Municipal Bond Participants - The Issuer
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U.S. Securities and Exchange Commission

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.

This representation was false and misleading. The $44,906,000 appraisal was almost $3 million higher than an appraisal prepared the previous year, despite the fact that in the one year intervening period the number of single family lots in the project had been reduced from 667 to 584 and real estate values in California had declined. In addition, the $44,906,000 appraisal was based on the assumption that part of the land would be developed into 90 high-density single family lots. That assumption, however, was not part of the developer's immediate plans, did not meet the required minimum square foot requirements, had not been approved, and lacked any then-developed market.

The Ione CFD-1 Official Statement failed to disclose that the Castle Oaks Project lacked sufficient capital to finance the planned development. The estimated cost of the infrastructure and golf course was between $25 and $30 million. Ione agreed to raise approximately $14 million by issuing bonds, and the developer was to bear the balance of the construction costs from its own private funding sources. The developer had obtained a $10 million construction loan from a foreign bank. Of that amount, $6.5 million was soon diverted by the developer to another company, leaving a substantial shortfall in private financing for the project. Ione was not informed about the diversion of funds until March of 1992.

On October 6, 1994, due to the developer's failure to pay special taxes, Ione announced that there were no funds to make the October 1, 1994, interest and principal payments on the Ione CFD-1 and CFD-2 bonds and that the bonds were in default. Not a single lot had been sold. The construction lender foreclosed on the property. After the construction lender was unable to sell the property at two successive foreclosure sales and failed to bring the special tax bonds current, Ione foreclosed on the property. On December 1, 1995, Ione sold the property to an investment group for $3.3 million at a sheriff's auction.

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).

While offering and selling its bonds to the public, Ione represented that the Castle Oaks Project was a financially viable project and therefore that the bonds were a secure investment. This representation was false and misleading in light of available cost estimates, errors in the tentative map and appraisals, and the developer's lack of sufficient funds for the project.

The misrepresentations contained in the Ione 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 Ione 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.

Even though it retained and relied upon professional financial and legal advisers and appraisers, Ione was responsible under Sections 17(a)(2) and 17(a)(3) for any misrepresentations and/or omissions in the CFD-1 and CFD-2 Official Statements. The Ione City Council approved both Official Statements.

IV. Based on the foregoing, the Commission finds that Ione committed violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act.

IV. Accordingly, IT IS HEREBY ORDERED, pursuant to Section 8A of the Securities Act, that Ione 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 1, Chapter 2.5, Division 2, Title 5 of the California Government Code ( 53311, et seq.).

To Contents

In re City of Syracuse, New York, Warren D. Simpson, and Edward D. Polgreen, Securities Act Release No. 7460, Exchange Act Release No. 39149, AAE Release No. 970, A.P. File No. 3-9452 (September 30, 1997).

I. The Securities and Exchange Commission ("Commission") deems it appropriate that cease-and-desist proceedings be instituted against the City of Syracuse, New York ("Syracuse" or "the City"), Warren D. Simpson ("Simpson"), and Edward D. Polgreen ("Polgreen"), pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Section 21C of the Securities Exchange Act of 1934 ("Exchange Act").

In anticipation of the institution of these cease-and-desist proceedings, the City, Simpson, and Polgreen have submitted Offers of Settlement ("Offers"), which the Commission has determined to accept. Solely for the purpose of these proceedings 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 set forth herein, except that the City, Simpson, and Polgreen, each admits the jurisdiction of the Commission over them and over the subject matter of these proceedings, the City, Simpson, and Polgreen by their Offers of Settlement, consent to the entry of this Order Instituting Cease-and-Desist Proceedings, Making Findings, and Issuing Cease-and-Desist Orders ("Order").

II. Accordingly, IT IS HEREBY ORDERED that proceedings pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act be, and hereby are, instituted.

III. On the basis of this Order, and the Offers, the Commission makes the following findings:

Summary

A. These proceedings involve violations of the antifraud provisions of the federal securities laws by the City in the offer and sale of municipal securities issued in December 1995 and February 1996. In connection with these offerings, the City materially misrepresented its financial condition and results of operations and described certain summary financial information as audited without disclosing that some of this information was derived from financial statements upon which auditors had issued reports containing qualified opinions. These actions were taken knowingly or recklessly, within the meaning of those terms under the federal securities laws. Simpson and Polgreen each were a cause of the City's violations, due to acts and omissions which they knew or should have known would contribute to the violations.

B. On December 19, 1995, the City issued $19.299 million of one-year bond anticipation notes ("12/95 Offering"). On February 22, 1996, the City issued an additional $3.768 million of one-year bond anticipation notes ("2/96 Offering"). In, and in connection with, the offer and sale of securities in the 12/95 Offering and the 2/96 Offering, the City issued official statements which were materially false and misleading in at least two respects:

  • First, the official statements contained materially inaccurate summary financial information for the fiscal year ended June 30, 1995 ("FY 1995"). The official statements falsely showed a surplus for FY 1995 of $.4 million in the Combined Statement of Revenue, Expenditures and Changes in Fund Balance for the City's General and Debt Service Funds when, in fact, there was a deficit of $9.4 million, a difference of $9.8 million. As a result of that misstatement and others, including the City's failure to recognize certain tax revenue in conformity with generally accepted accounting principles ("GAAP"), the City overstated the FY 1995 ending fund balance for the General and Debt Service Funds by $24.2 million.

  • Second, the official statements contained summary financial information that was labeled "audited," implying that the auditors had rendered unqualified opinions on the information as presented, when, in fact, certain of the auditors' reports on the financial statements from which such information was derived contained qualified opinions.

Respondents

C. Syracuse is a municipal corporation and the fifth largest city in the state of New York. The City encompasses approximately 25 square miles and, as of July 1994, had a population of 159,895.

D. Simpson was, at all relevant times until November 1995, the most senior accountant in the City's Finance Department. Among other things, the Finance Department was responsible for the City's securities offerings and the preparation of official statements in connection with those offerings. Simpson oversaw the preparation of the summary financial information contained in the official statements for the 12/95 Offering and the 2/96 Offering.1

E. Polgreen was, at all relevant times, the City's First Deputy Commissioner of Finance.

Other Related Person

F. The Syracuse City Auditor ("City Auditor") is an elected official who is responsible under the City charter for auditing the affairs of the City's officers, departments, and boards. For many years through and including the fiscal period ended June 30, 1994 ("FP 1994")2 , the City Auditor had audited the City's general purpose financial statements.

The FY 1995 Summary Financial Information in the Official Statements Was Prepared Before the City's Books Were Closed

G. The City historically issued debt securities in or about February, June, and December of each year and included in official statements for its offerings the City's most recent general purpose financial statements,3 ; as well as summary financial information. At the time of the 12/95 Offering, however, the City's FY 1995 general purpose financial statements were not complete. The Finance Department determined that the most recent general purpose financial statements, for FP 1994, were too stale to include in the official statement. Accordingly, the Finance Department decided to present only summary financial information and hastily produced FY 1995 summary financial information for inclusion in the official statement for the 12/95 Offering, even though the books for FY 1995 had not yet been closed.

H. The summary financial information in the official statement for the 12/95 Offering included a balance sheet and statement of revenue, expenditures and changes in fund balance, as of and for the fiscal year ended June 30, 1995, with comparative data for several preceding fiscal periods for each of the following: (1) the City's combined General and Debt Service Funds, (2) the City's combined Water and Sewer Funds, and (3) the City School District's General Fund.4 ; In the official statement for the 12/95 Offering, this summary financial information was included as an appendix and identified as "Financial Statements."5

I. The FY 1995 summary financial information included in the official statement for the 12/95 Offering was unreliable because the City's books were not closed for FY 1995. The delay in closing the books was due to various factors including: (1) the Finance Department had lost several employees who were experienced in closing the books and preparing the financial statements; (2) several important responsibilities of those who had left the Finance Department had not been reassigned; (3) the audit of the City's FP 1994 general purpose financial statements by the City Auditor was ongoing until October 1995, which required significant attention from the staff of the Finance Department and diverted them from other duties; and (4) the City's accounting systems were antiquated and had significant inefficiencies.

J. The summary financial information included in the official statements for the 12/95 and 2/96 Offerings, including the information for FY 1995, was virtually identical.6 Although the process of closing the City's books for FY 1995 continued between the time of the 12/95 and 2/96 Offerings, in preparing the official statement for the later offering, the City did not consider whether any changes to the FY 1995 summary financial information were necessary.

The FY 1995 Summary Financial Information in the Official Statements Was Materially Inaccurate.

K. When the City's Finance Department was unable to complete the FY 1995 financial statements by February 1996, additional personnel with accounting backgrounds were assigned from other departments to assist in completing the statements. The FY 1995 general purpose financial statements were completed in April 1996, approximately six weeks after the 2/96 Offering.

L. The outside auditor who ultimately audited the City's FY 1995 general purpose financial statements found that the City failed to record certain accounting entries, including accruals for accounts payable, workers' compensation, and retirement benefits.7 ; As a result of the City's failure to record these accounting entries in a timely manner and to record certain other entries accurately, the official statements for the 12/95 and 2/96 Offerings falsely stated that the Combined Statement of Revenue, Expenditures and Changes in Fund Balance for the City's combined General and Debt Service Funds showed a surplus for FY 1995 of $.4 million when, in fact, there was a deficit of $9.4 million, a difference of $9.8 million.

M. The outside auditor also discovered that the City's accounting practices with respect to the recognition of property tax revenue were not in conformity with GAAP.8 To bring its practice with respect to recognition of property tax revenue into conformity with GAAP, the City made a prior period adjustment of $12.5 million to the General Fund balance to reclassify Fund Balance - Reserved for Taxes to Deferred Revenue.9

N. The City's failure to make certain accounting entries in a timely manner and to record tax revenue in conformity with GAAP resulted in certain misstatements in the FY 1995 general purpose financial statements. Adjustments to correct those misstatements, as well as certain other adjustments, resulted in changes to the FY 1995 summary financial information for the City's combined General and Debt Service Funds and combined Water and Sewer Funds. The following table shows the changes to the FY 1995 summary financial information presented in the official statements for the 12/95 and 2/96 Offerings:

  FY 95 Fund Balance as Presented in Official Statements FY 95 Fund Balance -- Actual Understatement/ (Overstatement)/ %
General & Debt Service Funds $31 million $6.8 million ($24.2 million) / (355%)
Water and Sewer Funds $2.6 million $3.2 million $ 0.6 million / 19%
School District General Fund $27.2 million $27.2 million $ 0 / 0%

The Representation in the Official Statements that Certain Summary Financial Information Was Audited Was Also Materially Misleading

O. The summary financial information for fiscal periods prior to FY 1995 included in the official statements for the 12/95 and 2/96 Offerings was labeled "audited." In addition, the FY 1995 summary financial information for the City School District's General Fund included in the official statement for the 2/96 Offering was labeled "audited." Labeling the information "audited" implied that auditors had rendered unqualified opinions on the information presented.10

P. In fact, certain of the auditors' reports on the financial statements from which such information was derived contained qualified opinions. The auditor's report for the City's FP 1994 general purpose financial statements contained a qualified opinion, as did the auditors' reports on the general purpose financial statements of the City School District for all the periods presented. The official statements for the 12/95 and 2/96 Offerings did not include the auditors' reports on the general purpose financial statements of the City or of the City School District, from which the summary financial information labeled "audited" was derived, and did not disclose that some of these auditors' reports contained qualified opinions. Labeling certain of the summary financial information "audited" without including related auditors' reports containing qualified opinions or disclosing that the related reports contain qualified opinions was misleading.

City Officials, Including Simpson and Polgreen, Knew or Recklessly Disregarded That the FY 1995 Summary Financial Information Was Materially Inaccurate and That Labeling Certain of the Summary Financial Information "Audited" Was Materially Misleading.

Q. City officials, including Simpson and Polgreen, were aware of the problems within the Finance Department, knew that the City's books for FY 1995 had not been closed, and knew that the FY 1995 summary financial information included in the official statement for the 12/95 and 2/96 Offerings was subject to revision. In addition, at the time that he caused the FY 1995 summary financial information to be included in the official statements for the 12/95 and 2/96 Offerings, Simpson knew that the City's practice concerning the recognition of property tax revenue was not in conformity with GAAP.

R. City officials, including Simpson and Polgreen, knew that the auditor's report on the FP 1994 general purpose financial statements of the City and the auditors' reports on the City School District's general purpose financial statements for all periods presented contained qualified opinions. Moreover, prior to the closing of the 2/96 Offering, City officials, including Simpson and Polgreen, knew that the City Auditor objected to the financial presentation in the official statement for the 12/95 Offering because summary financial information presented for fiscal periods prior to FY 1995 was labeled "audited."

S. Simpson oversaw the preparation of the summary financial information included in the official statements for the 12/95 and 2/96 Offerings.

T. Polgreen was Simpson's direct supervisor and was aware that Simpson was providing the summary financial information to be included in the official statements for the Offerings. Polgreen signed a certification stating that the preliminary official statement for the 2/96 Offering did not contain any false statements of material fact, or omit to state material facts.11 Although Polgreen knew that the books for FY 1995 had not been closed and that some or all of the auditors' reports on the financial statements from which certain of the summary financial data was derived contained qualified opinions, Polgreen permitted the inclusion of the FY 1995 summary financial information and the use of the misleading label "audited". Moreover, Polgreen signed the certification for the official statement for the 2/96 Offering without making any inquiries to determine whether he could make the representation contained in the certification.

IV. Legal Analysis -- Violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 Thereunder

A. Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit any person, in the offer or sale, or in connection with the purchase or sale, of securities, from making any untrue statement of a material fact, or omitting to state a material fact, using any device, scheme or artifice to defraud, or engaging in any transaction, practice, or course of business which operates as a fraud. A misstatement or omission is material if there is a substantial likelihood that it would have been viewed by a reasonable investor as "having significantly altered the `total mix' of information made available." TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). See also Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988).

B. Scienter is a required element to prove violations of Section 17(a)(1), Section 10(b) and Rule 10b-5. See Aaron v. SEC, 446 U.S. 680, 701-02 (1980); Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976).12 Scienter is established by a showing of either intentional or reckless conduct. See Ernst, 425 U.S. at 194 n.12; SEC v. Blavin, Inc., 760 F.2d 706, 711 (6th Cir. 1985). Recklessness is "`highly unreasonable conduct which is an extreme departure from the standards of ordinary care.'" Id. (citation omitted). See also Estate of Detwiler v. Offenbecher, 728 F. Supp. 103, 137 (S.D.N.Y. 1989) (dissemination of material "knowing [it was] false or that the method of preparation was egregious as to render [its] dissemination reckless" satisfies the Scienter requirement); Goldman v. McMahan, Brafman, Morgan & Co., 706 F. Supp. 256, 259 (S.D.N.Y. 1989) ("[a]n egregious refusal to see the obvious, or to investigate the doubtful" may give rise to an inference of recklessness).

C. The information misstated in, and omitted from, the official statements for the 12/95 and 2/96 Offerings was material. There is a substantial likelihood that a reasonable investor would view the misstatements of the FY 1995 summary financial information as significantly altering the total mix of information made available. In addition, a reasonable investor would likely conclude from the labeling of certain summary financial information as "audited" that auditors had issued reports containing unqualified opinions on the summary financial information. There is a substantial likelihood that disclosure that the auditors' reports on the City's FP 1994 financial statements and on the City School District's financial statements for FY 1995 and the prior fiscal years, from which that summary financial information was derived, contained qualified opinions, would have been viewed by a reasonable investor as significantly altering the total mix of information available. Accordingly, the inaccuracy of the FY 1995 summary financial information and the failure to disclose that certain of the summary financial information was derived from financial statements upon which auditors had issued reports containing qualified opinions constituted material misstatements and omissions.

D. City officials, including Simpson and Polgreen, acted knowingly or recklessly in including the FY 1995 summary financial information in the official statements for the 12/95 and 2/96 Offerings and labeling certain of the summary financial information in the official statements as "audited", because:

  • They were aware of the problems within the Finance Department and knew that the City had not completed its closing process for FY 1995 by the time that summary financial information for FY 1995 was included in the official statements.

  • Simpson was aware that the City's accounting for property taxes did not conform with GAAP.

  • They knew that the auditor's report on the FP 1994 general purpose financial statements of the City and the auditors' reports on the general purpose financial statements of the City School District for the periods presented contained qualified opinions and knew, or were reckless in not knowing, that labeling the summary financial information in the official statements "audited" would be misleading to investors.

E. While engaged in the conduct described above, the City, directly and indirectly, used the means or instrumentalities of interstate commerce or the mails.

V. A. Based on the foregoing, the City violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.

B. Based on the foregoing, Simpson and Polgreen each were a cause of the City's violations due to their various acts and omissions which they knew or should have known would contribute to the City's violations.

VI. In view of the foregoing, the Commission deems it appropriate to accept the Offers of Settlement submitted by the City, Simpson, and Polgreen and impose the cease-and-desist orders specified in the Offers of Settlement. In determining to accept the Offers, the Commission considered remedial acts promptly undertaken by the City and cooperation afforded to the Commission's staff.

Accordingly, IT IS HEREBY ORDERED that:

A. The City 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;

B. Simpson 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; and

C. Polgreen 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]- In November 1995, Simpson was reassigned to the Budget Department; however, he retained responsibilities with respect to the preparation of the official statements after he was reassigned.

-[2]-Due to a change in the City's fiscal year, the fiscal period ended June 30, 1994 was a six-month period.

-[3]-Under governmental accounting and financial reporting standards, general purpose financial statements may be issued for inclusion in official statements for securities offerings and for distribution to users requiring less detailed information about the governmental entity's finances than is contained in a comprehensive annual financial report. To comply with GAAP, general purpose financial statements should include, among other things: (1) a combined balance sheet for all fund types, account groups, and discretely presented component units; (2) a combined statement of revenues, expenditures and changes in fund balance for all governmental fund types and discretely presented component units; and (3) notes to the financial statements. See Codification of Governmental Accounting and Financial Reporting Standards, 2200.134, 138 (Governmental Accounting Standards Board 1995).

-[4]- The City School District is a component unit of the City.

-[5]- Historically, the City included summary financial information in official statements in addition to the City's general purpose financial statements.

-[6]-The sole exception was that, in the official statement for the 2/96 Offering, the FY 1995 summary financial information for the City School District was labeled "audited." See discussion below.

-[7]-For many years, the City's general purpose financial statements had been audited by the City Auditor. As the result of disagreements between the City Auditor and the Finance Department, the City decided to hire an outside auditor to audit the FY 1995 general purpose financial statements. The outside auditor found that the City's books were in such disarray that the general purpose financial statements produced in April 1996 were "unauditable." Subsequently, a new version of the FY 1995 general purpose financial statements was prepared from the City's source documents.

-[8]-The City had for many years recognized the entire tax levy as revenue at the beginning of the fiscal year and made an entry at the end of the fiscal year to reclassify as Fund Balance - Reserved for Taxes, the taxes that were not collected during the year, but which were expected to be collected in the future. GAAP generally requires property taxes which are expected to be collected after 60 days of the fiscal year-end to be booked as deferred revenue and recognized as revenue when such amounts are collected. See Codification of Governmental Accounting and Financial Reporting Standards, _ P70.103, 104 (Governmental Accounting Standards Board 1995).

-[9]-Additional unrelated prior period adjustments totaled $1.9 million.

-[10]-Labeling the summary information "audited" also implied that the auditors had opined on the summary financial information. Instead, the summary financial information was derived from audited general purpose financial statements of the City and the City School District information included in the official statement for the 12/95 and 2/96 Offerings was subject to revision. In addition, at the time that he caused the FY 1995 summary financial information to be included in the official statements for the 12/95 and 2/96 Offerings, Simpson knew that the City's practice concerning the recognition of property tax revenue was not in conformity with GAAP.

-[11]-Certifications for the City's official statements were generally signed by the Commissioner of Finance. The Commissioner signed the certification for the 12/95 Offering. Subsequent to the 12/95 Offering, but prior to the closing of the 2/96 Offering, the Commissioner was injured and went out on disability leave.

-[12]-Scienter is not required for a violation of Sections 17(a)(2) and (3) of the Securities Act. See Aaron, 446 U.S. at 697.

To Contents

In re Maricopa County, Securities Act Release No. 7345, Exchange Act Release No. 37748, A.P. File No. 3-9118 (September 30, 1996).

On September 30, 1996, the Commission instituted cease-and-desist proceedings against Maricopa County, Arizona ("the County"). The County, formed in 1871, is the population center of Arizona and the sixth largest county in the nation. The Order Instituting Cease-and-Desist Proceedings ("Order") alleges that the County violated the antifraud provisions of the federal securities laws in connection with the July 1993 offer and sale of two series of general obligation bonds.

The County's Official Statements, which were the primary disclosure documents for the offerings, contained financial statements for the County for the year ended June 30, 1992. The Order alleges, however, that the County's financial condition at the time of the offerings had materially worsened since June 30, 1992. Specifically, during fiscal year 1992-93, the County developed a deficit in its General Fund and had nearly doubled the deficit in its Medical Center Enterprise Fund. The Official Statements failed to disclose these changes. The Official Statements further failed to disclose that the current liabilities of the Medical Center Enterprise Fund on June 30, 1993, exceeded its current assets by approximately 40% more than on June 30, 1992, and that the County's cash flow position had materially declined since the close of the prior fiscal year.

In addition, the Official Statements for one of the offerings represented that bond proceeds would be used to finance specific County projects. The Order alleges that the County in fact planned to, and did, use the bond proceeds to finance its deficit through the end of the 1993-1994 fiscal year. Despite the County's plan to use the proceeds to finance its deficit, it failed to revise or supplement its Official Statement to reflect this plan. Each of the omitted items referenced above would have been important for an investor to consider in deciding whether or not to purchase the County's bonds because they tended to bear upon the County's financial condition at the time the bonds were issued.

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In re Maricopa County, Securities Act Release No. 7354, Exchange Act Release No. 37779, A.P. File No. 3-9118 (October 3, 1996).

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 Maricopa County, Arizona ("the County") or "Respondent").n1 The County has submitted an Offer of Settlement ("Offer") to the Commission, 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 as to the jurisdiction of the Commission over it and over the subject matter of this proceeding, which is admitted, Maricopa County by its Offer consents to the entry of this Order Making Findings and Imposing Sanction Pursuant to Section 8A of the Securities Act of 1933 and Section 21C of the Securities Exchange Act of 1934 ("Order") containing the findings set forth in Section III below and imposing the sanction set forth in Section IV below.

III. On the basis of this Order and the Offer submitted by Maricopa County, the Commission findsn2 that:

A. Maricopa County, formed in 1871, encompasses approximately 9,226 square miles and is the population center of Arizona. Between July 26, 1993 and August 10, 1993, Maricopa County offered and sold $25.575 million worth of ten year general obligation project bonds ("Project Bonds") and $22.25 worth of four year general obligation refunding bonds ("Refunding Bonds") (collectively referred to as the "1993 G.O. Bond Offerings"). In, and in connection with, the offer, purchase and sale of the 1993 G.O. Bond Offerings the County violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, by using the means and instruments of transportation and communication in interstate commerce and the means and instrumentalities of interstate commerce, and the mails to, directly and indirectly, obtain money and property by means of untrue statements of material fact and omissions 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.

B. The County, assisted by others, including a financial adviser, prepared and distributed, or caused others to distribute, Official Statements and Closing Documents which were the primary disclosure documents used in connection with the 1993 G.O. Bond Offerings. The Official Statements were distributed to investors by use of the mails and means and instruments of transportation and communication in interstate commerce and the means and instrumentalities of interstate commerce. The Closing Documents, which included, among other things, a copy of the Official Statement for each offering and a certification of completeness, were distributed to others involved in the offer, sale and distribution of the Bonds.

C. The Official Statements for each offering contained financial statements for the year ended June 30, 1992. However, the County's financial condition at the time of the 1993 G.O. Bond Offerings had materially worsened since June 30, 1992, in that the County's operating cash flow had materially declined. Specifically, during fiscal year 1992-93, the County developed a deficit in its General Fund and had nearly doubled the deficit in its Medical Center Enterprise Fund, from $16.9 million to $31.8 million. The Official Statements, which included financial statements for 1992, failed to disclose these changes. In addition, the Official Statements failed to disclose that the current liabilities of the Medical Center Enterprise Fund on June 30, 1993, exceeded its current assets by approximately 40% more than on June 30, 1992. Furthermore, the Official Statements for the 1993 G.O. Bond Offerings failed to disclose that the County's cash flow position had materially declined since the close of the prior fiscal year. In fact, the County's preexisting G.O. Bond rating was downgraded by Moody's Investor Service due to the cash flow situation.

D. In addition, the Project Bonds' Official Statements represented that bond proceeds would be used to finance specific County projects. The Project Bonds' Closing Documents were even more specific, representing that construction on the projects would start in July 1993 and January 1994. Contrary to these representations, the County planned to and did use $25 million of the $25.575 million Project Bond proceeds to finance its cash flow deficit through July 1994.

E. The Refunding Bonds' Closing Documents represented that, subsequent to June 30, 1992, there had been no material change in the County's financial condition. In fact, the County had developed a deficit in its General Fund and had nearly doubled the size of the deficit in its Medical Center Enterprise Fund, both occurring after June 30, 1992.

F. These facts were material since: 1) the County's changed financial condition, as reflected by the development of a General Fund deficit and the doubling of the Medical Center Enterprise Fund deficit would have been important for an investor to consider in deciding whether or not to purchase the County's G.O. Bonds; and 2) use of Project Bond proceeds to alleviate the County's cash flow deficit was an undisclosed use of investor funds, which an investor would have considered important in deciding whether or not to purchase the Bonds.

IV. In view of the foregoing, it is in the public interest to impose the sanction specified in the Offer.

Accordingly, IT IS ORDERED THAT:

Respondent Maricopa County shall cease and desist from committing or causing any violation and any future violation of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.

For the Commission, by its Secretary, pursuant to delegated authority.

Footnotes

-[n1]-The Order Instituting Cease-and-Desist Proceeding in this matter was issued on September 30, 1996. See Exchange Act Release No. 37748.

-[n2]-The findings herein are made pursuant to Respondent's Offer of Settlement and shall not be binding on any other person or entity named as a respondent in this or any other proceedings.

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In re County of Orange, California; Orange County Flood Control District and County of Orange, California Board of Supervisors, Securities Act Release No. 7260, Exchange Act Release No. 36760, A.P. File No. 3-8937 (January 24, 1996).

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") and Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against the County of Orange, California ("Orange County" or the "County"), the Orange County Flood Control District (the "Flood Control District") and the County of Orange, California Board of Supervisors (the "Board").

II. In anticipation of the institution of this proceeding, Orange County, the Flood Control District and the Board have 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 Orange County, the Flood Control District and the Board each admits the jurisdiction of the Commission over them and over the subject matter of this proceeding, Orange County, the Flood Control District and the Board, by their Offer of Settlement, consent to the entry of this Order Instituting A Public Administrative Cease-And-Desist Proceeding 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") 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 and Section 21C of the Exchange Act be, and hereby is, instituted.

III. On the basis of this Order and the Offer of Settlement submitted by Orange County, the Flood Control District and the Board, the Commission finds that:1

A. SUMMARY

This Order concerns false and misleading statements in the offer and sale of over $2.1 billion in municipal securities issued in 1993 and 1994 by Orange County, the Flood Control District and a school district located in Orange County (the "School District").2 In connection with these offerings, the County, the Flood Control District and the Board variously made material misstatements in the disclosure documents for the offerings (the "Official Statements") or authorized the use of Official Statements that were either false or misleading by omitting to state material facts regarding: 1) the Orange County Investment Pools (the "County Pools"), including the County Pools' investment strategy and investment results, manipulation of the County Pools' yield, and investment in the County Pools of the funds pledged to repay the securities, which matters affected the issuer's ability to repay the municipal securities and the County Pools' ability to perform under agreements to repurchase or provide for repayment of the municipal securities (the "Purchase Agreements"); 2) Orange County's financial condition, including its economic reliance on the investment results of the County Pools as a source of funds to repay its obligations on the securities; 3) the tax-exempt status of the offering; 4) an undisclosed cap on the interest rate payable to investors on certain variable rate municipal securities sold in the offerings; and 5) the unauthorized use of an audit report. In addition, in connection with the offer and sale of certain of the municipal securities, misrepresentations were made to certain national securities rating agencies (the "Rating Agencies") concerning the County Pools. These material misstatements were made in violation of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.

B. THE RESPONDENTS

County of Orange, California ("Orange County" or the "County") is a legal subdivision and political subdivision of the State of California and a body corporate and politic having the powers specified in Title 3 of the California Government Code and such others necessarily implied from the express powers.3 [3]-On December 6, 1994, the County filed for protection under Chapter 9 of the United States Bankruptcy Code after incurring investment losses in the County Pools. Orange County conducted eight of the eleven offerings of municipal securities that are the subject of this Order.

Orange County Flood Control District (the "Flood Control District") is a body corporate and politic having the powers enumerated in its enabling legislation.4 The Orange County Board of Supervisors is designated and empowered to act as ex officio board of supervisors of the Flood Control District.5 The Flood Control District's principal functions are to provide for the control and preservation of flood and storm waters within Orange County. The Flood Control District conducted one of the municipal securities offerings that are the subject of this Order.

Orange County Board of Supervisors (the "Board") is the body through which the County exercises its powers.6 The Board consists of five full-time members, each serving a term of four years.7 The Board has legislative, financial and police powers. The Board exercises its financial powers through its supervision of and control over the financial affairs of the County. The financial powers of the Board include: examination and audit, or causing the audit, of the financial accounts and records of all officers having responsibility for County moneys; supervision of the official conduct of all County officers, including the Treasurer; investment of County surplus funds; approval of proposed County budgets and adoption of final County budgets; and contracting for County indebtedness, including issuing municipal securities. 8

C. RELATED INSTRUMENTALITIES AND PERSONS

The Orange County Investment Pools (the "County Pools") were instrumentalities of the County and were not established as legal entities distinct from the County. The County Pools operated as an investment fund managed by Orange County through which the Treasurer invested the County funds and public funds deposited in the County's control by various local governments or districts (the "Pool Participants" or the "Participants"). As of December 1994, the County Pools held approximately $7.6 billion in Participant deposits, including County funds. The County Pools consisted of the Commingled Pool (the principal investment pool with $6.126 billion in Participant deposits), the Bond Pool (the pool primarily for proceeds from tax-exempt offerings with $1.261 billion in Participant deposits) and Specific Investments (investments separately managed for certain Participants, including Orange County, with $210 million in Participant deposits).

As of December 1994, there were approximately 183 Pool Participants. Orange County invested essentially all of its liquid assets in the County Pools, almost $2.3 billion. In addition, approximately 80 other Participants were required by California law to deposit their funds with the Treasurer (the "Mandatory Participants"). As of December 1994, these Mandatory Participants had deposited about $1.6 billion into the County Pools. The remaining approximately 102 Participants voluntarily deposited their funds with the Treasurer for investment in the County Pools (the "Voluntary Participants"). As of December 1994, these Voluntary Participants had deposited approximately $3.7 billion into the County Pools. In total, the County, the Mandatory Participants and the Voluntary Participants had invested or deposited $7.6 billion into the County Pools.

The Orange County Treasurer-Tax Collector (the "Treasurer") is an elected official who manages the treasury and tax collection functions of Orange County under the authority of the Board. The Treasurer is aided in his treasury responsibilities by an assistant treasurer (the "Assistant Treasurer"), a non-elected County official. The Treasurer and Assistant Treasurer also serve as the Treasurer and Assistant Treasurer of the Flood Control District.9 The Treasurer and the Assistant Treasurer managed the County Pools' funds and securities, directed the County Pools' investments and communicated with Pool Participants and prospective investors in the County Pools.10

D. FACTS

1. Orange County's Financial Condition

Orange County's financial condition was closely tied to the financial condition of the County Pools. The County was heavily dependent on the County Pools as a source of income to balance its current operating budget.11 The County's use of interest income as a revenue source to balance its discretionary budget had been increasing since at least fiscal year 1991-92, and increased dramatically for fiscal year 1994-95.12 This increased use of interest income was due to a decline in revenue from other sources, particularly property taxes.13 The Board approved the County's budget and was aware of the County's increasing use of interest income from the County Pools to balance the discretionary budget.

The County had two sources of funds to invest in the County Pools and earn investment interest. First, from January 1993 to December 1994, Orange County had invested essentially all of its liquid assets in the County Pools, almost $2.3 billion, including funds pledged to repay municipal securities. Second, in 1993 and 1994, Orange County issued $1 billion in municipal securities, through two offerings, for the sole purpose of reinvesting the proceeds in the County Pools, $400 million of which was repaid in 1994.

Due to the County Pools' risky investment strategy, the County Pools ultimately lost approximately $1.7 billion of the Participants' deposits of $7.6 billion, a loss of about 22.3%, when the County Pools' securities portfolio was liquidated. Orange County itself lost approximately $600 million of its $2.3 billion investment in the County Pools. The County also suffered a loss of $157 million in estimated and budgeted interest earnings from the County Pools, contributing to a projected budget deficit for fiscal year 1994-95 of approximately $172 million. As a result of these losses, on December 6, 1994, Orange County filed a bankruptcy petition under Chapter 9 of the United States Bankruptcy Code. As a result of Orange County's economic dependence on the County Pools and their subsequent collapse, the County has not repaid or repurchased approximately $910 million in municipal securities at the time they were to mature by their original terms or were tendered for repurchase.14

2. The Orange County Investment Pools

The eleven municipal securities offerings that raised over $2.1 billion and that are the subject of this Order were significantly dependent on the investment performance of the County Pools in one or more of the following ways such that fair and accurate disclosure about the operation of the County Pools was material to investors in the municipal securities: 1) the proceeds from certain offerings, totaling $1.2 billion, were reinvested in the County Pools to obtain interest earnings; 2) the funds pledged to repay certain of the securities were invested in the County Pools; 3) the County Pools agreed to repurchase or repay certain of the securities; and/or 4) the County's economic reliance on the County Pools materially affected its ability to repay its securities. The false and misleading statements in the offer and sale of the municipal securities also related principally to the County Pools. Accordingly, in order to set forth these false and misleading statements, it is necessary to first discuss the County Pools and the reasons for their collapse.

a. The County Pools' Investment Strategy

The County Pools' investment policy as stated by the Treasurer's office to Pool Participants was, in order of importance: 1) preservation of investment capital; 2) liquidity; and 3) investment yield. The Treasurer, however, caused the County Pools to engage in a very risky investment strategy. The 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 volatile derivative securities.15

The County Pools' investment return was to result principally from the interest received on the securities in the County Pools. Leverage enabled the County Pools to purchase more securities for the purpose of generating increased interest income. This strategy was profitable as long as the County 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 County Pools' Holdings

During 1993 and 1994, the Treasurer on behalf of Orange County, using reverse repurchase agreements, leveraged the Participants' deposits to amounts ranging from 158% to over 292%. The Treasurer then invested the Participants' deposits and the funds obtained through reverse repurchase agreements in debt securities issued by the United States Treasury or government sponsored enterprises; however, many of these securities were risky derivative securities, comprising from 27.6% to 42.2% of the combined County Pools' portfolio and from 31% to 53% of the Commingled Pool's portfolio.

The County Pools were heavily invested in derivative instruments known as inverse floaters that pay interest rates inversely related to the prevailing market interest rate. Inverse floaters are negatively affected by a rise in interest rates. From January 1993 through November 1994, from 24.89% to 39.84% of the County Pools' total portfolio consisted of inverse floaters. In contrast, the County Pools invested only sparingly in securities that paid interest rates directly related to the prevailing interest rate (variable rate securities) or securities that paid interest rates that rose at certain stated intervals to certain stated rates (step-up securities). From January 1993 through November 1994, only 1.84% to 5.59% of the County Pools' portfolio consisted of such securities. Accordingly, the County Pools invested in inverse floaters to speculate on the direction of short and long-term interest rates.

c. The County Pools' Sensitivity To Interest Rate Changes

The composition of the County Pools' portfolio made it highly sensitive to interest rate changes. As interest rates rose, the market value of the County Pools' securities (debt instruments) fell, and the interest received on the County Pools' inverse floaters also dropped. In October 1992 and January 1993, the Treasurer was advised that the County Pools' modified duration was seven years.16 In other words, for each 1% increase (or decrease) in the prevailing interest rate, the County Pools' equity (i.e., the value of the County Pools' securities less the amount obtained through reverse repurchase agreements) would decrease (or increase) by approximately 7%. The Treasurer was also advised that the modified duration indicated substantially more price volatility than would be expected from a portfolio with the County Pools' short average maturity. The Treasurer was further advised that the County Pools' lengthy modified duration was the result of the County Pools' investment in inverse floaters and the use of reverse repurchase agreements to leverage the portfolio.

In February 1994, the Treasurer was advised that: over $5 billion of the County Pools' derivative securities (which comprised roughly 75% of the County Pools' total derivative holdings and about 25% of the entire portfolio) had an average duration of approximately five years; and for each basis point (.01%) rise in comparable duration Treasury securities, the mark-to-market value of these securities would fall by $2.7 million.

d. The Effect Of The Rise In Interest Rates In 1994 On The County Pools

The County Pools' investment strategy was profitable so long as interest rates, including rates on reverse repurchase agreements, remained low and the market value of the County Pools' securities remained stable. The Treasurer's Annual 1992-93 Financial Statement for the County 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 County Pools' investment strategy, the County Pools earned a relatively high yield of about 8% during 1993. Beginning in February 1994, interest rates began to rise. This rise in interest rates caused the County Pools' yield to decrease, the reverse repurchase costs to increase, the County Pools' interest income on inverse floaters to decrease and the market value of the County Pools' debt securities to decline.17 The rising interest rates and the declining market value of the County Pools' securities also caused the County to be subject to collateral calls and reductions in amounts obtained under reverse repurchase agreements of over $1.36 billion. In sum, because of the leverage employed in managing the County Pools and the losses which would be incurred by selling the securities subject to reverse repurchase agreements, the County Pools were facing a growing liquidity crisis.

e. Manipulation Of The County Pools' Yield

The Treasurer and the Assistant Treasurer manipulated the County Pools' yield by: 1) diverting interest income from Commingled Pool Participants to an account for the benefit of Orange County; and 2) causing the Commingled Pool to acquire and transfer securities at off-market prices to the detriment of Commingled Pool Participants.

Between April 1993 and June 1994, the Treasurer and the Assistant Treasurer misappropriated a total of $92.9 million from the Commingled Pool Participants, diverting these funds to an Orange County account designated the "Economic Uncertainty Fund." Between April 1993 and June 1994, they reported monthly, and distributed quarterly, to the Commingled Pool Participants the Commingled Pool's yield less the amount misappropriated. Then from July 1994 through November 1994, as the Commingled Pool's yield decreased, they overstated the Commingled Pool's yield to the Commingled Pool Participants by a total of $17.6 million.

From approximately April 1993 through November 1994, the Treasurer and the Assistant Treasurer caused the Commingled Pool to transfer securities at prices below market to, and to Investment Participants (including Orange County). These transactions resulted in a market value loss to the Commingled Pool that otherwise would have been borne by the Specific Investment Participants.

3. The Municipal Securities Offerings

The Board, the Treasurer and the Assistant Treasurer were the County officials primarily responsible for the issuance of the County's municipal securities. The Treasurer and the Assistant Treasurer were responsible for proposing to the Board and preparing the documents for the County's and the Flood Control District's short-term (less than thirteen months) debt offerings that are the subject of this Order. For such short-term debt offerings, they proposed the issuance of the securities, participated in the drafting and review of, and signed, the Official Statements and related documents and participated in the selection of the underwriters, bond counsel and financial advisers. They also participated in determining the County's cash flow deficit and the size of its cash flow borrowings. For the long-term debt offering that is the subject of this Order, the Treasurer and the Assistant Treasurer participated in the drafting and review of the portion of the Official Statement relating to the County Pools and in the preparation of various related documents.

The Assistant Treasurer, acting in his capacity as a County employee, was also principally responsible for the two offerings by the School District. He proposed that the School District issue the municipal securities and assisted in the drafting and review of the Official Statements and the selection of the underwriters, bond counsel and financial advisers. The Assistant Treasurer also met with the Rating Agencies to discuss the offerings that are the subject of this Order.

The Board had final authority to authorize and approve each of the municipal securities offerings by Orange County and the Flood Control District. The Board approved each of the County and the Flood Control District offerings discussed below, which raised over $2 billion. The Board's resolutions authorizing the issuance of the County's municipal securities specifically recited the approval of drafts of the Official Statements and authorized their completion and correction by a County official.

a. The Reinvestment Offerings

In 1993 and 1994, Orange County, the Flood Control District and the School District conducted a total of five municipal securities offerings raising $1.2 billion for the purpose of earning interest income by investing the offering proceeds in the County Pools at an expected higher rate of return (the "Reinvestment Offerings"). In these transactions, the municipal securities issuers expected to generate profits by investing at a rate of return that was higher than the rate of interest paid to the noteholders. Unlike most municipal securities offerings, these Reinvestment Offerings did not provide investors with interest income exempt from federal income taxation because the reinvestment practices used in these offerings did not conform to federal income tax law for tax-exempt securities.

(1) The 1993 Reinvestment Offerings

Orange County's first Reinvestment Offering was for $400 million in taxable notes (the "$400 Million Reinvestment Notes"). The notes had an interest rate of 3.95% per annum, matured, and were repaid, on July 1, 1994. On August 26, 1993, the School District issued $50 million in taxable notes (the "1993 $50 Million Reinvestment Notes"). The notes had an interest rate of 3.72% per annum, matured, and were repaid, on August 26, 1994.

The Official Statements for these 1993 Reinvestment Offerings represented that: the issuer would deposit the offering proceeds into an account pledged to repay the notes; the issuer intended to invest the funds in the repayment account; if the issuer suffered an investment loss, the pledged funds could be insufficient to repay the notes; and the issuer would satisfy any deficiency in the pledged funds from any other moneys lawfully available for repayment.

As discussed below, the Official Statements for the $400 Million Reinvestment Notes and the 1993 $50 Million Reinvestment Notes contained material misstatements and omissions regarding: 1) the County Pools, including the County Pools' investment strategy and investment in the County Pools of the funds pledged to repay the securities, which matters affected the issuer's ability to repay the municipal securities; and 2) the unauthorized use of an audit report (with respect to the $400 Million Reinvestment Notes only).

(2) The 1994 Reinvestment Offerings

In 1994, there were three Reinvestment Offerings. First, Orange County issued on July 8, 1994, $600 million in taxable notes (the "$600 Million Reinvestment Notes"). These notes had a variable interest rate equal to the one-month London Interbank Offered Rate ("LIBOR"); however, under the terms of the notes, the interest rate was not to exceed 12% per annum. The notes were originally due on July 10, 1995; the maturity of these notes has been extended to June 30, 1996. The School District issued $50 million in taxable notes (the "1994 $50 Million Reinvestment Notes") on August 1, 1994. The 1994 $50 Million Reinvestment Notes had a variable interest rate equal to the one-month LIBOR plus .03%; however, under the terms of the notes, the interest rate was not to exceed 12% per annum. The 1994 $50 Million Reinvestment Notes matured, and were repaid, on August 24, 1995. The Flood Control District, on August 2, 1994, issued $100 million in taxable notes (the "$100 Million Reinvestment Notes"). The notes had a variable interest rate equal to the one-month LIBOR plus .03%; however, under the terms of the notes, the interest rate was not to exceed 12% per annum. The notes matured, and were repaid, on August 1, 1995.

The proceeds from these Reinvestment Offerings were deposited into an account pledged to repay the notes. Each of the Official Statements for these Reinvestment Offerings disclosed that the issuer intended to invest the pledged funds in the County Pools and that, if an investment loss occurred, the issuer would satisfy the deficiency from any other moneys lawfully available for repayment. The lawfully available funds for the $600 Million Reinvestment Notes consisted essentially of funds in the discretionary budget.

The Official Statements for the $600 Million Reinvestment Notes and the $100 Million Reinvestment Notes contained material misstatements and omissions regarding: 1) the County Pools, including the County Pools' investment strategy and investment results, and manipulation of the County Pools' yield, which matters affected the issuer's ability to repay the municipal securities; 2) Orange County's financial condition, including its economic reliance on investment results of the County Pools as a source of funds to repay its obligations on the securities (with respect to the $600 Million Reinvestment Notes only); 3) an undisclosed cap on the interest rate payable to noteholders; and 4) the unauthorized use of an audit report. The Official Statement for the 1994 $50 Million Reinvestment Notes contained material misstatements and omissions regarding the County Pools, including the County Pools' investment strategy and investment results, and manipulation of the County Pools' yield, which matters affected the issuer's ability to repay the municipal securities.

b. The Tax And Revenue Anticipation Note Offerings

In 1994, Orange County conducted three separate tax and revenue anticipation note ("TRAN") offerings raising a total of almost $500 million. TRANs are designed to help local governments cover periodic cash flow deficits that arise because they receive revenues infrequently during the year while their working capital expenses are ongoing. Such notes are later repaid with the expected tax and other revenue received. As the deficits occur only periodically, TRANs proceeds are typically not spent immediately and are invested to earn investment income until needed to fund cash flow deficits. Because of the exclusion from federal income taxation of interest received, tax-exempt TRANs carry a lower interest rate than taxable securities of the same maturity and credit quality, thereby increasing the potential return on reinvestment.

(1) The 1994 $299.66 Million Pooled TRANs

On July 1, 1994, Orange County issued $299.66 million pooled tax and revenue anticipation notes (the "$299.66 Million Pooled TRANs"). These TRANs were tax-exempt and had an interest rate of 4.5% per annum. The notes matured, and were repaid, on July 28, 1995. As represented in the Official Statement, Orange County used the offering proceeds to purchase $299.66 million in notes issued by 27 Orange County school districts. The school districts then used these funds for their cash flow deficits. The Official Statement represented that, to repay the notes, the County would deposit certain funds pledged by the school districts in a repayment account, which the County pledged to repay the notes. The Official Statement also represented that the pledged money would be invested and reinvested but did not disclose where or how the pledged money would be invested.

The County Pools provided for repayment of the $299.66 Million Pooled TRANs through a Purchase Agreement, entitled Standby Purchase Agreement. Pursuant to this agreement, the Treasurer, as fund manager of the County Pools, agreed to purchase the school district notes to the extent they were not repaid by the school districts, thus assuring sufficient funds to repay the TRANs. The Assistant Treasurer signed the Purchase Agreement on behalf of the County Pools.

The Official Statement for the $299.66 Million Pooled TRANs contained material misstatements and omissions regarding the County Pools, including the County Pools' investment strategy and investment results, manipulation of the County Pools' yield, and investment in the County Pools of the funds pledged to repay the securities, which matters affected the issuer's ability to repay the municipal securities and the County Pools' ability to perform under the Purchase Agreement.

(2) The 1994 $169 Million and $31 Million TRANs

Orange County issued two series of TRANs for its own cash flow purposes. The first, issued on July 5, 1994, was the $169 Million 1994-95 Tax and Revenue Anticipation Notes, Series A (the "$169 Million TRANs"). These notes were represented to be tax-exempt and had an interest rate of 4.5% per annum. The second series of TRANs, the $31 Million 1994-95 Tax and Revenue Anticipation Notes, Series B (the "$31 Million TRANs"), was issued on August 11, 1994. These notes were also represented to be tax-exempt and had a variable interest rate equal to 70% of the one-month LIBOR; however, the interest rate on the notes was not to exceed 12% per annum. The $169 Million TRANs matured on July 19, 1995, and the $31 Million TRANs matured on August 10, 1995; the maturity of these notes has been extended to June 30,1996.18

In the Official Statements for these offerings, the County represented that the money to be used to repay the notes would be deposited in the County Pools. The Official Statements further advised prospective investors that, if Orange County suffered an investment loss and the repayment funds were insufficient to repay the notes, the County would satisfy the deficiency from any other moneys lawfully available for repayment. The lawfully available funds for these offerings consisted essentially of funds in the discretionary budget.

The Official Statement for the $169 Million TRANs and the $31 Million TRANs contained material misstatements and omissions regarding: 1) the County Pools, including the County Pools' investment strategy and investment results, and manipulation of the County Pools' yield, which matters affected the issuer's ability to repay the municipal securities; 2) Orange County's financial condition, including its economic reliance on the investment results of the County Pools as a source of funds to repay its obligations on the securities; 3) the tax-exempt status of the offering; and 4) the unauthorized use of an audit report.

c. The Teeter Note Offerings

In 1994, Orange County conducted two Teeter Note offerings. The purpose of the Teeter offerings was to fund the Teeter Plan which is an alternate method of property tax distribution. Pursuant to this plan, the County pays local entities (such as school districts) their share of property taxes from the offering proceeds upon levy rather than actual collection and then retains all property taxes, and the penalties and interest thereon, upon collection.

In the first Teeter offering, the County issued $111 million of taxable notes (the "$111 Million Teeter Notes") on July 20, 1994. These notes had a variable interest rate that was reset monthly at the one-month LIBOR; however, under the terms of the notes, the interest rate was not to exceed 12% per annum. In the second Teeter offering, the County issued $64 million of tax-exempt notes (the "$64 Million Teeter Notes") on August 18, 1994. The $64 Million Teeter Notes had a variable interest rate that was reset monthly at 70% of the one-month LIBOR; however, the interest rate was not to exceed 12% per annum. The $111 Million and the $64 Million Teeter Notes (the "Teeter Notes") matured, and were repaid, on June 30, 1995.

The Official Statements for the Teeter notes represented that the County planned to invest certain delinquent tax receipts pledged to repay the Teeter Notes in the County Pools. The County Pools also agreed to repurchase the Teeter Notes through Purchase Agreements, entitled Standby Note Purchase Agreements, which agreements obligated the Treasurer, as fund manager of the County Pools, to purchase the Teeter notes to the extent that there were insufficient funds to repay them. The Official Statements further advised potential investors that if the repayment funds were insufficient, any deficiency would be satisfied from moneys received under the Purchase Agreements and other moneys lawfully available for repayment. The lawfully available funds for these offerings consisted essentially of funds in the discretionary budget.

The Official Statement for the $111 Million Teeter Notes and the $64 Million Teeter Notes contained material misstatements and omissions regarding: 1) the County Pools, including the County Pools' investment strategy and investment results, and manipulation of the County Pools' yield, which matters affected the issuer's ability to repay the municipal securities and the County Pools' ability to perform under Purchase Agreements; 2) Orange County's financial condition, including its economic reliance on the investment results of the County Pools as a source of funds to repay its obligations on the securities; 3) an undisclosed cap on interest rate payable to noteholders (with respect to the $111 Million Teeter Notes only); and 4) the unauthorized use of an audit report.

d. The Pension Bond Offering

In September 1994, Orange County issued taxable Pension Obligation Bonds (the "Pension Bonds") for the purpose of financing the County's unfunded, but accrued, pension liability. The Pension Bonds were issued in two series. The fixed-rate Series A bonds in the amount of $209.84 million were dated as of September 1, 1994, and issued on September 28, 1994, and matured or mature in varying amounts in the years 1995 through 2004. The variable-rate Series B bonds in the amount of $110.2 million were dated and issued on September 28, 1994, and mature in 2008 (the "Series B Pension Bonds").

Under the terms of the Series B Pension Bonds, the investors had the right to tender their bonds to a remarketing agent for repurchase. If the remarketing agent could not remarket the tendered Series B Pension Bonds within seven days, the County Pools, pursuant to a Purchase Agreement, entitled Standby Withdrawal Agreement, agreed to purchase the tendered securities in an amount up to the County's unrestricted funds in the County Pools, which included funds in the County's discretionary budget.

According to the Official Statement, that amount was approximately $491.4 million as of June 30, 1994. After Orange County announced the County Pools' losses in early December 1994, the holders of the Series B Pension Bonds tendered the bonds to the County Pools for repurchase. Orange County and the County Pools declared bankruptcy and refused to purchase any of the Series B Pension Bonds.

The Official Statement for the Pension Bonds contained material misstatements and omissions regarding:

1) the County Pools, including the County Pools' investment strategy and investment results, and manipulation of the County Pools' yield, which matters affected the issuer's ability to repay the municipal securities and the County Pools' ability to perform under the Purchase Agreement; and 2) Orange County's financial condition, including its economic reliance on the investment results of the County Pools as a source of funds to repay its obligations on the securities.

4. Misrepresentations And Omissions In The Offer And Sale Of Municipal Securities

The offerings discussed above variously contained material misstatements and omissions regarding: 1) the County Pools, including the County Pools' investment strategy and investment results, manipulation of the County Pools' yield, and investment of funds pledged to repay certain securities into the County Pools, which matters affected the issuer's ability to repay the municipal securities and the County Pools' ability to perform under the Purchase Agreements; 2) the financial condition of Orange County, including its economic reliance on the investment results of the County Pools as a source of funds to repay its obligations on the securities; 3) the tax-exempt status of the offering; 4) an undisclosed cap on the interest rate payable to investors on certain variable rate municipal securities sold in the offerings; and 5) the unauthorized use of an audit report.

a. The Risks Relating To The County Pools

Each of the Official Statements for the eleven offerings misrepresented or was misleading in failing to disclose material information concerning the County Pools. The significance of the County Pools to these transactions was obvious. Where the funds pledged to repay the notes were invested in the County Pools, the issuer looked to that investment to satisfy its repayment obligations. Any risks that those pledged funds would decrease affected the issuer's ability to repay the notes. Similarly, in the offerings where the County Pools, pursuant to Purchase Agreements, provided for repurchase or repayment of the securities, disclosure regarding the County Pools was important so that investors could evaluate the County Pools' financial strength and ability to perform under the agreement. In addition, in certain County offerings in which other County funds were a source of repayment, disclosure regarding the County Pools was important to investors because availability of such other funds depended upon the County Pools' performance. The Official Statements variously contained false or misleading disclosure regarding the County Pools in four areas: 1) the investment strategy; 2) the investment results; 3) the manipulation of the County Pools' yield; and 4) investment of funds pledged to repay certain securities into the County Pools.

(1) The County Pools' Investment Strategy And The Risks Of That Strategy

The Official Statements for all eleven municipal securities offerings misrepresented and/or failed to disclose material information concerning the County Pools' investment strategy and the risks of that strategy, as more fully stated below. The County Pools' investment strategy, particularly the amount of leverage, and the risks of that strategy were material to these securities offerings. The County Pools' investment strategy and the risks of that strategy were directly related to the safety of an investment in the municipal securities, the safety of the funds pledged to repay the municipal securities and the County Pools' ability to fulfill its obligations to repurchase or repay municipal securities. The County Pools' investment strategy and the risks of that strategy also directly affected Orange County's ability to repay its securities from other available funds because of the County's economic dependence on the County Pools. Investors were not informed of these matters and were deprived of the ability to make an informed investment decision based upon all material facts.

(a) The $400 Million Reinvestment Notes, The 1993 $50 Million Reinvestment Notes And The $299.66 Million Pooled TRANs

The Official Statements for two offerings--the $400 Million Reinvestment Notes and the 1993 $50 Million Reinvestment Notes--completely omitted any discussion of the County Pools. The Official Statement for another offering--the $299.66 Million Pooled TRANs--only referenced the County Pools in setting forth the terms of the Purchase Agreement. This discussion failed to provide any disclosure on the County Pools' investment strategy and the risks of that strategy.

Specifically, the Official Statements for these three offerings failed adequately to disclose that the investment strategy: 1) was risky; 2) was predicated upon the assumption that prevailing interest rates would remain at relatively low levels; 3) involved a high degree of leverage through the use of reverse repurchase agreements; 4) involved a substantial investment in derivative securities, including inverse floaters; and 5) was very sensitive to changes in the prevailing interest rate because of the leverage.

The Official Statements for these three offerings also failed to adequately disclose the disproportionate risks that the investment strategy posed to repayment of the municipal securities.

(b) The 1994 Reinvestment Notes, The $169 Million TRANs, The $31 Million TRANs And The Teeter Notes

The Official Statements for seven of the offerings--the 1994 Reinvestment Notes, the $169 Million and $31 Million TRANs and the Teeter Notes--contained some disclosure regarding the County Pools, which disclosure was virtually identical to each other, with only the deviations noted below.

With respect to the County Pools' holdings, the Official Statements disclosed that the County Pools invested in "various fixed and floating rate securities."19 It was not disclosed that the County Pools were heavily invested in derivative securities, which comprised from 27.6% to 42.2% of the combined County Pools' portfolio and from 31% to 53% of the Commingled Pool's portfolio. In particular, inverse floaters comprised from 24.89% to 39.84% of the County Pools' holdings. The Official Statements further did not disclose the risks these holdings posed to repayment of the municipal securities.

With respect to the County Pools' investment strategy, the Official Statements disclosed that the County Pools' investment policy allowed for the purchase of a variety of securities, "with limitations as to exposure, maturity, and credit rating for each security type. The mix of securities held will vary depending upon liquidity requirements, interest rate expectations and other factors."20 This statement failed to disclose that the County Pools' investment strategy was risky, and was premised on the assumption that interest rates would remain relatively low. The Official Statement further did not disclose the risks this investment strategy posed to repayment of the municipal securities.

Additionally, with respect to the use of the County Pools' securities as collateral for the reverse repurchase agreements, the Official Statements for these offerings represented that: "from time to time," the Treasurer pledged "a signifticant portion" of the County Pools' securities "with respect to reverse repurchase agreements."21 No mention was made of the extremely high degree of leverage involved in the portfolio, at times as much as 292%, or the risk this posed to repayment of the municipal securities.

With respect to the County Pools' sensitivity to interest rate changes, the Official Statements represented that: "[t]he price and income volatility of the [Pools' floating rate securities was] greater than standard fixed income securities and may serve to increase the volatility of the [Pools'] return and market value in various interest rate environments."22 This statement is misleading in that it does not disclose that the County Pools' investment strategy was predicated on interest rates remaining low, nor the extent to which the County Pools were sensitive to interest rate changes; specifically, that rising interest rates would have an extremely negative impact on the County Pools, and in turn, upon the ability to repay the municipal securities from the sources dependent on the County Pools.

The Official Statements also represented that the "market value and liquidity of the [County Pools] will depend upon, among other factors, the maturity of the various investments," and that the average maturity of the County Pools' securities, depending on the offering, was from 843 to 884 days. The Official Statements did acknowledge that the "average maturities do not account for the impact of leverage and other factors related to various derivative securities in the portfolio."23 However, this statement also is misleading in that it failed to disclose, as the Treasurer had been advised, that: the modified duration indicated substantially more price volatility than would be expected from a portfolio with the County Pools' short average maturity; and the duration, or sensitivity of the portfolio to interest rate changes, was such that a large portion of the County Pools' securities holdings had an average duration of approximately five years. Moreover, it did not disclose the associated risks this posed to the repayment of the municipal securities.

Moreover, the Official Statements for these offerings failed to disclose the risks of rising interest rates on the County Pools' investment strategy. Namely, the Official Statements failed to disclose that if interest rates rose, as they did in 1994, it would have a substantial negative impact on the County Pools and, because of its dependence on the County Pools, the County itself. First, the reverse repurchase costs would increase and the income that the County Pools earned from the inverse floaters in the portfolio would decrease, creating lower earnings for the County Pools. Second, the County Pools' securities would decline in market value. Third, as the value of the County Pools' securities fell, the County would suffer collateral calls from broker-dealers and reductions in loan amounts on the reverse repurchase agreements. All three events would reduce the income that Orange County would receive from the County Pools, with the possible loss of principal of invested funds as well.

(c) The Pension Bonds

The Official Statement for the Pension Bond transaction contained even less disclosure regarding the County Pools' investment strategy and the risks of that strategy. The Official Statement represented that: "[t]he [County Pools'] investment policy focuses on retaining the safety of investment principal while earning satisfactory yields." It went on to state that: "it is the [County Pools'] practice to select quality investments from reputable, stable and trustworthy dealers, and not to take any risks which . . . would be unreasonable." Additionally, the Official Statement disclosed that:

The [County Pools'] funds are invested primarily in United States Government Securities, including, but not limited to, United States Treasury Notes, Treasury Bills, Treasury Bonds, and obligations of United States Government Agencies [and that w]hen circumstances warrant, the [County Pools'] investments may also include bankers acceptances, negotiable certificates of deposit of national or state-chartered banks and state or federal thrifts, commercial paper, repurchase agreements, reverse repurchase agreements, medium term corporate notes and collateralized time deposits.

The Official Statement further represented that "[t]o maintain the liquidity of its investments, the [County Pools] invest in securities that are actively traded in the securities markets."

These statements were false or misleading. The County Pools' investment strategy was not "focus[ed] on retaining the safety of investment principal" but was highly risky and premised upon the assumption that prevailing interest rates would remain at relatively low levels. The Official Statement omitted to disclose that the County Pools were highly leveraged through reverse repurchase agreements and that the County Pools were heavily invested in derivative securities, including inverse floaters. The Official Statement further omitted to disclose that the use of this strategy made the County Pools' extremely sensitive to changes in the interest rate.

(2) The County Pools' Investment Results

Moreover, as a result of the County Pools' investment strategy, the County Pools suffered investment losses in 1994, which investment results were also not disclosed to investors in the 1994 municipal securities offerings. As a result, investors were not provided information material to the assessment of the ability to repay the municipal securities from sources affected by the County Pools.

The Official Statements for the nine offerings conducted in 1994 failed to disclose material information concerning the County Pools' investment results. During 1994, the County Pools' investment income declined because reverse repurchase costs had increased while the income that the County Pools earned from inverse floaters had decreased. Additionally, the County Pools had suffered substantial market losses in the overall value of the portfolio. Declining market value of securities in the County Pools subject to reverse repurchase agreements resulted in collateral calls and reduction in loan amounts against such securities on rollover of the agreements, as well as reduction of the liquidity of the County Pools.24 None of these facts were disclosed in any of the Official Statements.

The Official Statements for these 1994 offerings included Orange County's financial statements for the fiscal year ended June 30, 1993, which were based on information that was at least twelve months old at the time of the offerings. The financial statements contained a footnote concerning the County Pools that presented information that the market value of the investments was above the purchase price, indicating that the County Pools had a market profit. By the end of June 1994, just prior to the 1994 offerings, the Treasurer's records indicated that the portion of the County Pools' securities that were marked-to-market had suffered market losses of over $443 million, or a 5.24% loss in value. In light of these market losses, the inclusion of the 1993 financial statements alone in the 1994 offerings without any update regarding investment results was materially misleading because the Official Statements failed to disclose information regarding the recent market losses, which related to the ability to repay the municipal securities.

Information concerning the decline in the County Pools' investment results was material to these securities offerings. The County Pools' declining investment results were directly related to the safety of an investment in the securities, the safety of the funds pledged to repay the securities and the ability of the County Pools to fulfill its obligations to repurchase or repay the securities. The County Pools' investment results also directly affected Orange County's ability to repay its securities from other available funds because of the County's economic dependence on the Pools.

(3) Manipulation Of The County Pools' Yield

The Official Statements for eight offerings--the 1994 Reinvestment Notes, the $169 Million and the $31 Million TRANs, the Teeter Notes and the Pension Bonds--misrepresented that the County Pools' yield would be distributed pro rata to the Participants. The Treasurer and the Assistant Treasurer had in fact diverted interest income from certain Commingled Pool Participants to an account for the benefit of Orange County. As a result, the Commingled Pools' yield was misrepresented in the Official Statements for these offerings. In late 1994, the Treasurer and the Assistant Treasurer used a portion of the misappropriated funds to supplement the Commingled Pool's yield. The "supplemented" yield was then falsely reported in the Official Statement for the Pension Bonds.

The Treasurer and the Assistant Treasurer also shifted $131 million in market losses from some Specific Investment Participants, including the County, to the Commingled Pool, causing the Commingled Pool Participants to suffer losses that should have been borne by others. This information was not disclosed and also rendered false the representations regarding the pro rata distribution.

The Commingled Pool's accurate reporting of investment results and assumption of market losses were directly related to the safety of an investment in the securities, the safety of the funds pledged to repay the securities and the ability of the County Pools to fulfill their obligations to repurchase or repay the securities. Accordingly, the information concerning the Commingled Pool's true yield, the calculation and payment of the Commingled Pool's yield, the misappropriation of interest income from the Participants and the Commingled Pool's acquisition and transfer of securities at off-market prices was material.

(4) Investment In The County Pools

The Official Statements for three offerings--the $400 Million Reinvestment Notes, the 1993 $50 Million Reinvestment Notes and the $299.66 Million Pooled TRANs--stated that the funds pledged to repay the notes would be invested as permitted by the resolutions authorizing the issuance and sale of the notes and by California law. None of the Official Statements for these three offerings disclosed that the issuer intended to invest such funds in the County Pools. The Official Statement for the $299.66 Million Pooled TRANs only mentions that, under the Purchase Agreement, the County Pools would purchase the school district notes to the extent that any of the school districts failed to repay.

Information concerning the issuers' use and investment of such funds was directly related to their ability to later repay the securities, an issue of critical importance to investors. Moreover, as discussed herein, disclosure regarding investment in the County Pools was material in light of the County Pools' risky investment strategy and poor investment results in 1994.

b. The Financial Condition Of Orange County

The Official Statements for six offerings--the $600 Million Reinvestment Notes, the $169 Million and $31 Million TRANs, the Teeter Notes and the Pension Bonds--failed to disclose Orange County's true financial condition, in particular, that the County was using interest income from the County Pools as the largest single source of revenue for its discretionary budget. Further, Orange County's use of this interest income as a revenue source was increasing while other traditional revenue sources, such as property taxes, were decreasing. The funds invested to generate investment income came from two sources, the County's own funds and proceeds from the Reinvestment Offerings. Orange County had invested essentially all of its liquid assets in the County Pools, including funds to repay its municipal securities. In addition, the investment of virtually all of the County's liquid assets in the County Pools exposed Orange County to the volatility of the County Pools, including the potential loss of not only interest income, but of principal as well. The failure to disclose this information rendered disclosure regarding the County's financial condition and its ability to repay its securities materially misleading.

The Official Statements disclosed the decline in certain traditional revenue and that, as a result of the decline, the County's fiscal year 1992-93 and 1993-94 budgets were becoming increasingly dependent on state funding for revenue to support County services. The Official Statements for the six 1994 offerings failed to disclose, however, that for the County's proposed 1994-95 discretionary budget, the County was using interest income as the largest single revenue source. The inclusion of the information concerning prior budgets was materially misleading in light of the proposed 1994-95 discretionary budget's use of interest income as the largest single revenue source.

Such information regarding Orange County's financial condition was important as it related to Orange County's ability to repay its obligations, including municipal securities debt. Moreover, with the exception of the Pension Bonds, these County offerings were short-term general obligations, which, under California law, the County could repay only with funds received or accrued during fiscal year 1994-95. Therefore, given the County's use of interest income from the County Pools, if the County Pools' investments performed poorly, as eventually occurred, the County would have a budget deficit and could not repay the securities and meet its other expenses. The County's financial condition was also material to the Purchase Agreement for the Series B Pension Bonds, under which the County Pools, to the extent of the County's unrestricted funds in the County Pools, agreed to repurchase any tendered securities. If the County Pools' investments performed poorly, as eventually occurred, the County would not have sufficient unrestricted funds to purchase the Series B Pension Bonds when tendered under the terms of the Purchase Agreement.

c. The Tax-Exempt Status Of The Offerings

The purpose of the tax-exempt $169 Million TRAN and the $31 Million TRAN offerings was purportedly to fund Orange County's projected cash flow deficit for fiscal year 1994-95. As such, these TRAN offerings were offered and sold as tax-exempt borrowings. Compliance with the Internal Revenue Code and Treasury Regulations is a prerequisite to exemption from federal income taxation of the interest received on the municipal securities by the investors. The Official Statements failed to disclose, however, that the County's activities in calculating the size of the offerings placed the tax-exempt status in jeopardy.25

The Internal Revenue Service has regulations that limit the size of a municipality's tax-exempt short-term working capital borrowings to, in effect, the amount that the municipality will actually use to fund cash flow deficits.26 Therefore, the determination of available amounts is critical to the sizing of a TRANs borrowing and ultimately to the tax-exempt status of the borrowing.

Internal Revenue Code 103(a) provides the statutory authority for tax-exempt bonds. This section provides, in summary, that gross income does not include interest on any state or local bond (i.e., the bonds are tax-exempt), with certain exceptions, including the exception that the exclusion from gross income does not apply to any "arbitrage bond."27 Municipal securities are arbitrage bonds under Internal Revenue Code 148 if an abusive arbitrage device is used in connection with the securities issue. Therefore, municipal securities are not tax-exempt if the issuer engages in an "abusive arbitrage device."28 If the IRS determines that a portion of a purported tax-exempt offering is an abusive arbitrage device, then the IRS can declare the entire offering taxable. Moreover, should the IRS later declare the notes to be taxable, its remedy is to seek the unpaid taxes from the noteholders.29

Information concerning the tax-exempt status of these TRANs offerings was very important to investors. Failure to disclose information regarding the tax analysis that provided the basis for the tax-exemption opinion deprived investors of information material to an assessment of the tax-exempt status of the TRANs.30 Tax-exempt securities typically pay a lower interest rate than other debt securities, which interest rate differential investors accept because of the tax-exempt status. Thus, if the securities are not tax-exempt, the interest rate is not competitive and the securities are not as attractive to investors. Further, the investors may be liable for the unpaid taxes on the interest received.

(1) The $169 Million TRANs

On June 21, 1994, the County restricted $27.5 million so that these funds could not be used to pay future working capital expenditures. The County restricted the funds to increase the amount of its projected cash flow deficit. The County intended to use the $27.5 million for working capital expenditures in fiscal year 1994-95 and budgeted for that purpose in the final budget adopted by the Board on September 27, 1994 (and effective July 1, 1994).

The effect of this artificial increase in the cash flow deficit was to enable the County to increase the size of its TRAN offering from $142 million to $169 million. A County Auditor-Controller employee testified that County officials questioned the propriety of the restrictions to increase the cash flow deficit and the size of the TRAN offering but dropped their objections after bond counsel opined that the $169 Million TRANs would be tax-exempt.

None of the facts relating to the County's artificial increase of the size of its cash flow deficit were disclosed in the Official Statement for this offering. The Official Statement also failed to disclose the risks that the IRS might declare the entire $169 Million TRANs taxable and that the investors may be liable for the unpaid taxes.

(2) The $31 Million TRANs

On August 2, 1994, Orange County restricted another $64 million. The purpose of this restriction was to make the $64 million unavailable to the County to pay future working capital expenditures and to thereby further increase the amount of its fiscal year 1994-95 cash flow deficit by $64 million. Accordingly, the County was able to issue the $31 million TRAN on August 11, 1994, to finance this cash flow deficit. As with the other TRANs borrowing, the Official Statement failed to disclose the facts surrounding the sizing of the offering and the risks this created to the tax-exempt status.

d. The Interest Rate Cap

The Official Statements for three offerings--the $600 Million Reinvestment Notes, the $111 Million Teeter Notes and the $100 Million Reinvestment Notes--each stated that they paid a variable interest rate equal to the one-month LIBOR. Undisclosed, however, was the fact that the notes for each of these offerings contained a 12% per annum cap on the maximum variable interest rate that the County would pay. While the existence of this cap was indicated on the face of the actual notes, no disclosure was made to noteholders in the Official Statements. The existence of an interest rate cap is material to investors.31

e. Unauthorized Use Of Audit Report

The Official Statements for seven offerings--the $400 Million, the $600 Million and the $100 Million Reinvestment Notes, the $169 Million and the $31 Million TRANs and the two Teeter Notes--falsely represented that the County's auditor had consented to the inclusion of its audit report of the County's financial statements in the Official Statements. This report and Orange County's audited financial statements were included as exhibits to the Official Statements for these offerings.

Under Generally Accepted Auditing Standards ("GAAS"), if the auditor had consented to the inclusion of its audit reports in the Official Statements, the auditor would have been required to "extend [its] procedures with respect to subsequent events from the date of [its] audit report[s] up to the effective date [of the sale of the securities]."32 Pursuant to the GAAS

subsequent events procedures, if the auditor had consented, the auditor should have, among other things, read the County's most recent interim financial statements, read minutes of Board meetings, made inquiries of County officials concerning the County's operations and finances, made inquiries of the County's legal counsel and made such other inquiries as it considered necessary and appropriate.33

The engagement contract between Orange County and the auditors provided that the auditors would perform a subsequent events review upon the request of the County Auditor-Controller as necessary to allow the use of the auditors' report in the Official Statements and that the auditors would perform two such reviews at no charge.

In fact, Orange County did not obtain the consent of the auditors to include their report in the Official Statements, and the auditors did not conduct any post-audit review. That the auditor had not consented to the inclusion of its audit report accompanying the County's financial statement in these Official Statements was important. Reasonable investors rely on audited financial statements in making investment decisions. Further, the representation that the auditor has consented to the inclusion of its audit report implies that the auditor has conducted some additional review prior to consenting to this use.

The investors' ability to rely on an audit opinion is affected by the fact that the auditor has not consented to the inclusion of its audit report in the Official Statement and has not conducted any post-audit review.

5. Misrepresentations To Rating Agencies

In presentations to the Rating Agencies relating to eight offerings--the $600 Million, the $100 Million and the 1994 $50 Million Reinvestment Notes, the $169 Million and the $31 Million TRANs, the two Teeter Notes and the Pension Bonds--the Assistant Treasurer misrepresented the County Pools' holdings. These misrepresentations ultimately ran to the purchasers of these securities. The Assistant Treasurer represented that only 20% of the County Pools' portfolio consisted of derivative securities. In fact, derivative securities comprised from 27.6% to 42.2% of the combined County Pools' portfolio and from 31% to 53% of the Commingled Pool's portfolio. In particular, inverse floaters comprised from 24.89% to 39.84% of the County Pools' holdings.34

The Assistant Treasurer also misrepresented to the Rating Agencies that money in the Economic Uncertainty Fund was available to pay the principal and interest on five offerings--the $600 Million Reinvestment Notes, the $169 Million and the $31 Million TRANs and the two Teeter Notes--and omitted to disclose that such funds had been misappropriated from the Commingled Pool Participants.

E. LEGAL DISCUSSION: ORANGE COUNTY, THE FLOOD CONTROL DISTRICT AND THE BOARD VIOLATED THE ANTIFRAUD PROVISIONS OF SECTION 17(a) OF THE SECURITIES ACT AND SECTION 10(b) OF THE EXCHANGE ACT AND RULE 10b-5 THEREUNDER IN THE OFFER AND SALE OF THE MUNICIPAL SECURITIES

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 (Section 17(a)) or in connection with the purchase or sale of any security (Section 10(b) and Rule 10b-5), to employ any device, scheme, or artifice to defraud, to make any untrue statement of a material fact, to omit to state a material fact, or to engage in any act, practice or course of business which operates or would operate as a fraud or deceit upon any person through the means or instruments of interstate commerce or the mails.

The notes and bonds issued by Orange County, the Flood Control District and the School District are clearly securities under Section 2(1) of the Securities Act and Section 3(a)(10) of the Exchange Act. In addition, the County Pools' obligations under the agreements to repurchase the Teeter Notes and the Series B Pension Bonds were puts and, therefore, separate 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). Furthermore, when the information pertains to a possible future event, materiality `will depend upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity.'" Basic Inc., 485 U.S. at 238 (quoting SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 849 (2d Cir. 1968) (en banc), cert. denied, 394 U.S. 976 (1969)).

Scienter is required to establish violations of Section 17(a)(1) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. See Aaron v. SEC, 446 U.S. 680, 701-02 (1980). Scienter is "a mental state embracing intent to deceive, manipulate or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). In the Ninth Circuit, recklessness satisfies the Scienter requirement. Hollinger v. Titan Capital Corp., 914 F.2d 1564 (9th Cir. 1990) (en banc), cert. denied, 499 U.S. 976 (1991). Recklessness is "an extreme departure from the standards of ordinary care, and which presents a danger of misleading [investors] that is either known to the defendant or is so obvious that the actor must have been aware of it." Id., 914 F.2d at 1569.

1. The Misrepresentations And Omissions Of Material Facts

As described more fully above, in the offer and sale of the Reinvestment Note offerings, the TRAN offerings, the Teeter Note offerings and the Pension Bond offering, Orange County misrepresented and/or omitted to disclose material information regarding: 1) the Orange County Investment Pools (the "County Pools"), including the County Pools' investment strategy and investment results, manipulation of the County Pools' yield, and investment in the County Pools of the funds pledged to repay the securities, which matters affected the issuer's ability to repay the municipal securities and the County Pools' ability to perform under Purchase Agreements; 2) Orange County's financial condition, including its economic reliance on the investment results of the County Pools as a source of funds to repay its obligations on the securities; 3) the tax-exempt status of the offering; 4) an undisclosed cap on the interest rate payable to investors on certain variable rate municipal securities sold in the offerings; and 5) the unauthorized use of an audit report. In addition, misrepresentations were made to the Rating Agencies concerning the County Pools.35

In the offer and sale of the $100 Million Reinvestment Notes, the Flood Control District misrepresented and/or omitted to disclose material information regarding: 1) the Orange County Investment Pools (the "County Pools"), including the County

Pools' investment strategy and investment results, manipulation of the County Pools' yield, and investment in the County Pools of the funds pledged to repay the securities, which matters affected the issuer's ability to repay the municipal securities; 2) an undisclosed cap on the interest rate payable to investors on certain variable rate municipal securities sold in the offerings; and 3) the unauthorized use of an audit report.

The Board, in the offer and sale of the $169 Million TRANs, the $31 Million TRANs, the $600 Million Reinvestment Notes, the $111 Million Teeter Notes, the $64 Million Teeter Notes and the Pension Bonds, approved Official Statements that misrepresented and/or omitted to disclose material information regarding the financial condition of Orange County, including its economic reliance on the investment results of the County Pools as a source of funds to repay its obligations on the securities.

2. Orange County, The Flood Control District And The Board Acted With Scienter

Orange County, the Flood Control District and the Board acted with Scienter in making the above misrepresentations and omissions of material fact in the securities offerings. For purposes of the County's and the Flood Control District's liability under the federal securities laws, the Scienter of Orange County and Flood Control District officials may be imputed to Orange County and the Flood Control District. See SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1089 n.3 (2d Cir. 1972).

The Treasurer and the Assistant Treasurer acted with a high degree of Scienter. They were involved in the day-to-day management of the County Pools and directed the County Pools' investments. Of all the participants involved, they had the most detailed knowledge of the County Pools' investment strategy and declining investment results during 1994. Further, they directed the misappropriation of interest income from the Commingled Pool Participants, the manipulation of the Commingled Pool's yield and the Commingled Pool's off-market securities transactions with Specific Investment Participants.

The Treasurer and the Assistant Treasurer also participated in Orange County's budget process by providing estimates of projected interest revenue. Additionally, they were involved in determining Orange County's cash flow deficit, increasing the size of that deficit by restricting Orange County funds, thereby artificially increasing the size of the $169 Million TRANs and the $31 Million TRANs. They actively participated in the offer and sale of the municipal securities, including participating in the preparation of the Official Statements and selecting the professional participants.

The Board acted with Scienter in authorizing the disclosure disseminated in connection with the issuance of six offerings--the $600 Million Reinvestment Notes, the $169 Million and the $31 Million TRANs, the two Teeter Notes and the Pension Bonds. The Board knew that the County intended to use interest income from the County Pools to fund a growing percentage of the County's discretionary budget. Nevertheless, the Board authorized the issuance of approximately $1.3 billion in debt in 1994, much of which was solely for reinvestment to generate interest income, without taking appropriate steps under the circumstances to assure that information about the County's finances was fairly and accurately disclosed to investors.

F. CONCLUSION

Accordingly, based on the foregoing, the Commission finds that Orange County, the Flood Control District and the Board violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.

IV. Orange County 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 Orange County to 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. As set forth in Orange County's Offer of Settlement, Orange County undertakes to cooperate with Commission staff in preparing for and presenting any civil litigation or administrative proceedings concerning the transactions that are the subject of this Order.

V. The Flood Control District 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 the Flood Control District to 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. A set forth in the Flood Control District's Offer of Settlement, the Flood Control District undertakes to cooperate with Commission staff in preparing for and presenting any civil litigation or administrative proceedings concerning the transactions that are the subject of this Order.

VI. The Board 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 the Board to 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. As set forth in the Board's Offer of Settlement, the Board undertakes to cooperate with Commission staff in preparing for and presenting any civil litigation or administrative proceedings concerning the transactions that are the subject of this Order.

VII. In determining to accept this Offer, the Commission considered remedial acts adopted and implemented by Orange County, the Flood Control District and the Board, such as the adoption and implementation of policies and procedures regarding the authorization, approval and issuance of proposed municipal securities offerings and regarding internal audit and accounting procedures and cooperation afforded the Commission staff.

VIII. In view of the foregoing, the Commission deems it appropriate to accept the Offer of Settlement submitted by Orange County, the Flood Control District and the Board and impose the cease-and-desist orders specified in the Offer of Settlement.

Accordingly, IT IS HEREBY ORDERED that, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act:

1. Orange County shall 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;

2. Orange County shall comply with its undertakings described in Section IV above;

3. The Flood Control District shall 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;

4. The Flood Control District shall comply with its undertakings described in Section V above;

5. The Board shall 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; and

6. The Board shall comply with its undertakings described in Section VI above.

Footnotes

-[1]-The findings herein are made pursuant to the Offer of Settlement of Orange County, the Flood Control District and the Board and are not binding on any other person or entity named as a respondent in this or any other proceeding.

-[2]-As more fully discussed below, the offerings may be categorized into four types: the reinvestment offerings; the tax and revenue anticipation note ("TRAN") offerings; the Teeter note offerings; and the Pension Bond offering. The reinvestment offerings were: the $400,000,000 COUNTY OF ORANGE, CALIFORNIA 1993-94 TAXABLE NOTES issued by Orange County on July 1, 1993; the $600,000,000 COUNTY OF ORANGE, CALIFORNIA 1994-95 TAXABLE NOTES issued by Orange County on July 8, 1994; the [SCHOOL DISTRICT] $50,000,000 TAXABLE NOTES issued by the School District on August 26, 1993; the [SCHOOL DISTRICT] $50,000,000 TAXABLE NOTES issued by the School District on August 1, 1994; and the $100,000,000 TAXABLE NOTES issued by the Flood Control District on August 2, 1994. The TRAN offerings were: the $299,660,000 COUNTY OF ORANGE, CALIFORNIA 1994-95 POOLED TAX AND REVENUE ANTICIPATION NOTES, issued by Orange County on July 1, 1994; the $169,000,000 COUNTY OF ORANGE, CALIFORNIA 1994-95 TAX AND REVENUE ANTICIPATION NOTES, SERIES A issued by Orange County on July 5, 1994; and the $31,000,000 COUNTY OF ORANGE, CALIFORNIA 1994-95 TAX AND REVENUE ANTICIPATION NOTES, SERIES B issued by Orange County on August 11, 1994. The Teeter offerings were: the $111,000,000 COUNTY OF ORANGE, CALIFORNIA 1994-95 (TEETER PLAN) TAXABLE NOTES issued by Orange County on July 20, 1994; and the $64,000,000 COUNTY OF ORANGE, CALIFORNIA 1994-95 (TEETER PLAN) TAX-EXEMPT NOTES issued by Orange County on August 18, 1994. The Pension Bonds were issued by Orange County on September 28, 1994 in two series: the $209,840,000 COUNTY OF ORANGE, CALIFORNIA TAXABLE PENSION OBLIGATION BONDS SERIES 1994A; and the $110,200,000 COUNTY OF ORANGE, CALIFORNIA TAXABLE PENSION OBLIGATION BONDS SERIES 1994B.

-[3]-See Cal. Const. Art. XI, _ 1 (West Supp. 1995); Cal. Gov't Code _ 23003 (West 1988).

-[4]-See Cal. Water Code App. _ 36-1 et seq. (West 1968 & West Supp. 1995).

-[5]-Cal. Water Code App. _ 36-3 (West Supp. 1995).

-[6]-See Cal. Gov't Code _ 23005; see also Board of Supervisors of Modoc County v. Archer, 18 Cal. App. 3d 717, 721, 96 Cal. Rptr. 379, 382 (1971).

-[7]-Simultaneous with the entry of this Order, the Commission, pursuant to Section 21(a) of the Exchange Act, issued a Report of Investigation in the Matter of County of Orange, California as It Relates to the Conduct of the Members of the Board of Supervisors, in connection with the matters discussed herein.

-[8]-See Cal. Gov't Code _ 25250 (West 1988) (examination and audit of County financial records); Cal. Gov't Code _ 25303 (West 1988) (supervision of County officials, particularly functions relating to public funds); Cal. Gov't Code _ 53601 (West Supp. 1995) (investment of surplus funds); Cal. Gov't Code _ 29064 & 29088 (West Supp. 1995) (approval of proposed budget and adoption of final budget); Cal. Gov't Code _ 25256 (West 1988) (limitation on amount of debt Board may approve); Cal. Gov't Code _ 53853 (West Supp. 1995) (authorization of short-term note offerings).

-[9]-See Cal. Water Code App. _ 36-3 (West Supp. 1995).

-[10]-Simultaneous with the entry of this Order, the Commission filed a complaint, Securities and Exchange Commission v. Robert L. Citron and Matthew R. Raabe, Civil Action No. (C.D. Cal.), in connection with the matters discussed herein.

-[11]-For fiscal year 1994-95, Orange County's total budget was approximately $3.7 billion. Of that amount, the County was required to spend about 88%, or $3.266 billion, for specific purposes. The remaining 12%, or $462.5 million, comprised Orange County's discretionary budget, over which the Board had authority to determine how funds would be allocated. Orange County's discretionary budget for fiscal year 1994-95 was $462.5 million. The largest portion of that amount, $162 million, or 35%, was budgeted to come from investment income on Orange County's investment in the County Pools.

-[12]-For fiscal year 1991-92, interest earnings were $36.8 million, or 7.4% of the discretionary budget; for fiscal year 1992-93, $64.5 million, or 12.4% of the discretionary budget; and for fiscal year 1993-94, they were budgeted at $58.3 million, or 15.1% of the discretionary budget.

-[13]-Property tax revenues comprised 52.8% of the total discretionary budget for fiscal year 1991-92, 49.1% for fiscal year 1992-93, 33.4% for fiscal year 1993-94, and were projected to be only 25.4% for fiscal year 1994-95.

-[14]-These municipal securities have been rated in default by one of the Rating Agencies. In Orange County's bankruptcy proceeding, the County, the noteholders and the creditors' committee agreed to extend, or rollover, the maturity of approximately $800 million of these municipal securities to June 30, 1996.

-[15]-The term leverage is used where the value of the position is greater than the equity in the position. In other words, a person would be deemed to hold a leveraged position if he or she can maintain a larger position than the equity in the position. The term repurchase agreement refers to an agreement by the seller (i.e., the dealer) to repurchase securities (usually government securities), and an agreement by the purchaser (i.e., the investor) to resell the same securities, for a certain price at a certain time in the future. In a reverse repurchase agreement, the dealer agrees to buy the securities and the investor agrees to repurchase them at a later date. Reverse repurchase agreements were a method by which the County obtained funds from broker-dealers and effectively pledged the County Pools' securities as collateral. Derivative instruments encompass a wide array of financial contracts, including swaps, futures, options and forwards, that derive their value from the performance of other assets, such as equities, debt, foreign currency and commodities.

-[16]-A measure of the County Pools' sensitivity to interest rate changes, and therefore risk, is the portfolio's "modified duration." Modified duration measures the sensitivity of the portfolio's market value to changes in prevailing interest rates (duration does not refer to maturity of the portfolio). The longer the modified duration of a portfolio, the more sensitive its market value is to interest rate change.

-[17]-By at least February 1992, the Treasurer generated month-end reports that marked-to-market a substantial portion of the County Pools' portfolio (from 26% to over 43%). These reports reflected that the securities marked-to-market declined 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), to over $565 million (or 6.27% loss in value) in September 1994.

-[18]-The County has also failed to set aside specified pledged amounts to repay these TRANs at maturity, as required under the terms of these TRANs.

-[19]-The Official Statements for the $64 Million Teeter Notes and the 1994 $50 Million Reinvestment Notes further disclosed that "as of June 30, 1994, approximately 20% of the [Pools] was invested in derivative products of which substantially all were floating rate and inverse floating rate government securities." As stated above, the Pools' derivative holdings were significantly greater than 20% and most of them were inverse floaters.

-[20]-The Official Statements for the $64 Million Teeter Notes and the 1994 $50 Million Reinvestment Notes stated that the County Pools' investment policy permitted a "variety of domestic securities and derivative products" with the same limitations as set forth above that would vary in the same way, i.e., "depending upon liquidity requirements, interest rate expectations and other factors."

-[21]-With respect to leverage, the Official Statement for the $169 Million TRANs instead stated: "from time to time, the [County Pools have] and may also enter into various reverse repurchase agreements which are essentially leverage investments."

-[22]-The Official Statement for the $100 Million Reinvestment Notes differed only in that it included a reference to reverse repurchase agreements, stating: "[t]he price and income volatility of floating rate securities and reverse repurchase agreements is greater than standard fixed income securities and may increase the volatility of the Pools' return and market value in various interest rate environments. . . ."

-[23]-The Official Statements for the $64 Million Teeter Notes and the 1994 $50 Million Reinvestment Notes also stated that "[i]f these derivative products were taken into account, the effect would be to lengthen the average maturity of the [County Pools]." As set forth above, the County Pools' derivative holdings were significantly greater than 20% and most of them were inverse floaters. This simple statement that the derivative products would lengthen maturity was inadequate to describe their actual or likely effect on the portfolio's interest rate sensitivity.

-[24]-From January through June 1994, the County was subject to approximately $873 million in collateral calls or reductions in loan amounts under reverse repurchase agreements.

-[25]-Orange County's bond counsel issued an opinion that these TRANs were tax-exempt. However, the County was aware of material facts concerning the relationship between the size of the offering and the County's cash flow deficit. As discussed below, the Official Statements were materially misleading in failing to disclose these facts and the significant associated risks that the tax-exempt status could be denied. Investors were, therefore, unable to make an informed investment decision regarding the tax-exempt status of the offerings.

-[26]-More specifically, Treasury Regulations include a proceeds-spent-last expenditure rule which implicitly provides the sizing rule for TRAN offerings. See Treasury Regulation 1.148-6(d)(3)(i). Sizing analysis of a tax-exempt borrowing is critical because oversizing a borrowing will preclude the conclusion that proceeds will be spent within the allowable temporary period, a necessary element of a tax-exempt borrowing. Under the rules regarding allocation of proceeds of an issue for determining when the proceeds are spent, proceeds of a TRAN borrowing are allocated to working capital expenditures as of any date only to the extent that those working capital expenditures exceed "available amounts." See id. Available amounts include amounts that may be used without legislative or judicial action and without a legislative, judicial or contractual requirement that amounts be reimbursed. See Treasury Regulation 1.148-6(d)(3)(iii).

-[27]-See Internal Revenue Code 103(b)(2).

-[28]-Treasury Regulation 1.148-10(a)(1) defines an abusive arbitrage device as any "action [that] has the effect of: (i) enabling the issuer to exploit the difference between tax-exempt and taxable interest rates to obtain a material financial advantage; and (ii) overburdening the tax-exempt bond market," which occurs if the action "results in issuing more bonds." Treasury Regulation 1.148-10(a) further states that the regulation concerning abusive arbitrage devices "is to be applied and interpreted broadly to carry out the purposes of section 148."

-[29]-Should the IRS determine that the tax-exempt securities are "arbitrage bonds" under Internal Revenue Code 148(a), the IRS would seek rebate of the excess interest earned from the issuer. See Internal Revenue Code 148(f). The IRS, however, does not have a right to tax or assess the issuer but can request that the amount be rebated. If the issuer fails to rebate the arbitrage, the remedy is to seek the amount from the noteholders as the interest earned on the notes is not excludable from the noteholders' income. See Harbor Bancorp v. Commissioner of Internal Revenue, 1995 U.S. Tax Ct. LEXIS at 54-55 (Oct. 16, 1995).

-[30]-See SEC v. Stifel, Nicholas and Co., Lit. Rel. No. 14587 (Aug. 3, 1995); In the Matter of Derryl W. Peden, Securities Act Rel. No. 7069, Exchange Act Rel. No. 35045, Admin. Proc. File No. 3-8400 (Dec. 2, 1994); SEC v. Matthews & Wright Group, Inc., Lit. Rel. No. 12072 (April 27, 1989).

-[31]-LIBOR never reached 12% per annum during the original term of the notes; therefore, the interest cap never limited the interest rate paid to investors. However, certain investors have investment policies against buying securities containing an interest rate cap.

-[32]-AICPA 1989 Audit and Accounting Guide, Audits of State and Local Governmental Units, Ch. 19, 19.6; see also AICPA Codification of Statements on Auditing Standards ("AU") 711.

-[33]--See AU 560.12.

-[34]-Obviously, the materiality of the percentage of securities in a portfolio that are derivatives will depend upon the type and use of the derivatives in that portfolio.

-[35]-The Assistant Treasurer's misrepresentations to the Rating Agencies are separate violations of the antifraud provisions of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. See SEC v. Coffey, 493 F.2d 1304 (6th Cir. 1974), cert. denied, 420 U.S. 908 (1975).

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Modified:09/21/1999