UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES ACT OF 1933 Release No. 7460 / September 30, 1997 SECURITIES EXCHANGE ACT OF 1934 Release No. 39149 / September 30, 1997 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 970 / September 30, 1997 ADMINISTRATIVE PROCEEDING File No. 3-9452 : In the Matter of : : THE CITY OF SYRACUSE, : NEW YORK, WARREN D. : SIMPSON, and EDWARD D. : POLGREEN, : ORDER INSTITUTING CEASE-AND- : DESIST PROCEEDINGS, MAKING : FINDINGS, AND ISSUING CEASE- Respondents. : AND-DESIST ORDERS : : 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 ======END OF PAGE 2====== 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. <(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. ======END OF PAGE 3====== 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)> <(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. ======END OF PAGE 4====== 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 <(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. ======END OF PAGE 5====== 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: <(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. ======END OF PAGE 6====== FY 95 Fund Balance as Presented in FY 95 Fund Official Balance -- Understatement/ Statements Actual / % 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 <(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. ======END OF PAGE 7====== 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 <(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. ======END OF PAGE 8====== 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 so 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. <(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. ======END OF PAGE 9====== 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; ======END OF PAGE 10====== 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. By the Commission. Jonathan G. Katz Secretary ======END OF PAGE 11======