UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES ACT OF 1933 Release No. 7456 / September 24, 1997 SECURITIES EXCHANGE ACT OF 1934 Release No. 39122 / September 24, 1997 ADMINISTRATIVE PROCEEDING File No. 3-9430 ORDER INSTITUTING CEASE-AND- DESIST PROCEEDING PURSUANT In the Matter of: TO SECTION 8A OF THE SECURITIES ACT OF 1933 AND DWIGHT ALLEN, SECTION 21C OF THE SECURITIES EXCHANGE ACT OF Respondent. 1934, MAKING FINDINGS, AND IMPOSING A CEASE-AND-DESIST ORDER I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that a 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") to determine whether Dwight Allen ("Allen" or "Respondent") violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. II. In anticipation of the institution of this proceeding, Allen has submitted an Offer of Settlement ("Offer"), 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 in which the Commission is a party, and without admitting or denying the findings contained herein, except that Respondent admits the jurisdiction of the Commission over him and over the subject matter of this proceeding, Allen consents to the issuance of this Order Instituting 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 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 Respondent's Offer, the Commission finds<(1)> the following: A. THE RESPONDENT Dwight Allen, 51 years old, resides in Greenbrae, California. He is a certified public accountant who operates a sole proprietorship called Allen & Co. located in San Francisco, California. Allen served as the "Independent Financial Consultant" to the Wasco and Avenal Public Financing Authorities for their purchases of City of Ione Community Facilities District 1989-1 Special Tax Bonds. B. BACKGROUND 1. The Relevant Bond Legislation a. The Marks-Roos Bond Act The California Marks-Roos Local Bond Pool Act of 1985 ("Marks-Roos Act")<(2)> permits municipalities to organize "public financing authorities" ("PFAs") that sell bonds to the general public in order to create pools of monies which are, in turn, used to buy bonds, notes and other obligations of other public entities. 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 other 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. On June 1, 1989, the Avenal Public Financing Authority ("Avenal") issued $11 million in municipal bonds under the Marks-Roos Act. On September 20, 1989, the Wasco Public Financing Authority ("Wasco") issued $35 million in bonds under the Marks-Roos Act.<(3)> The Wasco and Avenal Indentures of Trust ("Indentures") both contained a three year limitation on the placement of funds ("the origination period") and <(1)> The findings herein are made pursuant to Respondent's Offer and are not binding on any other person or entity in this or any other proceeding. <(2)> See Article 4, Chapter 5, Division 7, Title 1 of the California Government Code ( 6500, et seq.). <(3)> The Cities of Avenal and Wasco are both located in the State of California. ======END OF PAGE 2====== required that all funds not used within the origination period be repaid to investors. b. The Mello-Roos Bond Act The California Mello-Roos Community Facilities Act of 1982 ("Mello- Roos Act")<(4)> authorizes cities, special districts, joint power authorities and other municipal corporations to organize community facilities districts ("CFDs") for the purpose of financing the building of infrastructure. CFDs are empowered to issue bonds secured by special taxes to finance both localized improvements such as streets and sewers, and more regional facilities, such as schools and freeway exchanges. However, the vast majority of CFDs are formed to finance the public infrastructure of real estate developments. Mello-Roos bonds are payable from special taxes levied on the property to be developed. The Mello-Roos bonds are not personal debts of the landowners or general obligations of the municipalities. On May 28, 1991, the City of Ione issued $6.55 million in Special Tax, Community Facilities District 1989-1 Series 1991 Bonds ("the Ione CFD 89-1 bonds") pursuant to the Mello-Roos Act.<(5)> 2. The Value-to-Lien Ratio for a Land-Secured Financing The relationship between the value of the land and the amount of bond debt is referred to as the value-to-lien ratio. The land is not collateral in the sense that a default on the bonds results in the transfer of title to bondholders. Rather, adequate land values offer the best assurance that bondholders will receive principal and interest payments because, if necessary, the issuer can foreclose on the tax lien and the proceeds from the sale of the delinquent properties can be used to bring the bonds current and repay the bondholders. Special tax liens have no intrinsic value without adequate property values to support them. Because a substantial portion of California land-secured municipal debt is sold without a credit rating, investors have relied on the value- to-lien ratio to measure the creditworthiness of a land-secured financing. The higher the ratio the lower the degree of risk to the investor and the lower the borrowing cost to the issuer in the form of a lower interest rate on the issue. In California, a 3 to 1 value-to-lien ratio served as the informal standard for a number of years. The belief was that a value-to- lien ratio of 3 to 1 offered a sufficient cushion against declines in land <(4)> See Article 1, Chapter 2.5, Division 2, Title 5 of the California Government Code ( 53311, et seq.). <(5)> The City of Ione is a political division and legal subdivision of the State of California. On February 7, 1991, Ione also issued $7.5 million in Special Tax, Community Facilities District 1989-2, Series 1991 Bonds pursuant to the Mello-Roos Act. ======END OF PAGE 3====== value as well as some protection against the uncertainties of the appraisal process itself. The Wasco and Avenal Indentures of Trust required that a local obligation had to have a value-to-lien ratio of at least 3 to 1, a requirement the Indentures referred to as the "minimum credit requirement." To satisfy the Wasco and Avenal PFA minimum credit requirement, "the current market value of the land and improvements subject to the lien of such issue . . . , as determined by an appraisal rendered by an MAI certified real estate appraiser selected by the Authority" had to be three times the value of the special tax liens. 3. The Role of the Independent Financial Consultant The Wasco and Avenal Indentures also required that the Authorities retain an Independent Financial Consultant to verify that a project had a value-to-lien ratio of at least 3 to 1. A local obligation could not be acquired by the Authorities without a certificate from the Independent Financial Consultant stating that the "minimum credit requirement" had been met. An Independent Financial Consultant was defined in the Indentures as "any financial consultant or firm of such financial consultants appointed by the Authority and who, or each of whom: (a) is judged by the Authority to have experience with respect to the financing of public capital improvement projects; (b) is in fact independent and not under the domination of the Authority; (c) does not have any substantial interest, direct or indirect, with the Authority, other than as Original Purchaser; and (d) is not connected with the Authority as an officer or employee of the Authority, but who may be regularly retained to make reports to the Authority." C. FACTS 1. Limitations on the Local Obligations Wasco and Avenal Could Purchase The Avenal and Wasco Official Statements disclosed that the bond pools had been established for the express purpose of acquiring the specific projects identified in the Official Statements. The Official Statements stated that if for some reason the money was not used for those specific projects, other public agencies could join the Authorities and participate in the bond pools, as long as their bonds satisfied the minimum credit requirement and other requirements. 2. Allen Represents that the Ione CFD 89-1 Bonds Satisfy the Minimum Credit Requirement As of June 1991, a number of the specific projects identified in the Avenal and Wasco Official Statements had not been funded by the Authorities. As a result, the Avenal and Wasco PFAs both had millions of dollars in uncommitted funds that had to be used to acquire other projects or returned to investors upon the expiration of the three year origination ======END OF PAGE 4====== period. The underwriter recommended that the Authorities consider purchasing the Ione CFD 89-1 bonds that it was then underwriting. Based on the underwriter's recommendation, the Authorities retained Allen to act as their Independent Financial Consultant in connection with their purchases of the Ione bonds. Allen testified that he was not familiar in detail with the Marks-Roos or Mello-Roos Bond Acts. His prior experience in municipal finance was limited to verifying calculations regarding debt service coverage of bond financing. He had no experience reviewing appraisals for public capital improvement projects. Allen never spoke with anyone from the Avenal or Wasco PFAs. Allen received the Wasco and Avenal Official Statements which contained the definitions of "minimum credit requirement" before preparing his opinion letters. He received and relied on excerpts of the Wasco and Avenal Indentures (namely, Sections 1.02, 3.05, and 3.06). In order to prepare his June 7 and 11, 1991 opinion letters, Allen also received and relied on a May 1, 1991, appraisal which had been prepared for Ione. Avenal and Wasco had not contracted to have an appraisal prepared. The appraisal found three values for the property: raw land was $1,380,000; bulk sale value was $27,957,000; and project build out value was $44,906,000. In order to satisfy the minimum credit requirement, the "current market value of the land and improvements" had to be at least $42.15 million. The special tax liens on the property were to total $14.05 million. The raw land and bulk sale values were too low. The project build out value did not reflect the current market value, as it was an estimate of what the land might sell for once the infrastructure was completed. Allen conceded in testimony that without the built out improvements, the current market value of the property was not three times the value of the bonds. This assumes the current market value meant what the property could sell for on the May 1, 1991, appraisal date. Allen signed two opinion letters to the Wasco and Avenal PFAs, respectively, on June 7 and 11, 1991, which stated in part: We have read Section 3.05, Section 3.06, Section 1.02 (regarding the content of this opinion) and the related definitions thereto of the Indenture of Trust. . . . We have read the terms and conditions of the Local Obligation and are qualified to render the opinion set forth below. We have made or caused to be made such examinations as is necessary to enable us to express an informed opinion with respect to the subject matter herein contained. In our opinion, the provisions of said Section 3.05 of the Indenture have been complied with. Based on the foregoing, we express the following opinion: The Local Obligation satisfies the Minimum Credit Requirements as required by Section 3.05(a) and as defined in the Indenture. The MAI certified real ======END OF PAGE 5====== estate appraisal reflects a value of approximately 3.2 times the aggregate of Special Tax Bonds issued under the authority of the CFD 1989-1 and CFD 1989-2. The determined value of the land and improvements is based upon the appraised build-out value as defined in the certified appraisal. The Ione CFD 89-1 bonds did not satisfy the Indenture's requirements because the current market value of the land and improvements securing the bonds was less than $42.15 million, or three times $14.05 million. In October 1994, the Ione CFD stopped paying principal and interest on the bonds and the City of Ione declared a default. In December 1995, the bonds were brought current through the sale of the property to an investment group. D. FINDINGS During the offer and sale of the Ione CFD 89-1 bonds, Allen made representations that were false to the Wasco and Avenal PFAs. As discussed above, in his Independent Financial Consultant Certificates, Allen represented that the Ione bonds satisfied the minimum credit requirement of the Indentures. The misrepresentations were material. The minimum credit requirement was intended to measure the creditworthiness of the bonds and to limit the risk being assumed by the Authorities and their bondholders. ======END OF PAGE 6====== The misrepresentations were "in connection with" and "in the offer or sale" of the Ione bonds. Allen acted with scienter. Given that Allen relied solely on the appraisal to determine the current market value of the property, his conduct was reckless. Based on the foregoing, and the Offer submitted by Respondent, the Commission finds that Allen violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder. IV. Accordingly, IT IS HEREBY ORDERED, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, that Allen 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 promulgated thereunder. By the Commission. Jonathan G. Katz Secretary ======END OF PAGE 7======