UNITED STATES OF AMERICA
In the Matter of
|ORDER INSTITUTING CEASE-AND-DESIST PROCEEDINGS, MAKING FINDINGS, AND IMPOSING CEASE-AND-DESIST ORDER PURSUANT TO SECTION 8A OF THE SECURITIES ACT OF 1933|
The Securities and Exchange Commission ("Commission") deems it appropriate that cease-and-desist proceedings be, and hereby are, instituted pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") against the Massachusetts Turnpike Authority ("Turnpike Authority") and James J. Kerasiotes ("Kerasiotes") (collectively "Respondents").
In anticipation of the institution of these proceedings, Respondents have submitted Offers of Settlement (the "Offers"), which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission's jurisdiction over them and the subject matter of these proceedings, Respondents consent to the entry of this Order Instituting Cease-and-Desist Proceedings, Making Findings, and Imposing Cease-and-Desist Order Pursuant to Section 8A of the Securities Act of 1933 ("Order"), as set forth below.
On the basis of this Order and Respondents' respective Offers, the Commission finds that:
This matter involves misrepresentations resulting from the delay in disclosing cost increases at the Massachusetts Central Artery/Ted Williams Tunnel Project (the "Project"), popularly known as the "Big Dig," by the Turnpike Authority and Kerasiotes in connection with three municipal bond offerings during 1999. The offerings were by the Turnpike Authority in March 1999, the Commonwealth of Massachusetts ("Commonwealth") in September 1999, and the Massachusetts Bay Transportation Authority ("MBTA") in December 1999. At the time of each of these offerings, the Project staff had projected cost increases exceeding $1 billion, which should have been disclosed to the public, including potential bondholders, underwriters, and credit rating agencies in connection with the bond offerings. However, because the cost increases had not been fully quantified or confirmed, the Respondents deemed them to be speculative and did not disclose them. Instead, beginning in the spring of 1999, the Project staff embarked upon an effort to quantify and confirm the specific amount of any cost increases, including a "bottom-up" review of every Project contract. As a result, the offering materials accompanying each of the bond offerings indicated that the Project was on budget and that it would cost only $5.5 billion to complete. The cost increases were ultimately disclosed to the public in February 2000. Although Respondents' approach to dealing with projected cost increases was part of an effort to control Project costs, their failure to disclose such cost increases did not take into account their obligations under the federal securities laws. By their negligent conduct, the Turnpike Authority committed and Kerasiotes committed and caused violations of Sections 17(a)(2) and (3) of the Securities Act.
1. The Turnpike Authority, at all times relevant to this matter, was an agency of the Commonwealth. From 1997 through the present, the Turnpike Authority was responsible for overseeing the Project, described more fully below. The Project was staffed by approximately 625 employees of a joint venture between two major international construction companies, Bechtel Corporation and Parsons Brinckerhoff Quade & Douglas ("Bechtel/Parsons"), approximately 125 employees of the Turnpike Authority, and legal counsel (collectively referred to herein as the "Project staff").
2. Kerasiotes, age 49, of Medfield, Massachusetts, was the chairman of the Turnpike Authority from 1996 through April 11, 2000. Kerasiotes oversaw the Project for a decade in various positions -- first as Massachusetts Transportation Secretary (from 1990 through 1992), then as Secretary of the Executive Office of Transportation and Construction (from 1992 through 1996), and finally as Chairman of the Turnpike Authority (from 1997 through April 11, 2000). Kerasiotes delegated day-to-day management duties to the Project director, who reported to him regularly.
1. The Executive Office for Administration and Finance ("Administration and Finance") is an agency of the Commonwealth responsible for, among other things, preparing municipal bond offering materials for the Commonwealth and certain of its agencies that describe the financial condition of the Commonwealth.
2. The MBTA is an agency of the Commonwealth that operates mass transit facilities in 78 cities and towns in greater Boston. At all times relevant to this matter, the MBTA was authorized to issue municipal bonds, and the Commonwealth was the guarantor of such bonds.
3. Bechtel/Parsons was hired as the Project's outside private contractor and management consultant. Hired for their expertise at financial oversight of multi-billion dollar construction projects, Bechtel/Parsons was contractually obligated to create, track, and estimate the Project's budget, which Bechtel/Parsons did at all times relevant hereto. Bechtel/Parsons' contract required it to prepare quarterly cash flow projections reflecting the financial status of the Project, which the Turnpike Authority reviewed and provided to Administration and Finance for inclusion in bond offering materials.
The Project is a large, complex highway construction project that involves the depression under ground of a three-mile portion of Interstate 93 in downtown Boston (known as the Central Artery) and the construction of a new tunnel under Boston Harbor to link the Massachusetts Turnpike to Logan International Airport (the Ted Williams Tunnel) and two bridges over the Charles River. Construction of the Project began in 1991 and is currently expected to be completed in December 2004.
Historically, Project costs were borne by the Commonwealth, the Turnpike Authority, and the federal government. Through 1999, a majority of Project costs were borne by the federal government. However, as of March 1999, the federal contribution was reaching its limit, and by late 1999, it was apparent that the federal government would not provide additional funds for the Project. Accordingly, any Project cost increases were the responsibility of the Commonwealth and the Turnpike Authority.
Given the scope of the Project, costs were a concern from its inception. In an attempt to contain costs and achieve the Project's budget, the Project staff continually reviewed cost trends and pressures. Bechtel/Parsons regularly prepared cost estimates, which were reviewed and then used by the Turnpike Authority to manage the Project. Throughout this period, Kerasiotes told the Project staff that budget management was a "zero sum game," meaning that, for every cost increase, the Project staff must find a corresponding cost reduction or source of revenue. Kerasiotes was reluctant to approve increases in the Project budget estimates in part because hebelieved that public disclosure of an increase before it was absolutely certain that such an increase was unavoidable would make such an increase a self-fulfilling prophecy, thereby leading to Project cost increases that might otherwise have been prevented. Although this approach was an effort by Respondents to attempt to hold Project costs down, Respondents were negligent in failing to disclose cost increases in 1999, given how far the Project had progressed.
In 1997, Kerasiotes presided over a budget revision that established the total cost of the Project at $10.8 billion. From 1997 until February 2000, at Kerasiotes' direction, the Turnpike Authority, its employees, and Bechtel/Parsons consistently stated to the public that the Project cost would total $10.8 billion and that the Project was "on time and on budget." However, by March 1999, Respondents and the Project staff had become aware of significant projected cost increases that they negligently failed to disclose.
2. Project Costs Increased
The $10.8 billion budget was built on a number of budget assumptions adopted in connection with the Project staff's last detailed budget review in 1995. The budget assumptions, which were based in part upon experience through 1995 and then recently-implemented cost controls, included: (1) the Project would be able to award contracts for 13% less than the Project's market estimates (a "market discount"); (2) the cost of previously-awarded contracts would not increase (due to unexpected construction problems) by more than 10.7% overall and 7% going forward; and (3) the Project would terminate and stop paying Bechtel/Parsons as the Project's management consultant in 2002 -- two years before the Project's then-projected completion date -- after construction of the underground artery was scheduled to be completed and the less complicated demolition of the existing highway was scheduled to begin.
From April 1998 through December 1999, the Project staff regularly prepared internal projections of best and worst-case budget scenarios, known as "up-down" charts. By July 1998, these charts consistently showed projected cost increases in excess of $1 billion, most of which would be incurred in 2000 and 2001. Most of the cost increases were directly related to the failure of various assumptions underlying the $10.8 billion budget, both on a historical and going-forward basis. These charts also showed potential offsets consisting of sources of revenue and scope or cost reductions to pay for the cost increases, such that the charts reflected no net increase in the budget. However, by the summer of 1999, the Project had progressed to the point where meaningful scope or cost reductions were no longer feasible.
In February 1999, and on additional occasions thereafter, the Project staff reviewed the various assumptions underlying the $10.8 billion budget. Those reviews revealed significant cost increases arising from the failure of those assumptions. As of February 1999, contracts were being awarded for 6.5% less than the Project's market estimates (not 13%), the cost of previously-awarded contracts had increased by 11.6% (not 7%), and it had become apparent that the Turnpike Authority would not terminate Bechtel/Parsons as the Project's management consultant in 2002. As a result, by March 1999, Respondents should have recognized that significant projected cost increases would occur. Instead of disclosing this information, beginning in the spring of 1999, the Project staff embarked upon a process to quantify thespecific amount and timing of the cost increases. Between September and December 1999, the Project staff conducted a comprehensive bottom-up review of all Project contracts and costs. Kerasiotes believed that the Project staff could not determine the actual amount of a budget increase until it completed such a review and then submitted that review to an outside consultant for verification, a process that had been followed prior to the Project cost increases announced in 1995. Moreover, Kerasiotes did not want to disclose the problem until the Project staff determined its scope and came up with a solution. However, given Respondents' awareness of significant projected cost increases, Respondents acted negligently in failing to disclose such increases in the three bond offerings in 1999.
By mid-November 1999, the bottom-up review indicated that the Project's actual and projected costs were likely to exceed the Project's budget by approximately $1.4 billion and that additional funding would be needed beginning in 2001. After a series of meetings between the Turnpike Authority staff, Bechtel/Parsons, and legal counsel, the results of this review were presented to Kerasiotes on December 15, 1999.
3. The March 1999 Turnpike Authority Offering
On March 24, 1999, the Turnpike Authority sold approximately $809 million in 30-year revenue bonds that were insured by a AAA-rated insurance company. In its Official Statement accompanying the bond offering, which was signed by Kerasiotes, the Turnpike Authority stated that future Project costs would total approximately $5.5 billion. This amount was derived from a quarterly cash flow projection prepared by the Project staff (and reviewed by Turnpike Authority finance personnel) by subtracting the costs incurred to date on the Project from the $10.8 billion budget. The $5.5 billion figure did not include any cost increases.
4. The September 1999 Commonwealth Offering
On September 22, 1999, the Commonwealth sold $500 million in 20-year general obligation bonds using an Official Statement containing information concerning Project costs provided by the Turnpike Authority. The Official Statement accompanying the bond offering, prepared by Administration and Finance, contained the Project's cash flow information provided by the Turnpike Authority, which represented that the Project's cash needs and sources for each fiscal year from 1999 through completion of the Project would total $5.5 billion. This amount was derived from a quarterly cash flow projection prepared by the Project staff (and reviewed by Turnpike Authority finance personnel) by subtracting the costs incurred to date on the Project from the $10.8 billion budget amount. Pursuant to Kerasiotes' approach to addressing cost increases, the $5.5 billion figure did not include any cost increases.
5. The December 1999 MBTA Offering
On December 9, 1999, before the Project staff presented the results of its bottom-up review to Kerasiotes, the MBTA sold $200 million in 30-year general obligation bonds using an Information Statement containing information concerning Project costs provided by the Turnpike Authority. The bonds were general obligations of the MBTA payable from theMBTA's general revenue fund. However, if the MBTA was not able to pay the bonds, they would be paid by the Commonwealth and were secured by the Commonwealth's full faith and credit. Accordingly, the MBTA's Official Statement contained an Information Statement from the Commonwealth. Based upon information the Turnpike Authority provided to Administration and Finance, the Information Statement stated that it would cost $5.5 billion to complete the Project. This amount was derived from a quarterly cash flow projection prepared by the Project staff (and reviewed by Turnpike Authority finance personnel) by subtracting the costs incurred to date from the $10.8 billion budget amount. Pursuant to Kerasiotes' approach to addressing cost increases, the $5.5 billion figure did not include any cost increases.1
6. Disclosure of Cost Increases and Subsequent Events
On February 1, 2000, Kerasiotes and the Turnpike Authority disclosed to the media that the Project would cost approximately $1.4 billion more than the $10.8 billion budget. These cost increases equaled approximately 3% of the total revenues of the Commonwealth estimated for fiscal year 2000 and 2001 and 9% of the total Commonwealth debt load as of January 1, 1999. Moreover, these cost increases exceeded the amount of the Commonwealth's Stabilization (or "rainy day") Fund, which the Commonwealth had pledged to use to provide tax relief, save for future contingencies, and fund one-time expenditures.
Following the disclosure of the cost increases, the Turnpike Authority took several steps to improve its disclosure practices. These steps included, but are not limited to, generating a publicly-available monthly report that includes detailed information regarding the Project's cost projections, conducting an annual, detailed review similar to the reviews conducted in 1994 and 1999, utilizing estimates of an outside consultant to test budget assumptions and cost figures generated by Project staff, and retaining outside counsel to provide disclosure advice on an ongoing basis.
As a result of the negligent conduct described above, the Turnpike Authority committed and Kerasiotes committed and caused violations of Sections 17(a)(2) and (3) of the Securities Act.2 In order to establish a cause of action under Sections 17(a)(2) and (3) of the Securities Act, it must be established that: (1) the misrepresentations were material; and (2) the misrepresentations were in the offer or sale of securities. Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); Superintendent of Ins. v. Bankers Life and Casualty Co., 404 U.S. 6 (1971); Aaron v. SEC, 446 U.S. 680, 686 n.5 (1980). A finding of scienter is not required to establish violations of Sections 17(a)(2) and (3) of the Securities Act; negligence is sufficient. Aaron, 446 U.S. at 696-97; SEC v. Hughes Capital Corp., 124 F.3d 449, 453-454 (3d Cir. 1997).
The cost increases identified by the Project staff were material to each of the three bond offerings in this matter. Information is material if there is a substantial likelihood that a reasonable investor would consider it important in making his or her investment decision. See Basic, 485 U.S. at 231-32, 240; TSC Industries v. Northway, Inc., 426 U.S. 438, 439 (1976); SEC v. Steadman, 967 F.2d 636, 643 (D.C. Dir. 1992); Selective Disclosure and Insider Trading, Rel. No. 33-7881 (Aug. 15, 2000), 2000 SEC LEXIS 1672 at *32 (adopting case law definition of materiality for purposes of Regulation FD). See also City of Miami, Initial Dec. Rel. No. 185 (June 22, 2001), 2001 SEC LEXIS 1250, *51 (whether official statement is misleading depends on "whether an investor who had been reasonably diligent in reviewing the Official Statement would have been misled") (citation omitted). This requirement is fulfilled if there is a substantial likelihood that the information would have been viewed by the reasonable investor as having significantly altered the total mix of information made available. Id. If the information relates to possible future events, 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, 485 U.S. at 238; SEC v. MacDonald, 699 F.2d 47, 50 (1st Cir. 1983) ("materiality of facts regarding a contingent future event is simply a function of the anticipated magnitude of the event if it occurs, discounted by the probability of its occurring"). See also Milton v. Van Dorn Co., 961 F.2d 965, 969-70 (1st Cir. 1992) (same).
Reasonable investors would have considered Project cost increases in excess of $1 billion to be an important factor in the investment decision-making process and would have viewed such information as significantly altering the total mix of information available. In addition to being a substantial amount in absolute terms, the cost increases equaled approximately 3% of the total revenues of the Commonwealth estimated for fiscal year 2000 and 2001 (when the majority of the cost increases would be incurred) and 9% of the total Commonwealth debt load as of January 1, 1999, and exceeded the amount of the Commonwealth's rainy day fund. Reasonable investors were entitled to know about cost increases of this magnitude that would have to be met by the Commonwealth and/or the Turnpike Authority so the investors themselves could evaluate the financial condition of the Turnpike Authority and/or Commonwealth and analyze fully the bond offerings. See Basic, 485 U.S. at 234 ("[d]isclosure, and not paternalistic withholding of accurate information, is the policy chosen and expressed by Congress"). See also Statement of the Commission Regarding Disclosure Obligations of Municipal Securities Issuers and Others, Exchange Act Release No. 34-33741 (March 9, 1994), 1994 SEC LEXIS 700, *16 (citing same standard for municipal security offerings).
Because the Project cost information provided by the Turnpike Authority was included in the materials accompanying each offering at issue here, the misrepresentations about such costs were made in the offer or sale of securities under Section 17(a) of the Securities Act. See Miami, 2001 SEC LEXIS 1250 at *50 (finding violations of Sections 17(a) where issuer's offering materials "distributed to inform and influence the investing public"). Section 17(a) is to be interpreted broadly, and an individual who provides false or misleading information included in offering materials may be liable under this section even if that individual does not have direct contact with investors or editorial control of offering materials. See SEC v. Holschuh, 694 F.2d 130, 142-45 (7th Cir. 1982). Here, the Turnpike Authority and Kerasiotes are liable because they negligently created, directly or indirectly, the particular misrepresentations at issue.
In determining to accept the Respondents' Offers, the Commission considered the remedial acts promptly undertaken by the Turnpike Authority.
In view of the foregoing, the Commission deems it appropriate to issue the cease-and-desist order specified in Respondents' respective Offers.
ACCORDINGLY, IT IS HEREBY ORDERED:
Pursuant to Section 8A of the Securities Act, that Respondents Turnpike Authority and Kerasiotes cease and desist from committing or causing any violations and any future violations of Sections 17(a)(2) and (3) of the Securities Act.
By the Commission.
Jonathan G. Katz
|1||Kerasiotes was not unjustly enriched and did not profit financially by his conduct in connection with any of the bond offerings at issue in this matter, and no investor suffered a financial loss.|
|2||The actions and state of mind of high-ranking Turnpike Authority and Project staff officials, can be imputed to the Turnpike Authority even though no member of the Turnpike Authority's current board knew of the information set forth above during 1999. See City of Miami, Initial Dec. Rel. No. 185 (June 22, 2001), 2001 SEC LEXIS 1250, *53 ("City is responsible for the acts of its City Manager and Finance Department officials, and the knowledge of these individuals is imputed to the City"), aff'd, Securities Act Rel. No. 8213 (March 21, 2003), 2003 SEC LEXIS 676; Erik W. Chan, Initial Dec. Rel. No. 172 (Sept. 14, 2000), 2000 SEC LEXIS 2274 at 28-29 (same) (citing cases). Good faith conduct may constitute a violation when negligent. See SEC v. Brincat, 2001 U.S. Dist. LEXIS 20213, *3 (N.D. Ill. Dec. 5, 2001) ("Even if [respondent] acted in good faith, he may still be liable ... if he acted ... negligently"). See also SEC v. Pros Int'l, Inc., 994 F.2d 767, 769 (10th Cir. 1993) ([respondent] acted negligently even though "there has been no showing that [he] intended to defraud investors").|
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