UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES ACT OF 1933 Release No. 7260 / January 24, 1996 SECURITIES EXCHANGE ACT OF 1934 Release No. 36760 / January 24, 1996 ADMINISTRATIVE PROCEEDING File No. 3-8937 _____________________________ : In the Matter of : ORDER INSTITUTING A PUBLIC : ADMINISTRATIVE CEASE-AND- COUNTY OF ORANGE, : DESIST PROCEEDING PURSUANT TO CALIFORNIA; ORANGE : SECTION 8A OF THE SECURITIES COUNTY FLOOD CONTROL : ACT OF 1933 AND SECTION 21C OF DISTRICT; and COUNTY OF : THE SECURITIES EXCHANGE ACT OF ORANGE, CALIFORNIA BOARD OF : 1934, MAKING FINDINGS AND SUPERVISORS, : IMPOSING CEASE-AND-DESIST : ORDER Respondents. : : ____________________________: 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 ---------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 (continued...) ==========================================START OF PAGE 2====== 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 ---------FOOTNOTES---------- -[2]-(...continued) 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. ==========================================START OF PAGE 3====== 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]- 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; ---------FOOTNOTES---------- -[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. ==========================================START OF PAGE 4====== 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 ---------FOOTNOTES---------- -[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). ==========================================START OF PAGE 5====== 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, ---------FOOTNOTES---------- -[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. ==========================================START OF PAGE 6====== 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]- ---------FOOTNOTES---------- -[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 (continued...) ==========================================START OF PAGE 7====== 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, totalling $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]- ---------FOOTNOTES---------- -[14]-(...continued) 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 (continued...) ==========================================START OF PAGE 8====== 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 ---------FOOTNOTES---------- -[15]-(...continued) 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. ==========================================START OF PAGE 9====== 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 ---------FOOTNOTES---------- -[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. ==========================================START OF PAGE 10====== 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 ---------FOOTNOTES---------- -[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. ==========================================START OF PAGE 11====== 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 acquire securities at above market prices from, six Specific 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. ==========================================START OF PAGE 12====== 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. ==========================================START OF PAGE 13====== (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. ==========================================START OF PAGE 14====== 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, ==========================================START OF PAGE 15====== 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]- ---------FOOTNOTES---------- -[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. ==========================================START OF PAGE 16====== 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 ==========================================START OF PAGE 17====== 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. ==========================================START OF PAGE 18====== 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 ==========================================START OF PAGE 19====== 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. ==========================================START OF PAGE 20====== (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 ---------FOOTNOTES---------- -[19]- The Official Statements for the $64 Million Teeter Notes and the 1994 $50 Million Reinvestment Notes further disclosed that "[a]s 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." ==========================================START OF PAGE 21====== 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: "[f]rom time to time," the Treasurer pledged "a significant 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 ---------FOOTNOTES---------- -[21]- With respect to leverage, the Official Statement for the $169 Million TRANs instead stated: "[f]rom 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. . . ." ==========================================START OF PAGE 22====== 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 ---------FOOTNOTES---------- -[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. ==========================================START OF PAGE 23====== 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 ==========================================START OF PAGE 24====== 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 ---------FOOTNOTES---------- -[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. ==========================================START OF PAGE 25====== 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 ==========================================START OF PAGE 26====== 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 ==========================================START OF PAGE 27====== 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, ---------FOOTNOTES---------- -[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). ==========================================START OF PAGE 28====== 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]- ---------FOOTNOTES---------- -[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). ==========================================START OF PAGE 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 ---------FOOTNOTES---------- -[30]- See SEC v. Stifel, Nicolaus 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). ==========================================START OF PAGE 30====== 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 ---------FOOTNOTES---------- -[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, (continued...) ==========================================START OF PAGE 31====== 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 ---------FOOTNOTES---------- -[32]-(...continued) 19.6; see also AICPA Codification of Statements on Auditing Standards ("AU")  711. -[33]- See AU  560.12. ==========================================START OF PAGE 32====== 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 ---------FOOTNOTES---------- -[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. ==========================================START OF PAGE 33====== 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 ---------FOOTNOTES---------- -[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). ==========================================START OF PAGE 34====== 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. ==========================================START OF PAGE 35====== 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. As 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. ==========================================START OF PAGE 36====== 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 ==========================================START OF PAGE 37====== 6. The Board shall comply with its undertakings described in Section VI above. By the Commission. Jonathan G. Katz Secretary ==========================================START OF PAGE 38======