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U.S. Securities and Exchange Commission

UNITED STATES OF AMERICA
Before the
SECURITIES AND EXCHANGE COMMISSION

SECURITIES ACT OF 1933 Release No. 8411 / April 22, 2004

SECURITIES EXCHANGE ACT OF 1934 Release No. 49600 / April 22, 2004

ADMINISTRATIVE PROCEEDING File No. 3-11461


In the Matter of

NESHANNOCK TOWNSHIP
SCHOOL DISTRICT,

Respondent.


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ORDER INSTITUTING PROCEEDINGS,
MAKING FINDINGS, AND IMPOSING A
CEASE-AND-DESIST ORDER PURSUANT
TO SECTION 8A OF THE SECURITIES
ACT OF 1933 AND SECTION 21C OF
THE SECURITIES EXCHANGE ACT OF 1934

I.

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") and Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Neshannock Township School District (the "School District" or "Respondent").

II.

In anticipation of the institution of these proceedings, the School District has submitted an Offer of Settlement (the "Offer") 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 it and the subject matter of these proceedings, the School District consents to the entry of this Order Instituting Proceedings, Making Findings, and Imposing a Cease-and-Desist Order Pursuant to Section 8A of the Securities Act of 1933 and Section 21C of the Securities Exchange Act of 1934 ("Order"), as set forth below.

III.

On the basis of this Order and the School District's Offer, the Commission finds that

Respondent

1. The Neshannock Township School District ("School District") is a school district duly organized under the Pennsylvania School Code of 1949, as amended, and located in Lawrence County, Pennsylvania. The School District is governed by a board ("School Board") comprised of nine unpaid elected school directors. In June 2000, the School District conducted an offering of its $9,600,000 aggregate principal amount General Obligation Notes, Series of 2000 dated May 15, 2000 and maturing May 15, 2003 (the "Notes").

Summary

2. This matter involves the issuance of the Notes in June 2000 by the School District. The Notes were offered and sold based upon an opinion from counsel experienced in municipal finance matters ("Note Counsel") to the effect that interest on the Notes would be excluded from gross income for federal income tax purposes. However, a School District official executed an inaccurate certificate concerning the School District's plans to expend Note proceeds. Moreover, the School District's disclosure document (the "Official Statement"), which referenced the certificate, did not disclose that the School District's proposed capital projects were in the exploratory stage, and did not disclose any resulting risk to the Notes' purported tax-exempt status. Consequently, the School District made untrue statements of material fact and omitted to state material facts in connection with the offer and sale of the Notes.

Facts

3. In early 2000, representatives of a broker-dealer located in Pittsburgh, Pennsylvania ("Underwriter") approached the School District and proposed that the School District issue up to $10 million of purportedly tax-exempt three year notes. According to the Underwriter, given then-current market conditions, if the School District issued $9.6 million of tax-exempt three year notes, and reinvested the proceeds in U.S. Treasury obligations, $225,000 would be available for capital improvements at closing, an amount equal to the excess investment earnings, net of costs of issuance. The School District employed Note Counsel to advise it on the issuance of the proposed Notes.

4. Although various School Board members perceived a general need to either renovate or add to an existing school building, the School Board had not conducted the demographic study needed to justify the project, had not formally hired an architect, and had not resolved amongst themselves issues such as whether renovating existing classrooms or constructing new classrooms would be more appropriate. Some School Board members were initially skeptical about the financing proposal, and raised questions with Note Counsel and the Underwriter. After discussions with both Note Counsel and the Underwriter, the School Board voted unanimously to issue the Notes.

5. As of the date of closing on the Notes, a School District official executed an inaccurate non-arbitrage certificate, drafted by Note Counsel, to the effect that, among other matters, the School District reasonably expected (i) within six months to enter into a binding obligation to expend at least five percent of the Note proceeds on the costs of capital projects, and (ii) within three years to expend eighty-five percent of the Note proceeds on capital projects. In fact, although the School District did intend at some point to proceed with the capital projects, the School District was not certain when it would enter into any binding obligations and had not planned to spend a significant portion of the Note proceeds within three years.

6. The School District offered its Notes to potential investors through its Official Statement, signed by a representative of the School District. The Official Statement represented that the net proceeds from the sale of the Notes would be used to provide funds for capital improvement projects of the School District. In fact, shortly after the closing on the Notes and upon the advice of the Underwriter, the School District invested the net Note proceeds in a Federal Home Loan Bank obligation maturing within sixty days of the maturity date for the Notes. Moreover, in a separate section entitled "Not Arbitrage Notes," the Official Statement highlighted the existence of the inaccurate non-arbitrage certificate described above. According to the Official Statement, the School District would issue its certificate to the effect that the proceeds of the Notes would not be used in a manner that would cause the Notes to be or become "arbitrage notes," as described in Section 148 of the tax code. The Notes were offered at interest rates commensurate with their purported tax-exempt status. The Official Statement did not accurately describe the use of the Note proceeds, and did not disclose the resulting risk to the Notes' purported tax-exempt status.

7. The School District did not enter into any formal commitment to expend any portion of the Note proceeds within the six month time period, nor did it expend any portion of the net Note proceeds on any capital project. In November 2000, the Internal Revenue Service ("IRS") commenced an examination of the Notes. Shortly thereafter, the School District decided to redeem the Notes on May 15, 2001, the first call date. The redemption price for the Notes was paid from the proceeds of the Notes. In September 2001, the IRS issued a preliminary determination that the Notes were taxable arbitrage notes. In the IRS's view, the School District had issued the Notes without any reasonable expectation to expend the proceeds on capital projects. The School District and the IRS entered into a closing agreement that, among other things, provides for a payment by the School District to the IRS and preserves the tax-exempt status of the Notes. The closing agreement also provides that it is not to be construed as an admission by the School District that it acted wrongly with respect to the Notes.

Legal Discussion

8. The relevant tax code sections and Treasury regulations generally prohibit entities issuing tax-exempt securities from taking undue advantage of the resulting artificially low cost of capital. See IRC 148. In particular, absent an exemption from the general rule, issuers are not permitted to invest the proceeds of the offering at yields greater than the yield on the relevant tax-exempt debt, thereby generating what is known as arbitrage profit. Although entities that issue $10 million or less in securities a year in order to finance construction projects for public schools may be eligible for such an exemption, the issuer must reasonably expect, on the date of issuance of the tax-exempt securities, to: (i) incur within six months of the date of issuance a substantial binding obligation to a third party to expend at least five percent of the net sale proceeds on the capital project; (ii) proceed with due diligence to completion of the capital project; and (iii) expend at least eighty-five percent of the net sale proceeds on the capital project within three years of the date of issuance. Under the tax code, if these preconditions are not satisfied, and the issuer nevertheless earns arbitrage, then the securities are taxable retroactive to the date of issuance. When statements by issuers regarding reasonable expectations with respect to the amount and use of proceeds are not made in good faith, the relevant securities are deemed to be taxable arbitrage bonds. See Revenue Ruling 85-182, 1985-2 C.B. 39. A determination that purportedly tax-exempt securities were in fact taxable would significantly reduce the market value of those securities.

9. Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, prohibit misrepresentations or omissions of material facts in the offer or sale of securities and in connection with the purchase or sale of securities. Violations of these provisions of the securities laws may be established by showing reckless conduct.

10. The Notes issued by the School District are securities under Section 2(1) of the Securities Act and Section 3(a)(10) of the Exchange Act. A substantial risk to the tax-exempt status of securities which have been sold as tax-exempt is a material item. See In re County of Orange, California; Orange County Flood Control Dist.; and County of Orange, California Board of Supervisors, Exchange Act Release No. 36760, 61 S.E.C. Docket 395 (January 24, 1996). The Official Statement for the Notes did not accurately describe the use of the Note proceeds, and did not disclose the resulting risk to the purported tax-exempt status of the Notes.

11. The School District was reckless in making misrepresentations of material facts and omitting to state material facts in the Official Statement concerning the use of the Note proceeds and the resulting risk to the purported tax-exempt status of the Notes.

12. As a result of the conduct described above, the Commission finds that the School District committed violations 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, and in connection with the purchase or sale of, the Notes.

IV.

In view of the foregoing, the Commission deems it appropriate to impose the sanctions specified in the School District's Offer.

Accordingly, it is hereby ORDERED:

A. Pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, that the School District cease and desist from committing or causing any violations and any future violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; and

B. IT IS FURTHERED ORDERED that the School District shall, within ten days of the entry of this Order, pay disgorgement and prejudgment interest in the total amount of $28,904.00 to the United States Treasury. Such payment shall be: (A) made by United States postal money order, certified check, bank cashier's check or bank money order; (B) made payable to the Securities and Exchange Commission; (C) hand-delivered or mailed to the Office of Financial Management, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Alexandria, Stop 0-3, VA 22312; and (D) submitted under cover letter that identifies Neshannock Township School District as a Respondent in these proceedings, the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Arthur Gabinet, District Administrator, Philadelphia District Office, Securities and Exchange Commission, Mellon Independence Center, Suite 2000, 701 Market Street, Philadelphia, PA 19106.

By the Commission.

Jonathan G. Katz
Secretary

 

http://www.sec.gov/litigation/admin/33-8411.htm


Modified: 04/22/2004