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 <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
<(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======