SECURITIES ACT OF 1933
Release No. 7696 / July 1, 1999

ADMINISTRATIVE PROCEEDING
File No. 3-9739

In the Matter of

CITY OF ANAHEIM, CITY OF IRVINE,
IRVINE UNIFIED SCHOOL DISTRICT,
and ORANGE COUNTY BOARD OF EDUCATION
Respondents.

ORDER MAKING FINDINGS AND
IMPOSING CEASE-AND-DESIST
ORDER

I.

In this public administrative cease-and-desist proceeding ordered pursuant to Section 8A of the Securities Act of 1933 ("Securities Act"),1 Respondents City of Anaheim, City of Irvine (the "Cities"), Irvine Unified School District, and Orange County Board of Education (the latter two collectively, the "Districts") (collectively, the "Issuers" or the "Respondents") have submitted Offers of Settlement ("Offers") 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 the Respondents admit the jurisdiction of the Commission over them and the subject matter of this proceeding, the Respondents, by their Offers, consent to the entry of the findings and the cease-and-desist order set forth below in this Order Making Findings and Imposing Cease-and-Desist Order ("Order").

II.

On the basis of this Order, the Order Instituting Public Administrative Cease-and-Desist Proceeding Pursuant to Section 8A of the Securities Act of 1933, and the Offers submitted by the Respondents, the Commission finds that:2

A. City of Anaheim, California ("Anaheim") is a chartered city organized under the constitution and laws of the State of California. Anaheim is the second most populous city in Orange County, California, with over 285,000 residents and an annual budget of over $245 million during the relevant period. Anaheim possesses the power to sue and be sued, and to issue debt. Anaheim conducted three taxable note offerings that are the subject of this Order.

B. City of Irvine, California ("Irvine") is a chartered city organized under the constitution and laws of the State of California. Irvine is among the largest cities in Orange County, California, with over 117,000 residents and an annual budget exceeding $56 million during the relevant period. Irvine possesses the power to sue and be sued, and to issue debt. Irvine conducted two of the taxable offerings that are the subject of this Order.

C. Irvine Unified School District ("Irvine USD") is a school district organized under the constitution and laws of the State of California. Irvine USD operates public schools in and around Irvine, California, serving over 21,000 students. Irvine USD's annual budget exceeded $96 million during the relevant period. Irvine USD possesses the power to sue and be sued, and to issue debt. Irvine USD conducted one of the offerings that are the subject of this Order.

D. Orange County Board of Education ("OC Board") is a county board of education organized under the constitution and laws of the State of California. OC Board provides a variety of educational and administrative support services for local educational districts in Orange County, California. OC Board's annual budget exceeded $88 million during the relevant period. OC Board conducted one of the offerings that are the subject of this Order.

The Orange County Investment Pools

E. The Orange County Investment Pools (the "Pools") operated as an investment fund managed by the Orange County Treasurer-Tax Collector (the "County Treasurer"). The Pools consisted of the Commingled Pool, the Bond Pool, and certain specific investments, in which the County and various local governments or districts (the "Pool Participants") deposited public funds. As Orange County educational districts, the Districts were mandatory Pool Participants because state law required them to deposit their funds with the County Treasurer. The Cities, as cities located in Orange County, were voluntary Pool Participants.

F. As of December 6, 1994 (the date the County and the Pools filed bankruptcy petitions), the Pools held approximately $7.6 billion in Pool Participant deposits, which the County Treasurer had leveraged to an investment portfolio with a book value of over $20.6 billion. The Commingled Pool was the principal investment pool and consisted of $6.126 billion in Pool Participant deposits. The proceeds from the offerings that are the subject of this Order were deposited into the Commingled Pool.

The Pools' Investment Strategy

G. The Pools' investment policy as stated by the County Treasurer to the Pool Participants was, in order of importance: (1) preservation of investment capital; (2) liquidity; and (3) investment yield. Contrary to that policy, the County Treasurer caused the Pools to engage in a risky investment strategy. This 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 derivative securities known as inverse floaters.

H. The Pools' investment return was to result principally from the interest received on the securities in the Pools. Leverage enabled the Pools to purchase more securities to generate increased interest income. This strategy was profitable as long as the 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.

The Commingled Pool's Portfolio

I. During 1993 and 1994, the County Treasurer, using reverse repurchase agreements, leveraged the Participants' deposits in the Commingled Pool to amounts ranging from 110% to 280%. The County Treasurer then typically invested the Participants' deposits and the funds obtained through reverse repurchase agreements in debt securities issued by the United States Treasury or United States government sponsored enterprises.

J. Many of these securities were derivative securities, comprising from 31% to 53% of the Commingled Pool's portfolio. In particular, the Commingled Pool was heavily invested in derivative instruments known as inverse floaters, which paid interest rates inversely related to the prevailing market interest rate. From January 1993 through November 1994, 24% to 52% of the Commingled Pool's total portfolio consisted of inverse floaters. Inverse floaters are negatively affected by a rise in interest rates.

The Rise in Interest Rates During 1994 and its Effect on the Commingled Pool

K. The composition of the Commingled Pool's portfolio made it highly sensitive to interest rate changes. As interest rates rose, the market value of the Commingled Pool's securities fell, and the interest received on the Commingled Pool's inverse floaters also dropped. Thus, the County Treasurer's investment strategy was profitable so long as interest rates, including the cost of borrowing through reverse repurchase agreements, remained low and the market value of the Commingled Pool's securities remained stable. Indeed, the County Treasurer's 1992-93 Financial Statement for the Pools stated that the investment strategy was "predicated on interest rates to continue to remain low for a minimum of the next three years."

L. During 1993, interest rates remained low and relatively stable. Due to the low interest rates and the County Treasurer's investment strategy, the Commingled Pool paid a relatively high yield of approximately 8% during 1993. Beginning in February 1994, interest rates began to rise. This rise in interest rates caused the Commingled Pool's yield to decrease, the reverse repurchase costs to increase, the interest income on inverse floaters to decrease, and the market value of the Commingled Pool's debt securities to decline. Month-end reports generated by the County Treasurer reflected that the securities marked-to-market for all of the Pools experienced a sharp drop in value, ranging from over $26 million in January 1994 (or 0.45% loss in value), to over $443 million in June 1994 (or 5.24% loss in value).

M. The rising interest rates and the declining value of the Commingled Pool's securities caused the Commingled Pool to suffer corresponding losses through collateral calls and reductions in the amounts loaned under reverse repurchase agreements. From January through June 1994, the County's Pools suffered collateral calls and reductions in loan amounts totaling over $873 million.

The Municipal Securities Offerings

N. In 1993 and 1994, Respondent Anaheim made three offerings of municipal securities in the form of taxable notes for the purpose of investing the proceeds in the Pools. These three offerings were: the 1993 $66 Million Notes, issued on March 31, 1993, and delivered on April 8, 1993; the 1993 Series B $25 Million Notes, issued on June 24, 1993, and delivered on July 8, 1993; and the 1994 $95 Million Notes, issued on March 23, 1994, and delivered on April 5, 1994. Anaheim paid these notes in full and on time.

O. In 1993 and 1994, Respondent Irvine made two offerings of municipal securities in the form of taxable notes for the purpose of investing the proceeds in the Pools. Irvine's two offerings were: the 1993 $60 Million Notes, issued on April 28, 1993, and delivered on May 6, 1993; and the 1994 $62.455 Million Notes, issued on July 21, 1994, and delivered on July 27, 1994. Irvine paid these notes in full and on time.

P. In 1994, Respondent Irvine USD issued municipal securities in the form of taxable notes for the purpose of investing the proceeds. Irvine USD's securities offering was the 1994 $54.575 Million Notes, issued on June 10, 1994, and delivered on June 14, 1994. The proceeds of this offering were invested in the Commingled Pool. Irvine USD paid these notes in full and on time.

Q. In 1994, Respondent OC Board issued municipal securities in the form of taxable notes for the purpose of investing the proceeds. OC Board's securities offering was the 1994 $42.18 Million Notes, issued on June 10, 1994, and delivered on June 14, 1994. The proceeds of the 1994 offering were invested in the Commingled Pool. OC Board paid these notes in full and on time.

R. Each offer of securities described above was made through an underwriter. The underwriter for each transaction purchased the total amount of securities offered, and then offered and sold the securities to investors. At the time each offering of securities was made, each Issuer knew that the underwriter would offer and sell some or all of the securities to others.

The Omissions Regarding Investment of the Proceeds

S. In connection with the issuance of the securities described above, each Issuer approved for distribution a written offering document called an "Official Statement," which described to potential purchasers certain information about the Issuer's note offering. Each Official Statement was then distributed to potential purchasers by the underwriter for the transaction. In addition to officials at each Issuer, the Issuer's outside financial advisor, bond counsel, counsel to the underwriter, and the underwriter participated in the preparation of the Official Statements, which each Issuer reviewed and approved before issuing the notes.

T. Each Official Statement contained a section entitled "Purpose of Issue," in which each Issuer described the purpose of each offering. This section of the Official Statements for Anaheim's offerings and Irvine's 1993 offering represented that the offerings were to provide funds to meet each issuer's current fiscal year expenditures, including current expenses, capital expenditures, and the discharge of other obligations or indebtedness of the issuer. This section of the Official Statements for Irvine's 1994 offering and the Districts' offerings represented that the offerings were to provide funds to meet each issuer's current fiscal year expenditures, including current expenses, capital expenditures, investment and reinvestment, and the discharge of other obligations or indebtedness of the issuer.

U. The disclosure in the Issuers' Official Statements was misleading because it omitted material information that the intended purpose of the debt offerings was to invest the note proceeds into the Commingled Pool for profit. Furthermore, the Official Statements misleadingly retained information typically used in tax and revenue anticipation note offerings, which is another type of municipal securities offering, such as statements that the taxable notes were issued "in anticipation of the receipt of taxes, revenue and other moneys" to be received by the issuer.

V. The Issuers failed to disclose in the Official Statements any information about the investment of the note proceeds in the Commingled Pool. Accordingly, the Official Statements failed to disclose that the Commingled Pool's investment strategy: (i) was predicated upon the assumption that prevailing interest rates would remain at relatively low levels; (ii) involved a high degree of leverage through the use of reverse repurchase agreements; (iii) involved a substantial investment in derivative securities, including inverse floaters, that are negatively affected by a rise in interest rates; and (iv) was sensitive to changes in the prevailing interest rate because of the combined effect of the derivative securities and leverage.

W. The Official Statements for these offerings further omitted to disclose the risks of the Commingled Pool's investment strategy. In particular, the Official Statements omitted to disclose that rising interest rates would have a substantial negative impact on the Commingled Pool in several respects: (i) the Commingled Pool's cost of borrowing on the substantial reverse repurchase position would increase; (ii) the interest income on the Commingled Pool's substantial investment in inverse floaters would decrease; (iii) the Commingled Pool's securities would decline in market value; (iv) as the value of the securities fell, the Commingled Pool would suffer collateral calls and reductions in amounts obtained under reverse repurchase agreements; (v) as a result of the above effects of a rise in interest rates, the Commingled Pool's earnings would decrease; and (vi) the Commingled Pool would suffer losses of principal at certain interest rate levels.

X. Finally, the Official Statements for the Issuers' 1994 offerings omitted to disclose certain material information concerning the Commingled Pool's investment results. In particular, the Official Statements omitted to disclose that, as a result of rising interest rates in early 1994: (i) the Commingled Pool's cost of borrowing had increased while the income earned from inverse floaters had decreased; (ii) the Commingled Pool had suffered substantial market losses in the overall value of the portfolio; and (iii) the Commingled Pool had suffered losses on the reverse repurchase transactions through collateral calls and reductions in amounts obtained under reverse repurchase agreements, which in turn, had a negative impact on liquidity.

Y. The Issuers knew that the purpose of the offerings was to invest the proceeds in the Commingled Pool. Moreover, the Issuers knew or should have known of certain information regarding the investment strategy of the Commingled Pool and, in 1994, the declining performance of the Commingled Pool. The Issuers should have known of certain related risks of the Commingled Pool's investment strategy. The Issuers received this information about the Pools from, and held meetings with representatives of, the County Treasurer, who managed the Pools. In addition, the Cities received reports which listed the Commingled Pool's portfolio holdings on a monthly basis in 1993 and 1994.

Anaheim, Irvine, Irvine USD, and OC Board Violated Sections 17(a)(2) and (3) of the Securities Act Through Negligent Conduct in the Offer and Sale of the Taxable Notes

Z. Sections 17(a)(2) and (3) of the Securities Act prohibit any person, directly or indirectly, by the use of the means or instruments of transportation or communication in interstate commerce or the mails, in the offer or sale of any security from obtaining money or property by means of any untrue statement of material fact or by omitting to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, and to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser. Scienter is not required to prove violations of Sections 17(a)(2) and (3) of the Securities Act. Aaron v. SEC, 446 U.S. 680, 697 (1980). Violations of these sections may be established by a showing of negligence. SEC v. Hughes Capital Corp., 124 F.3d 449, 453-54 (3d Cir. 1997); SEC v. Steadman, 967 F.2d 636, 643 n.5 (D.C. Cir. 1992). Accordingly, Anaheim, Irvine, Irvine USD, and OC Board, through negligent conduct, violated Sections 17(a)(2) and (3) of the Securities Act in the offer and sale of the taxable notes.

III.

The Issuers have submitted Offers of Settlement in which, without admitting or denying the findings herein, each consents to the Commission's entry of this Order, which makes findings, as set forth above, and orders the Issuers to cease and desist from committing or causing any violations and any future violations of Sections 17(a)(2) and (3) of the Securities Act. As set forth in the Offers of Settlement, the Issuers each undertake to cooperate with the Commission staff in preparing for and presenting any civil litigation or administrative proceedings concerning the transactions that are the subject of this Order.

IV.

In view of the foregoing, the Commission deems it appropriate to accept the Offers submitted by the Issuers and impose the cease-and-desist order specified in the Offer.

Accordingly, IT IS HEREBY ORDERED that, pursuant to Section 8A of the Securities Act:

1. Anaheim, Irvine, Irvine USD, and OC Board shall cease and desist from committing or causing any violation and any future violation of Sections 17(a)(2) and (3) of the Securities Act.

2. Anaheim, Irvine, Irvine USD, and OC Board shall each comply with the undertaking described in Section III. above.

By the Commission.

Jonathan G. Katz

Secretary


FOOTNOTES

1
The Order Instituting Public Administrative Cease-and-Desist Proceeding Pursuant to Section 8A of the Securities Act of 1933 in this matter was instituted on September 29, 1998. See Securities Act Release No. 7590.

2
The findings herein are made pursuant to the Respondents' Offers and are not binding on any other person or entity named as a respondent in this or any other proceeding.