6.1.4.1 Recent SEC Enforcement Focus

Although SEC enforcement activity has covered a broad and expanding range of perceived securities law violations, recent activity has been focused in particular on the following.

INADEQUATE PENSION DISCLOSURES – The SEC brought actions against the City of San Diego (2006), the State of New Jersey (2010), the State of Illinois (2013) and the State of Kansas (2014), all of which were settled. In the case of San Diego, however, the SEC also levied fines on certain individual officials. These actions generally focused on failure to adequately disclose funding shortfalls in pension systems, and the potential for future budget difficulties as pension contributions would have to be increased. One common theme of all these actions was inadequacy of internal procedures and training to ensure accurate disclosure in securities offering documents.

MISLEADING OR INCOMPLETE FINANCIAL DISCLOSURES AND UNUSUAL ACCOUNTING ACTIONS – Clear financial presentation is, of course, critical to disclosure, and enforcement activity has been directed against issuer’s efforts to hide or obscure financial difficulties.

City of Miami, Florida (2013). The SEC alleged that the city had hidden shortfalls in its General Fund by temporarily transferring moneys from other funds into the General Fund just before the fiscal year end, and then transferring the funds out again. The city and its budget director took the case to trial, where a jury found in favor of the SEC. The city then settled the case and agreed to pay a fine of $1 million.
City of Allen Park, Michigan (2014). The city failed to reveal a budget gap, which was supposed to be closed by private investment from a movie studio development. The movie studio plan fell apart, but the city did not reveal the impact of that event on the budget gap. The city and two of its officials settled charges; the two officials were barred from taking part in future municipal securities offerings and one official paid a penalty of $10,000.
Westlands Water District, California (2016). In 2010, during a drought that reduced water usage (and hence revenue), the district took an unusual accounting action to transfer money from certain reserves to add to its “revenues” in order to maintain minimum “coverage” requirements under its bond indentures, an action that was approved by its accountants. In a later bond offering that showed prior years’ coverage, the district failed to disclose that it only met the coverage in 2010 by use of the one time accounting transfer. The SEC charged that not pointing this out was a securities law violation. The district settled and paid a fine of $125,000; its general manager and assistant general manager were also charged and paid fines of $50,000 and $20,000, respectively.
Town of Ramapo, New York (2016). The town, its local development corporation, and various officials were charged with deliberately keeping misleading books that hid financial deficits and budget strains. According to the SEC, the problems arose from declining tax revenues and the failure of a minor league baseball park project. In addition to the SEC charges, the Department of Justice brought criminal charges for securities fraud against a town attorney and the town supervisor. The town supervisor was found guilty by a jury and was sentenced to 2.5 years in prison and a $75,000 fine. The town attorney pled guilty and was sentenced to 18 months of supervised release and a $20,000 fine.

FAILED ECONOMIC DEVELOPMENT PROJECTS – Failed development projects often lead to municipal security defaults, in which disclosure is subject to scrutiny with the benefit of hindsight.

Greater Wenatchee Regional Events Center, Washington (2013). Short term construction notes for a regional event center were coming due and had to be refinanced by new notes at the height of the financial crisis. The OS for the new notes failed to disclose a less favorable consultant report than the one used in the document. The events center did not, in fact, meet revenue estimates and the new notes defaulted. The issuer settled and paid a fine of $20,000.
City of Harvey, Illinois (2014). This case involved a failed hotel development and diversion of bond funds for unauthorized purposes by the city controller. The city settled the SEC charges, which included a requirement to hire outside securities counsel and consultants. The controller was fined and had to disgorge moneys received totaling over $200,000.
Rhode Island Economic Development Corporation (2016). A state authority issued bonds, guaranteed by the state itself, to subsidize the move of a start up software firm from Massachusetts to Rhode Island. The OS indicated that the bonds would only cover part of the startup costs needed to produce the planned software game but failed to disclose that the remaining funding was never obtained, and the company went bankrupt. Charges were brought against the state authority, several officials, the underwriter and the lead banker at that firm. The state authority and two officials settled charges and the two officials paid fines of $25,000 each.

FAILURE TO DISCLOSE RISKS – Although this element may have occurred in some of the cases already noted, the cases below focused on failures to disclose known risks that the SEC asserted would have been material to investors.

City of South Miami, Florida (2013). The city borrowed money from a statewide pool and used it to build a parking garage. Contrary to its tax agreement, the city leased portions of the garage to a private developer, likely making the bonds taxable. On a second bond issue, it failed to disclose this tax risk. The city settled the case.
UNO Charter School, Illinois (2014). A nonprofit charter school used bond proceeds for construction but failed to disclose in the OS that its senior management had engaged with the school in certain transactions that violated prohibitions under state law against conflicts of interest. These conflicts could have led to withdrawal of state grants, which were critical to the school’s finances. The school settled SEC charges and the founder of the school paid a fine of $10,000.
Port Authority of New York and New Jersey (2017). In selling bonds for several years for a variety of projects, the port authority did not disclose that its internal counsel had raised significant legal concerns about use of bond proceeds to fund certain road improvements in New Jersey. Although the road projects were ultimately funded with other moneys, the SEC alleged securities law violations for failing to disclose the legal risk. The Port Authority settled but had to admit wrongdoing and agree to a fine of $400,000, to improve internal procedures for board of directors’ approvals of bond sales, and to hire an outside consultant.

FAILURE OF CONTINUING DISCLOSURE – The SEC has also brought actions based on issuers’ failures to comply with continuing disclosure obligations.

City of Harrisburg, Pennsylvania (2013). The city was under severe financial strain and did not produce and file annual audits and financial reports as required by its continuing disclosure agreements (CDAs). Nonetheless, the city and its officials made public statements concerning its financial condition, including budget reports. The SEC sued on the grounds that these public statements and budget reports omitted material information about the city’s dire financial condition, asserting that in the absence of the required continuing disclosure reports, investors had no choice but to rely on the other statements for current information on which to make investment decisions.
West Clark Community Schools, Indiana and City Securities Corporation (2013). The school district affirmatively stated in an OS that it had not failed to comply in all material respects with any prior disclosure undertakings when it had, in fact, never filed any annual financial reports as required by its existing CDA. The school district settled the case. The underwriter of the bonds was also sanctioned for failing to adequately perform due diligence on the school district’s statement for CDA compliance and paid a substantial fine.