum lot size requirement set forth in the Development Agreement between Ione and the developer. When the lot size was recalculated, the development had only 584 single family lots rather than 667 as originally calculated and represented in the Ione CFD-2 Official Statement.
The Ione CFD-1 Offering in June 1991
On June 6, 1991, in a separate underwriting, First California underwrote $6.55 million of Ione CFD-1 bonds under the Mello-Roos Act. The Ione CFD-1 Official Statement represented that the build-out value of the Castle Oaks Project was $44,906,000, an amount that appeared to satisfy the 3-to-1 value-to-lien ratio for the $14.05 million in total bonds (CFD-2 and CFD-1) then issued. The value was based on an appraisal prepared by William McKay.
