UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES ACT OF 1933 Release No. 7455 / September 24, 1997 SECURITIES EXCHANGE ACT OF 1934 Release 39121 / September 24, 1997 ADMINISTRATIVE PROCEEDING File No. 3-9429 ORDER INSTITUTING CEASE-AND- DESIST PROCEEDING PURSUANT In the Matter of: TO SECTION 8A OF THE SECURITIES ACT OF 1933 AND RICHARD MILBRODT, SECTION 21C OF THE SECURITIES EXCHANGE ACT OF Respondent. 1934, MAKING FINDINGS, AND IMPOSING A CEASE-AND-DESIST ORDER I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that a cease-and-desist proceeding be, and hereby is, instituted pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") to determine whether Richard Milbrodt ("Milbrodt" or "Respondent") violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. II. In anticipation of the institution of this proceeding, Milbrodt has submitted an Offer of Settlement ("Offer"), which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceedings brought by or on behalf of the Commission or in which the Commission is a party, and without admitting or denying the findings contained herein, except that Respondent admits the jurisdiction of the Commission over him and over the subject matter of this proceeding, Milbrodt consents to the issuance of this Order Instituting Cease-and- Desist Proceeding Pursuant to Section 8A of the Securities Act of 1933 and Section 21C of the Securities Exchange Act of 1934, Making Findings, and Imposing a Cease-and-Desist Order ("Order") and to the entry of the findings and the imposition of the relief set forth below. III. On the basis of this Order and Respondent's Offer, the Commission finds<(1)> the following: A. THE RESPONDENT Richard Milbrodt, 64 years old, resides in Sacramento, California. He provides financial consulting services to municipalities under the name Administrative Budget Counseling. Milbrodt served as the "Independent Financial Consultant" to the Wasco and Avenal Public Financing Authorities for their purchases of Nevada County Series E-1990 Special Tax Bonds. B. BACKGROUND 1. The Relevant Bond Legislation a. The Marks-Roos Bond Act The California Marks-Roos Local Bond Pool Act of 1985 ("Marks-Roos Act")<(2)> permits municipalities to organize "public financing authorities" ("PFAs") that sell bonds to the general public in order to create pools of monies which are, in turn, used to buy bonds, notes and other obligations of other public entities. Marks-Roos bonds are payable from the principal and interest of the local obligations purchased with the pool's proceeds. Funds raised in a Marks-Roos offering must be used within a certain amount of time to purchase other local obligations. Under Section 149(f) of the Internal Revenue Code, a pooled financing is tax exempt only if the issuer reasonably expects that 95 percent of the net proceeds of the bond pool will be used within three years of the date of issuance. For this reason, bond pools generally require that all funds not applied within three years of issuance be returned to investors. On June 1, 1989, the Avenal Public Financing Authority ("Avenal") issued $11 million in municipal bonds under the Marks-Roos Act. On September 20, 1989, the Wasco Public Financing Authority ("Wasco") issued $35 million in bonds under the Marks-Roos Act.<(3)> The Wasco and Avenal Indentures of Trust ("Indentures") both contained a three year limitation ("the origination period") on the placement of funds and <(1)> The findings herein are made pursuant to Respondent's Offer and are not binding on any other person or entity in this or any other proceeding. <(2)> See Article 4, Chapter 5, Division 7, Title 1 of the California Government Code ( 6500, et seq.). <(3)> The Cities of Avenal and Wasco are both located in the State of California. ======END OF PAGE 2====== required that all funds not used within the origination period be repaid to investors. b. The Mello-Roos Bond Act The California Mello-Roos Community Facilities Act of 1982 ("Mello- Roos Act")<(4)> authorizes cities, special districts, joint power authorities and other municipal corporations to organize community facilities districts ("CFDs") for the purpose of financing the building of infrastructure. Unlike public financing authorities, CFDs are formed for funding purposes only and are governed by the legislative bodies which authorize their formation. CFDs are empowered to issue bonds secured by special taxes to finance both localized improvements such as streets and sewers, and more regional facilities, such as schools and freeway exchanges. However, the vast majority of CFDs are formed to finance the public infrastructure of real estate developments. Mello-Roos bonds are payable from special taxes levied on the property to be developed. The Mello-Roos bonds are not personal debts of the landowners or general obligations of the municipalities. On December 20, 1990, the County of Nevada<(5)> issued $9.07 million in Series E-1990 Special Tax, Community Facilities District 1990-1 Bonds ("the Nevada bonds") pursuant to the Mello-Roos Act. 2. The Value-to-Lien Ratio for a Land-Secured Financing The relationship between the value of the land and the amount of bond debt is referred to as the value-to-lien ratio. The land is not collateral in the sense that a default on the bonds results in the transfer of title to bondholders. Rather, adequate land values offer the best assurance that bondholders will receive principal and interest payments because, if necessary, the issuer can foreclose on the tax lien and the proceeds from the sale of the delinquent properties can be used to bring the bonds current and repay the bondholders. Special tax liens have no intrinsic value without adequate property values to support them. Because a substantial portion of California land-secured municipal debt is sold without a credit rating, investors have relied on the value- to-lien ratio to measure the creditworthiness of a land-secured financing. The higher the ratio the lower the degree of risk to the investor and the lower the borrowing cost to the issuer in the form of a lower interest rate on the issue. In California, a 3 to 1 value-to-lien ratio served as the informal standard for a number of years. The belief was that a value-to- lien ratio of 3 to 1 offered a sufficient cushion against declines in land value as well as some protection against the uncertainties of the appraisal <(4)> See Article 1, Chapter 2.5, Division 2, Title 5 of the California Government Code ( 53311, et seq.). <(5)> Nevada County is a political division and legal subdivision of the State of California. ======END OF PAGE 3====== process itself.<(6)> The "value" of the land for the purposes of the value-to-lien ratio can be measured in different ways. The Wasco and Avenal Indentures mandated that a project had to have a value-to-lien ratio of at least 3 to 1 as appraised by a member of the Appraisal Institute ("MAI") selected by the Authorities. Furthermore, the 3 to 1 ratio was based on the "current market value of the land and improvements subject to the lien" divided by the total amount of public debt secured by liens against the property. This requirement was defined in the Indentures as the "minimum credit requirement." 3. The Role of the Independent Financial Consultant To ensure that the "minimum credit requirement" was satisfied, the Wasco and Avenal Indentures required that the Authorities retain an Independent Financial Consultant to verify that a project had a value-to- lien ratio of at least 3 to 1. A local obligation could not be acquired by the Authorities without a certificate from the Independent Financial Consultant stating that the "minimum credit requirement" had been met. An Independent Financial Consultant was defined in the Indentures as "any financial consultant or firm of such financial consultants appointed by the Authority and who, or each of whom: (a) is judged by the Authority to have experience with respect to the financing of public capital improvement projects; (b) is in fact independent and not under the domination of the Authority; (c) does not have any substantial interest, direct or indirect, with the Authority, other than as Original Purchaser; and (d) is not connected with the Authority as an officer or employee of the Authority, but who may be regularly retained to make reports to the Authority." <(6)> In 1994, the 3 to 1 standard was enacted as state law to address investor concerns arising from the collapse in real estate values in many CFDs during the early 1990s. ======END OF PAGE 4====== C. FACTS 1. Limitations on the Local Obligations Wasco and Avenal Could Purchase The Avenal and Wasco Official Statements disclosed that the bond pools had been established for the express purpose of acquiring the specific projects identified in the Official Statements. While the Official Statements stated that Wasco and Avenal intended to and reasonably expected to purchase these projects, they noted that there could be no guarantee that any of the specified projects would be constructed and, if so, acquired by the Authorities. In such an event, they disclosed that the bond pools had been designed to allow other public agencies to join the Authorities and participate in the bond pools, as long as their bonds satisfied the minimum credit requirement, in addition to other requirements. 2. Milbrodt Represents that the Nevada Bonds Satisfy the Minimum Credit Requirement As of December 1990, a number of the specific projects identified in the Avenal and Wasco Official Statements had not been funded by the Authorities. As a result, Avenal and Wasco both had millions of dollars in uncommitted funds in their bond pools that had to be used to acquire other projects or returned to investors prior to the expiration of the origination period. The underwriter of the Wasco and Avenal bonds recommended that the Authorities consider purchasing some of the Nevada bonds, which it also was underwriting. Upon the underwriter's recommendation, the Authorities retained Milbrodt to act as their Independent Financial Consultant in connection with their purchases of the Nevada bonds. Milbrodt testified that he did not read the Indentures and that he was unaware of the Indentures' "minimum credit requirement." Milbrodt also testified that he did not read the Nevada Official Statement before rendering an opinion and did not know that the Nevada CFD had issued $9 million in bonds. Notwithstanding, Milbrodt issued separate certificates to Avenal and Wasco in which he represented that "we have read the terms and conditions of the Local Obligation and are qualified to render the opinion set forth below" that "the Local Obligation satisfies the Minimum Credit Requirements provided in the Indenture." After Milbrodt issued his certificates, Avenal purchased $1 million and Wasco purchased $3.5 of the Nevada bonds. Milbrodt's certificates were false and misleading. To satisfy the "minimum credit requirement" specified in the Indentures, the land and improvements securing the Nevada bonds had to have a "current market value" that was three times the value of the special tax liens, as determined by a certified MAI appraiser selected by the Authorities. The Nevada bonds did not satisfy these requirements because the current market of value of the land and improvements was far less than three times the principal amount of ======END OF PAGE 5====== the bonds. <(7)> Milbrodt had no evidence that the current market value of the property securing the Nevada bonds was anything close to that amount. In addition, the Authorities had not retained their own MAIs to appraise the property securing the Nevada bonds. In December 1994, the Nevada CFD stopped paying principal and interest on the bonds and the County declared a default. In February 1996, the bonds were brought current through the sale of a portion of the property securing the bonds. The reserve fund, however, was not replenished. The Nevada CFD will not be able to make future principal and interest payments on the bonds unless there are additional sales of the remaining real estate securing the bonds. D. FINDINGS During the offer and sale of the Nevada bonds, Milbrodt made misrepresentations to Wasco and Avenal. As discussed above, in his Independent Financial Consultant Certificates, Milbrodt falsely represented that the Nevada bonds satisfied the "minimum credit requirements" of the Indentures. As a result, Avenal and Wasco were deceived into purchasing the Nevada bonds in violation of the undertakings contained in their Indentures. The misrepresentations were material. As discussed above, the "minimum credit requirement" was intended to measure the creditworthiness of the bonds and to limit the risk being assumed by the Authorities and their bondholders. Milbrodt's misrepresentations led the Authorities to falsely believe that the Nevada bonds were adequately secured and that the level of risk was appropriate. The misrepresentations were "in connection with" and "in the offer or sale" of the Nevada bonds. All were designed to induce the Authorities to purchase the Nevada bonds. There was a causal nexus between Milbrodt's misrepresentations and Avenal and Wasco's decisions to purchase the bonds. Milbrodt acted with scienter. Given that Milbrodt testified that he never received copies of the Indentures, issued his certificates without viewing the minimum credit requirement, did not know the amount of bonds issued by the Nevada CFD, yet <(7)> In January 1990, the developer of the Nevada project purchased the property for $1,980,000. In a June 23, 1990 appraisal of the property, the appraiser selected by the underwriter valued the raw land at $2,980,000. ======END OF PAGE 6====== certified that the Nevada bonds satisfied the minimum credit requirement, his conduct, at a minimum, was reckless. Based on the foregoing, and the Offer submitted by Respondent, the Commission finds that Milbrodt violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder. IV. Accordingly, IT IS HEREBY ORDERED, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, that Milbrodt cease and desist from committing or causing any violation and any future violation of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder. By the Commission. Jonathan G. Katz Secretary ======END OF PAGE 7======