SECURITIES AND EXCHANGE COMMISSION
In the Matter of
THE CITY OF MIAMI, FLORIDA
OPINION OF THE COMMISSION
Grounds for Remedial Action
Fraud in the offer and sale of securities
Municipal securities issuer distributed offering documents and an annual financial report that contained material misstatements and omitted material facts concerning its financial condition. Held, it is in the public interest to order the municipal securities issuer to cease and desist from committing or causing any violation or future violation of the antifraud provisions of the federal securities laws.
Thomas Tew, and Daniel S. Newman of Tew Cardenas Rebak Kellogg Lehman DeMaria Tague Raymond & Levine, LLP, for the City of Miami, Florida.
Teresa J. Verges, for the Division of Enforcement.
Appeal filed: October 16, 2001
Last brief received: December 10, 2001
The City of Miami, Florida ("City"or "Miami") appeals from the decision of an administrative law judge. The law judge found that the City willfully violated Section 17(a) of the Securities Act of 1933,1 Section 10(b) of the Securities Exchange Act of 1934,2 and Exchange Act Rule 10b-53 with respect to its offer and sale of three municipal bond issues. The law judge ordered the City to cease and desist from committing or causing any violation or any future violation of the antifraud provisions. We base our findings on an independent review of the record, except with respect to those findings that are not challenged on appeal.4
A. The City
During the period under review, the City had an annual budget of approximately $250 million and about 3,300 employees. The City had an elected City Commission form of government, consisting of the Mayor, Vice Mayor, and three Commissioners. The City Commission delegated the responsibility for the day-to-day management of the City's affairs to a City Manager, appointed by the Mayor. The City Manager had responsibility for all City departments and supervision of all City employees.
Cesar Odio was the City Manager from 1985 until his resignation in September 1996. At the time, Manohar Surana was the City's Director of Management and Budget.5 In February1995, when Carlos E. Garcia retired as the City's Director of Finance, Odio consolidated the Departments of Finance and of Management and Budget and named Surana Director. Although not an accountant, Surana was directly responsible for preparation of the City's fiscal year ("FY") 1995 financial statements and the FY 1995 budget.
B. Miami's Financial Reporting
Miami's fiscal year began on October 1 and ended on September 30 the following year (e.g., the City's FY 1995 began on October 1, 1994 and ended on September 30, 1995). The largest component of the City's operating budget was the General Fund. The General Fund accounted for most of the City's core activities, such as the fire and police departments. Miami also maintained a series of separate funds. The Enterprise Funds recorded the operations that were supposed to be financed through the collection of user fees. The Internal Service Funds accounted for goods or services provided by one department or agency to another. The Capital Projects Funds accounted for the acquisition and construction of major capital facilities. During the period under review, Miami used "pooled accounting," that is, the City deposited cash for all funds in one account. No records were maintained to identify the amount of cash belonging to each fund.
C. The Gates Judgment
Further complicating the City's finances was a 1985 consent decree, the so-called "Gates Judgment," requiring Miami to repay money transferred from City pension funds. The City's obligation under the Gates Judgment was projected to total $473 million through 2012. Payments under the Gates Judgment and other annual pension payments totaled approximately $32 million per year. The City made these payments from the General Fund. Odio testified that in 1985, his first year as City Manager, he calculated that, unless the Gates Judgment was refinanced, by the mid-1990s Miami would face a fiscal crisis and experience a $66.5 million deficit.
D. Miami's FY 1994 - 1995 Financial Condition
1. The FY 1995 Budget
Under Florida law, Miami's annual budget was required to be balanced.6 The City had sustained deficits in the General Fund for several years and had borrowed from other funds to satisfy operating expenses. The record demonstrates that, by the end of FY 1994, Miami's ongoing financial problems were well known to City officials.
On September 22, 1994, Miami's City Commission approved a $222 million budget for FY 1995.7 This budget included $9 million dollars that were to come from the federal government in the form of a Crime Bill grant and $3 million in revenue to be generated from the sale of land fill. Earlier that month, City officials and City Commissioners had been informed that Miami should expect to receive the Crime Bill funds "starting in FY 1996." On September 21, 1994, the day before the budget was approved, Surana sent a memo to the City's Police Chief, with a copy to Odio, stating that program authorization for the Crime Bill would not begin until 1996.8 Dipak Parekh ("D. Parekh"), the City's then Revenue Management Administrator who drafted the memo, testified that he gave this information to Odio. D. Parekh further testified that prior to the first bond offering, there was "no basis to believe that the City would ever get that $9 million."9
2. Financial Advisers Warn Miami Of A Deficit
Miami retained two financial advisers: Howard Gary & Company ("HG & Co.") and Raymond James & Associates, Inc., ("Raymond James"). Kishor Parekh ("K. Parekh"), a partner of HG & Co. and D. Parekh's brother, was the HG & Co. primary contact with Miami.10 By letter dated September 30, 1994, addressed to Garcia, then Director of Finance, the financial advisers warned Miami that "the City's general credit rating will experience a downgrade in the near future." The letter highlighted Miami's "low level of unreserved General Fund balances, the City's reliance on non-recurring revenue initiatives, asset sales, basic infrastructure maintenance needs, as well as the City's overall revenue inflexibility." The financial advisers believed that Miami's fiscal health was approaching a "precarious situation."11
According to K. Parekh, Garcia chastised him for sending the letter and instructed that in the future any similar concerns should be raised only orally. Less than three weeks following the financial advisers' warning, Standard & Poor's ("S & P") downgraded Miami's outstanding general obligation bonds from A+ to A. S & P cited "continuing fiscal stress arising primarily from revenue inflexibility, which has caused the City to utilize nonrecurring sources to support operations."12
3. Auditor Tells Miami That It Will Run Out Of Cash
Deloitte & Touche, LLP ("Deloitte") was Miami's outside auditor from 1989 through 1995. Francisco Paredes was the partner who supervised the City's account for FY 1994 and FY 1995. During the FY 1994 audit, Deloitte determined that Miami faced a potential shortfall of $35 - $40 million for FY 1995, and that the City could run out of cash by May 1995. During a meeting in December 1994 or early January 1995, Paredes informed Garcia and Odio of Miami's cash flow problems. This conversation alerted Odio to the increased seriousness of the City's cash flow deficiency because it was the first time that Paredes had ever discussed Miami's finances directly with him.
4. Operation Right Size
Shortly after being confronted with Deloitte's warnings, Odio, Surana, Paredes, one of the City's Commissioners, and representatives of "all the City staff" met at the Orange Bowl to discuss the $35-$40 million deficit projected by Deloitte. Odio testified that those in attendance did not consider increasing taxes or service fees to raise needed revenue because they knew that the City Commission had rejected this option in the past for "political reasons."13 Following the Orange Bowl meeting, Miami initiated a program called Operation Right Size, which required every city department to review its budget for possible savings, according to Odio to "salvage the situation." Operation Right Size, starting June 1, 1995, was expected to reduce City expenditures by $15 million to $25 million in succeeding years by, among other things, reducing the number of City employees and introducing a two-tiered salary structure that would replace long-time workers with lower-cost employees. However, in February 1995, Odio informed Paredes that, despite the City's best efforts to reduce expenditures through Operation Right Size, Miami would be expected to save only $5 million from the program in FY 1995. Odio testified that Miami's cash flow problems for FY 1995 could not be solved solely by implementing Operation Right Size. He added that making up a $35 million deficit in a $222 million budget would have been "kind of a miracle."
Deloitte debated whether it had to qualify its opinion on Miami's FY 1994 financial statements with respect to whether Miami would remain a going concern.14 A Deloitte work paper, dated March 1995, stated that "it appears the City is approximately $20 to $40 million behind in cash flows," and projected that "the City will definitely have a deficit cash flow deficit in the General Fund at September 30, 1995." The work paper also included best-case and worst-case analyses of Miami's finances for FY 1995, based on projections prepared by Garcia using actual revenues through November 1994.15 Both analyses assumed that Miami would sell bonds.
Paredes testified that Miami's leadership was "well aware" of Deloitte's prognosis for the City's finances, and that the City officials planned to issue $20 million in Self Insurance Bonds "if cash flow  necessitated."16 Odio admitted that Miami had to sell bonds to survive FY 1995 stating, "[T]hat's the only choice we had, to borrow money."
Deloitte did not qualify its opinion on Miami's financial statements.17 According to Paredes, Miami avoided issuance of a going concern qualification on its FY 1994 financial statements because the City intended to sell bonds. Paredes testified that he also based his decision on his view that the City was "progressing as planned," many City employees hadagreed to take early retirement, and there had been discussions about the sewer and pension bonds.18
5. 1994 CAFR
During the period under review, the City prepared and disseminated a yearly Comprehensive Annual Financial Report ("CAFR") containing the City's yearly audited General Purpose Financial Statements and a transmittal letter from the City Manager and other city officials to the Mayor and the City Commission. Miami sent its CAFR biannually to credit rating agencies, and widely disseminated the CAFR to bond insurers, and investors.
The 1994 CAFR included the independent auditor's report on the City's financial statements, and a transmittal letter to the Mayor and City Commissioners from the City Manager and Finance Director. The transmittal letter stated that:
To the best of our knowledge and belief, the enclosed data is accurate in all material respects and is reported in a manner designed to present fairly the financial position and results of operations of the various funds and account groups of the City. All disclosures necessary to enable the reader to gain an understanding of the City's financial activities have been included.
Note 9 to the financial statements discussed a deficit of about $80 million in the City's Enterprise and Internal Service Funds. Note 9, titled "Fund Equity," stated that:
The following schedule lists fund deficits for Governmental and Trust and Agency type funds as of September 30, 1994 (in thousands):
Rescue Services Special Revenue ($285)
Self Insurance Trust Fund ($6,472)
Pension Administration Trust Fund ($34)
In addition to the above fund deficits, the City also experienced cash deficits in several of its operating funds which were temporarily remedied by loans from other funds. See Note 5.19 It is management's intention to replenish these deficits and, accordingly, in February 1995, the City initiated a review process to "right-size" its operations with the goal of reducing its FY 95-96 budget by $30 million. As part of this initiative, significant concessions obtained from the sanitation union are expected to reduce the Solid Waste Department's FY 95-96 budget by $10 million. In addition, several departments are being consolidated and certain operations not directly related to the City's basic services are expected to be discontinued by September 30, 1995. Early retirement plans have been agreed to in principle by the City's administration and union's leadership with the purpose of reducing the City's workforce by approximately 400 employees by September 30, 1995. The implementation of the proposals discussed above are expected to strengthen the City's financial condition.
6. Miami's Financial Condition Continues to Deteriorate
In March 1995, Surana directed Miami's financial advisers to explore various financing alternatives that would raise cash immediately. Ultimately, K. Parekh informed Surana that none of the proposed options was feasible. On May 9, 1995, K. Parekh was summoned to a meeting with Surana, Odio, other City officials, and representatives of the financial advisers. K. Parekh testified that the participants discussed "the City's inability to meet its obligations. They were running out of money." According to K. Parekh's contemporaneous handwritten notes, Surana stressed that, it was imperative that the City's "[a]ctual cash deficit must be solved by Mid-June " and that "[a]ll GF/Budget must be solved by [September 1995]" (emphasis in original). Surana warned that, if the cash crunch was not resolved prior to this date, City employees' paychecks would bounce.
In advance of the May 9 meeting, K. Parekh and Miami's Debt Service Coordinator prepared an analysis demonstrating that, although Miami's financial statements showed a positive $3.167 million General Fund balance as of September 30, 1994, in reality, the account had a $3.156 million deficit.
7. The Bond Issues
a) Sewer Bonds
On May 25, 1995 the City Commission authorized the sale of the $22.5 million general obligation Sewer Bonds for improvements to the City's sewer system and to pay pensionliabilities for the fiscal year ending September 30, 1995. The Official Statement20 for the Sewer Bonds included the City's FY 1994 audited financial statements, including Note 9, and incorporated a certificate executed by Miami's City Manager stating that the Official Statement was free of misstatements and omissions of material facts, and that there had been no material adverse change in Miami's financial condition since September 30, 1994, the close of the prior fiscal year.21 The Official Statement also contained a summary of Miami's $222 million FY 1995 budget, claiming that the City anticipated receiving $9 million in Crime Bill monies and the $3 million proceeds from the sale of land fill, and represented that the City's "Revenues and Other Financing Sources" equaled "Expenditures and Other Uses" (the "balanced budget summary").
The Sewer Bonds were sold on June 27, 1995. Following the bond sale, Miami transferred $8.8 million, or 39 percent, of the bond proceeds into the General Fund in order to address the impending operating fund deficiency. The Sewer Bonds were insured by Financial Guaranty Insurance Company ("FGIC").
On June 9, 1995, Surana, Odio, K. Parekh, representatives of the City's employees, and representatives of Rauscher Pierce Refsnes, Inc. ("Rauscher Pierce"), an underwriter, met to discuss the City's cash flow problems. K. Parekh testified that, although the attendees expressed concern that Miami "was running out of money," it was "obvious" that the City had found a solution to its cash flow crunch because, in contrast to the prior month's meeting, "people weren't running around as crazy as they used to before" and no one talked about the City running out of cash by mid-June.
b) FP & L Bonds
On August 24, 1995, the City sold the $22 million Special Obligation Non-Ad Valorem Revenue Bonds ("FP & L Bonds"). According to the Official Statement, proceeds from the bond sale were to be used to purchase property, to make capital improvements, and to acquire an administration building. Financial disclosures in the Official Statement for the FP & L Bonds were the same as those for the Sewer Bonds. The FP & L Bonds were also insured by FGIC. The City transferred $21 million of the bond proceeds to the General Fund for an ending balance of $26 million on September 30, 1995.
c) Pension Bonds
Miami asked Rauscher Pierce to examine refinancing strategies that would provide immediate cash flow. In a letter to Deloitte dated June 14, 1995, Rauscher Pierce made clear that Miami was looking for a "big bang" to solve the City's fiscal problems. On the same day, Rauscher Pierce's Sarasota, Florida office faxed a document to its Miami office concerning a proposed issuance of Pension Bonds. The Sarasota office concluded that, if the bond proceeds were used directly for operating expenses, the City's liability would in essence be doubled, and the financing would be "pure deficit financing," which was prohibited by Florida law. The document also noted that "[t]his instrument is a deferral of the budget problem from one year to the next. So in essence, it buys one year's time."22
On July 13, 1995, the City Commission adopted a resolution that gave the City Manager authority to issue bonds totaling $309 million between 1995 and 2008 (the "pension bonds resolution"). Pursuant to this resolution, the City Manager had sole authority to issue bonds up to $22 million annually in order to make payments under the Gates Judgement and for other pension costs.23
On October 19, 1995, K. Parekh again met with Surana and others to discuss the City's cash flow needs.24 In a follow-up letter dated November 7, 1995, K. Parekh reminded Suranathat one aim of the July 1995 pension bonds resolution was to "reduce (to the maximum possible extent) the amount of 'fiscal stress' upon the City." K. Parekh testified that later in November Surana telephoned him at home and reported that Miami was "out of money."
On December 12, 1995 the City's sold its first offering pursuant to the July 13, 1995 pension bonds resolution, a negotiated offering of $72 million Non-Ad Valorem Revenue Bonds (the "Pension Bonds"). The Official Statement declared the bond proceeds would be used to pay accrued and future liabilities to City pension plans and to reimburse the City for payments made in FY 1995. Financial disclosures in the Official Statement for the Pension Bonds were the same as those for the Sewer Bonds and the FP & L Bonds. The Pension Bonds were insured by AMBAC Insurance.
8. Appointment of the Oversight Board
On September 13, 1996, following the resignations of Odio and Surana, the City appointed an Interim City Manager. In December 1996, the Mayor and City Commissioners declared a fiscal emergency, causing Florida's Governor to put the City under the aegis of a Financial Emergency Oversight Board ("Oversight Board"). The Oversight Board was to have "continuous existence until three years after the City has produced two successive years of balanced operations and none of the statutory conditions for determining a local government financial emergency exists."
The antifraud provisions of the securities laws prohibit fraudulent and deceptive acts and practices in connection with the offer, purchase, or sale of a security.25 In 1989, when the Commission adopted Exchange Act Rule 15c2-12, "Municipal Securities Disclosure," the Commission noted that municipal "issuers are primarily responsible for the content of their disclosure documents and may be held liable under the federal securities laws for misleading disclosure."26 We have long emphasized the need for adequate disclosure in the sale of municipal securities.27
Early in FY 1995, Miami learned that it was facing an unprecedented cash flow shortage and would not be able to meet its obligations by May 1995, unless it took drastic steps both to generate cash flow and reduce expenses. To survive the year, Miami had to sell bonds and use the proceeds to meet its operational expenses. Miami officials knew that Operation Right Size would not turn around the City's financial crisis in FY 1995. Contrary to the "balanced budget" summary included in the Official Statements, before the first of the three bond issues was sold the City knew that it faced at least a $12 million deficit because it would not receive either the land fill or Crime Bill monies, and that the City would experience a deficit in FY 1995.
Note 9 to Miami's financial statements, included in the 1994 CAFR and Official Statements, failed to reveal Miami's cash flow problem and, instead, gave the misleadingimpression that the City was taking steps that would allow it to finish FY 1995 in a stronger financial position than in FY 1994. Miami did not disclose that the City was facing such severe cash flow challenges that, absent borrowing funds, it might be unable to pay municipal workers in FY 1995. Nor did it disclose that Deloitte had informed Miami of a projected $35 - $40 million deficit for FY 1995.
Miami claims that "Note 9 made it absolutely clear that the majority of the savings from the right-sizing efforts were not anticipated to be realized until FY 1996, and this fact was obvious to any reader, as were the consequences of the right-sizing efforts not being successful." The disclosures regarding Operation Right Size were anything but "obvious." Note 9 did not disclose that Operation Right Size would generate only $5 million in savings in FY 1995. It also did not state that Miami would have to sell bonds to stay afloat in FY 1995. Paredes admitted that Note 9 only "implied" that Miami would incur cash deficits in FY 1995.28
The certificate stating that there was no material change in Miami's financial condition included in the Official Statements for the bond offerings was false because it did not represent the financial facts that existed at the time of the bond sales. Soon after September 30, 1994, City officials became aware that the City's finances were deteriorating significantly. Odio testified that FY 1995 was the worst threat to City finances he had confronted in his fifteen years with the City. Although it appeared that the City had met payroll and paid other ongoing expenses, and had achieved a positive General Fund balance in FY 1995, in reality, the ever-growing budget deficit was masked by transfers from other funds and the use of bond proceeds. The Interim City Manager concluded that in the summer of 1995 the City's financial situation:
had to be shaky, certainly because of the cannibalization, if you will, of storm water trust money, of unfunded liabilities, utilizing pension bond issue proceeds to meet annual budget requirements for the pension funds. So you've got clear indications of fiscal shortfalls and questionable accounting, official policy.
In light of the City's critical cash flow shortfall, the certification was a material misrepresentation. The balanced budget summary29 was misleading because, throughout FY 1995, Miami's operating expenses exceeded budgeted operating revenues by millions of dollars and Miami knew that it would not receive some of the projected revenues.
Miami's cash flow crisis and the consequent possibility that it would not meet its operating expenses would be viewed by a reasonable investor as a material factor in deciding whether to purchase Miami's debt.30 A reasonable investor would have considered it important to know that Miami could not generate sufficient revenues to pay its bills or its employees. The fact that Miami needed to use bond proceeds to satisfy operational expenses demonstrated the gravity of its cash flow deficit, and, thus, the City's need to disclose this fact to public investors and the marketplace. Miami's financial disclosures would be no less important to investors, who held previously issued City bonds, and were entitled not to be mislead about Miami's current financial condition in deciding whether to hold or sell their bonds. "Information about the issuer and other obligated persons is as critical to the secondary market . . . as it is in primary offerings."31
Miami argues that it was excused from disclosing that the City was experiencing cash flow stress and would be unable to meet its obligations because Deloitte did not issue a "going concern" qualification.32 Miami erroneously equates the absence of a going concern qualification with the absence of adverse financial conditions that should have been disclosed. A going concern qualification discloses that the client will not meet its obligation in the coming twelve months. Paredes testified that, although Miami's cash position was "very tight," the City avoided a "going concern" qualification only because City officials represented that bonds would be issued to address any cash needs - - the very bonds at issue here. Although Miami's plan to survive the fiscal year by selling bonds may have removed the need for a going concern qualification, it did not relieve Miami of its obligation to disclose adequately the City's cash crisis or the role of those bonds in remedying the crisis. We have previously found antifraud violations where a municipal issuer failed to disclose that its cash flow position had materially declined (since the close of the prior fiscal year's financial statements included with its Official Statements) and misrepresented that there had been no material change in its financial condition.33
Miami asserts that the law judge erred in concluding that the balanced budget summary, included in the Official Statements, was a material misrepresentation because the summary "reflected historical information." Although the City Commission's approval of the FY 1995 budget was "historical," publication of the budget summary in the Official Statement was misleading. Before the first offering, City officials knew that Miami's FY 1995 budget was not balanced and that the City would not receive the Crime Bill Funds or much, if any, revenue from the sale of landfill. We conclude that the misrepresentations, false statements and omissions made by Miami in the Official Statements and 1994 CAFR were material.34
Scienter is a necessary element of a violation of Section 17(a) (1) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder.35 Proof of scienter need not be direct, but may be "a matter of inference from circumstantial evidence."36 Scienter has been defined by the Supreme Court as "a mental state embracing intent to deceive, manipulate, or defraud."37 A showing of recklessness or actual knowledge can satisfy the scienter requirement.38
Miami argues that the Division failed to meet its burden of proving scienter because the Division failed to establish that Miami "did not act in good faith." As made clear above, in the face of obvious indicators to the contrary, Miami was at least reckless in misstating that its FY 1995 budget was balanced, downplaying its cash flow crisis, failing to disclose that Miami needed to issue debt to resolve its crisis, and misrepresenting that there were no material changesin its financial condition. Miami's officials ignored the City's disclosure responsibilities. Odio admitted that he was not familiar with Miami's disclosure requirements and dismissed the importance of the bond offering documents.
Let me ask you this, does anybody read this [Official Statement]? I mean, only experts read this . . . . [M]ost people don't read this, nobody reads this. They go by what the raters, that is Moody's, Standard & Poor's, saying that these bonds are safe to buy. By rating them AAA, they're a very good buy. Therefore, they wouldn't go reading through this. Nobody does.
Bond insurance did not give Miami license to misrepresent its financial condition or withhold material information from the marketplace.39
Miami further asserts that the City relied on Deloitte, and other professionals who participated in the bond offerings, to advise the City on its disclosure in the Official Statements.40 Primary responsibility for the accuracy of information filed with the Commission and disseminated among investors rests upon the municipality.41 A city does not discharge this obligation by the employment of independent public accountants or other professionals.42 As we have repeatedly emphasized, issuers of municipal securities "are primarily responsible for the content of their disclosure documents and may be held liable under the federal securities laws for misleading disclosure."43 Municipal issuers have an affirmativeobligation to know the contents of their securities disclosure documents, including their financial statements.44
Moreover, the record is unclear as to whether and to what extent Miami consulted with or relied on professionals.45 Miami does not point to any professional advice that it received with respect to its certificate of no material change or its budget summary. Miami claims that Deloitte drafted Note 9 to its 1994 financial statements. However, Paredes testified that he recommended that Miami disclose the "cash deficits that were being funded by other funds," and that as the result of a "consultative type process" Miami decided to add Note 9. Paredes further testified that he could not "specifically recall exactly who wrote the first draft of Note 9."
Even if Paredes drafted Note 9, however, Miami knew that Note 9 did not disclose the scope of its cash flow predicament or the necessity to issue debt to remedy that problem. If a company officer knows that "financial statements are false or misleading and yet proceeds to file them, the willingness of an accountant to give an unqualified opinion with respect to them does not negative the existence of the requisite intent or establish good faith reliance."46
Accordingly, we find that Miami willfully violated Sections 17(a)(1)-(3) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder in connection with the offer and sale of the three bond issues. We further find that Miami willfully violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder in connection with its outstanding bonds by makingmaterially false and misleading statements and omitting material information in its 1994 CAFR.47
In assessing whether a cease-and-desist order is an appropriate sanction, we focus on the risk of future violations.48 "This inquiry is a flexible one and no one factor is dispositive. This inquiry is undertaken not to determine whether there is a 'reasonable likelihood' of future violations but to guide our discretion."49 In the ordinary case, and absent evidence to the contrary, a finding of past violation raises a risk of future violation sufficient to support our ordering a respondent to cease and desist. "To put it another way, evidence showing that a respondent violated the law once probably also shows a risk of repetition that merits our ordering to cease and desist."50 We also consider:
the seriousness of the violation, the isolated or recurrent nature of the violation, the respondent's state of mind, the sincerity of the respondent's assurances against future violations, the respondent's recognition of the wrongful nature of his or her conduct, and the respondent's opportunity to commit future violations. In addition, we consider whether the violation is recent, the degree of harm to investors or the marketplace resulting from the violation, and the remedial function to be served by the cease-and-desist order in the context of any other sanctions being sought in the same proceeding.51
We further may consider the function a cease-and-desist order will serve in alerting the public that a respondent has violated the securities laws.52
Miami argues that the cease-and-desist order is inappropriate because the violative conduct giving rise to the sanction occurred approximately seven years ago, and the officials involved with that conduct are no longer with the City. The Division emphasizes that the mere passage of years alone cannot determine whether Miami will commit violations in the future, and that the departure from City government of officials responsible for Miami's financial misrepresentations and omissions is not determinative of the appropriateness of a cease-and-desist order. We agree with the Division. The departures of Odio and Surana from City government provide no assurance that Miami will not commit similar violations in the future.
Miami's actions were not the result of an isolated incident but were recurrent and stretched from one fiscal year and into the next. In the three bond issues, the City used financial statements that failed to warn investors about its ongoing financial stress; falsely certified that there had been "no material adverse change" in its financial condition since FY 1994, even though Miami faced a cash shortfall of over $30 million; and depicted a balanced budget, knowing that $12 million in revenue would not be forthcoming. These violations were committed with at least recklessness.
Miami argues that its conduct did not result in harm to either public investors or the market place. This is not true. Because Miami failed to make full and accurate disclosures about its financial condition, investors purchased the City's debt without full information.
Miami also asserts that appointment of the Oversight Board negates the need for a cease-and-desist order. The Oversight Board was not a permanent watchdog over Miami's finances. Miami has not adduced evidence of what changes in policy and financial controls have been introduced to eliminate the "possible risk" of future violation. We disagree with Miami's contention that a cease-and-desist order will serve no remedial purpose. We believe that the order will help prevent future violations.
Miami still maintains that it did nothing wrong. The fact that Miami has pointed its finger at Deloitte, and other bond professionals, without taking any responsibility for its own conduct, suggests that Miami has not accepted fully its responsibility for the City's financial disclosures. It is likely that Miami will sell bonds in the future. The City must be given the clear message that Miami is responsible for the adequacy of its financial disclosures when seeking
money from the investing public. Accordingly, we will order Miami to cease-and-desist from committing or causing any violations or future violations of the antifraud provisions of the securities laws.
An appropriate order will issue. 53
By the Commission (Chairman DONALDSON and Commissioners GLASSMAN, GOLDSCHMID and ATKINS); Commissioner CAMPOS not participating.
Jonathan G. Katz
UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
SECURITIES EXCHANGE ACT OF 1934
Admin. Proc. File No. 3-10022
In the Matter of
THE CITY OF MIAMI, FLORIDA
ORDER IMPOSING REMEDIAL SANCTIONS
On the basis of the Commission's opinion issued this day, it is
ORDERED that the City of Miami cease and desist from committing or causing any violations or future violations of Section 17 (a) of the Securities Act of 1933, Section 10 (b) of the Securities Exchange Act of 1934, and Exchange Act Rule 10b-5.
By the Commission.
Jonathan G. Katz
|1||15 U.S.C. § 77q.|
|2||15 U.S.C. § 78j.|
|3||17 C.F.R. § 240.10b-5.|
|4|| Miami requests that we conduct a de novo review of the record and "reject" the law judge's decision. Rule of Practice 410 requires the petitioner to "set forth the specific findings and conclusions of the initial decision as to which exception is taken." In our discretion, we may deem that the petitioner waived any exception not stated in the petition for review.
Under Rule of Practice 411, we "make any findings or conclusions that in [our] judgment are proper and on the basis of the record." We give "considerable weight and deference" to the trier of fact's credibility determinations and reject them only where there is substantial evidence for doing so. Jay Houston Meadows, 52 S.E.C. 778, 784 (1996), aff'd, 119 F. 3d 1219 (5th Cir. 1997).
|5||Odio and Surana, who were respondents in this proceeding, resigned their positions as theresult of a joint state/federal investigation of corruption in Miami's municipal government, known as Operation Green Palm. The Commission subsequently accepted Odio's and Surana's Offers of Settlement. Without admitting or denying liability, Odio and Surana agreed to cease and desist from committing or causing any violations or future violations of Sections 17(a)(1), 17(a)(2), and 17(a)(3) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Our findings here with respect to Odio and Surana are solely for the purpose of this opinion. Manohar Surana, Securities Act Rel. No. 1110 (Sept. 22, 2000) 73 SEC Docket 869; Cesar Odio, Securities Act Rel. No. 7851 (Apr. 14, 2000) 72 SEC Docket 614.|
|6||The governing body of each municipality "shall make appropriations for each fiscal year which, in any one year, shall not exceed the amount to be received from taxation or other revenue sources." Fla. Stat. Ann. § 166.241(3).|
|7||According to minutes of the Commission meeting at which the budget was approved, the Vice-Mayor observed: "This is the same method of budget balancing we do each year. OK? Now, you see it; now, you don't. OK? That nine million dollars will never show up anyplace but on paper, and it will be shifted around from place to place . You will never see nine million dollars." Another Commissioner responded: "Tell my colleague it goes back to his old saying of 'voodoo economics.'"|
|8||During his testimony at the hearing, Odio could not recall receiving the document.|
|9||Miami asserts that D. Parekh's statement about when Miami found out that the Crime Bill had changed from a block grant to a discretionary program was impeached by his prior investigative testimony. D. Parekh initially testified that in January or February 1995, after the FY 1995 budget had been approved, the City learned that the nature of the program had changed. Miami concludes that this is also when the City came to know the timing of its receipt of funds under the Crime Bill. We find no connection between the two events. D. Parekh testified that, before the FY 1995 budget had been approved, City officials learned that the Crime Bill monies would not be received until FY 1996. The law judge found D. Parekh to be a credible witness; D. Parekh's hearing testimony is consistent with substantial documentary evidence in the record including the Suranamemo and the discussion at the City Commission meeting. See nn.4, 7 supra.|
|10||Howard Gary, the president, CEO, and principal of HG & Co., was Miami's City Manager prior to Odio. Miami terminated its contract with HG & Co. in late 1996.|
|11||K. Parekh testified that the financial advisers put their concerns in writing to ensure that Miami understood that the City's "deteriorating fiscal condition" would continue to decline, and was "extremely important" to address. K. Parekh further testified that in deviation from their usual practice, the financial advisers captioned the letter to Miami, "PRIVILEGED AND CONFIDENTIAL," in order to stress the sensitivity of the issues raised.|
|12||For example, in September 1994, the City issued $18 million Pension Bonds to finance payments under the Gates Judgement. The financial advisers had informed Miami that they opposed issuing these bonds because they felt it was inappropriate to fund an operating expense (like a legal settlement) with municipal securities having a 20-year maturity.|
|13|| For example, from 1990 through 1995 Miami charged each citizen $160 annually for garbage fees when the service actually cost over $380 per year. This shortfall, which cost Miami between $12 million and $15 million per year, was paid from the General Fund.
The Florida Constitution permitted the City to levy ad valorem taxes up to $10 per thousand dollars of assessed valuation for general governmental services. For the FY ending September 30, 1995, the rate was $9.5995 per thousand dollars; the same level since 1988. Witnesses testified that raising the rate would not have been sufficient to close the deficit.
For the six years prior to the period under review, Miami issued Tax Anticipation Notes ("TAN") in October to finance operations until the subsequent year's tax revenues were collected in December. Miami could not issue additional TANs until October 1, 1995.
|14||Pursuant to Statement of Auditing Standards No.59, an auditor must conduct a "going concern" review to determine a client's ability to meet its operating expenses and debt service for the twelve months following the date of the audited financial statements. Where there is doubt about the client's ability to do so, the auditor must evaluate management's plans to mitigate those concerns, and determine whether to issue a "going concern" qualification on the audit report.|
|15||Deloitte's work papers noted that Miami's projected FY 1995 budget "included the Federal Crime Bill, land sales and others, whose realizeability was not assured." Miami knew that it would not realize the $3 million from the sale of land fill included in its budget for FY 1995. In his "Best Case" projection, Paredes assumed that Miami would receive only $500,000 from the sale of land fill. Ultimately, no revenue was realized from the sale of land fill in FY 1995.|
|16||Miami did not issue the Self Insurance Bonds but sold the three bonds at issue here.|
|17||Paredes testified that: "Because the City had plans and was instituting processes . . . . They had the capacity to issue debt and sell assets which all generate resources to make their ends meet. I think we need to understand that this analysis was done to see if there was a going-concern need in the opinion. We concluded clearly that there was no need for that."|
|18|| Deloitte completed its fieldwork for the FY 1994 audit on February 28, 1995, the date appearing on the signed audit opinion. However, the record is unclear as to when the City received the FY 1994 audit. Miami asserts that the law judge improperly concluded that the City received the FY 1994 audit in February or March 1995.
Odio testified that he received Deloitte's Management Letter on February 28. However, Paredes testified, based Deloitte's Record of Report Issuance, that the audited financial statements were delivered to the City on May 31, 1995. Notwithstanding the dispute about the date of Miami's receipt of the audit opinion, the record is clear that the City was aware of its serious cash flow problems by February 1995.
|19||Note 5 to the financial statements showed that almost $20 million of the $23.8 million "Due from Other Funds" came from five Capital Improvement Funds.|
|20||An Official Statement is the "municipal equivalent of a corporate prospectus." It constitutes "financial disclosure by a state or local government planning a municipal securities offering that states the purpose for the issue and . . . discloses pertinent information on the issuer's financial condition." Barron's Dictionary of Finance and Investment Terms, 318, 408, 475 (4th ed. 1995).|
|21||The certificate was required for the Official Statement for each of the three bond issues, as well as for the bond purchase agreements for the FP & L and Pension Bonds. K. Parekh testified that none of the bond transactions could have closed without the representations in the certificate.|
|22||On September 27, 2001, pursuant to Rauscher Pierce's Offer of Settlement, the Commission issued an Order Instituting Proceedings and Cease-and-Desist Proceedings, Making Findings and Imposing Remedial Sanctions ("Order") against Rauscher Pierce in connection with its role as underwriter of Miami's Pension Bonds in December 1995. The Order required Rauscher Pierce to cease-and-desist from committing or causing any violations and any future violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act, Section 15B(c)(1) of the Exchange Act, and MSRB Rule G-17, and ordered Rauscher Pierce to pay a civil penalty in the amount of $200,000. See Rauscher Pierce Refsnes, Inc., Exchange Act Rel. No. 44864 (Sept. 27, 2001), 75 SEC Docket 2510, 2516.|
|23||Griffith Pitcher, Miami's bond counsel on the Pension Bonds, testified that it would be "very unusual" for any City Commission to delegate to the City Manager discretion as to the timing and amount of debt to issue.|
|24|| K. Parekh testified that Surana had suggested a number of novel transactions, including "Yankee bonds, issuing Yen-denominated securities, to securities issued in Austrian shillings, to currency swaps to interest rate swaps, and lots of innovative and interestingstructures." According to K. Parekh, during the October 19 meeting, he advised Surana that some of those financing scenarios were "illegal" or "extremely improper." K. Parekh further testified that in response Surana berated him for two hours and told him that he was "incompetent."
In an attempt to discredit K. Parekh's testimony about Miami's ongoing cash deficiency, the City asserts that K. Parekh fabricated the October 19 dispute between Surana and himself because he had an "ax to grind" with Surana. Miami claims that Griffith Pritcher, bond counsel, contradicted K. Parekh's testimony that Surana berated Parekh by testifying that he had no recollection of the incident. Regardless of what occurred at this meeting, K. Parekh's overall testimony regarding Miami's financial condition is corroborated independently by other testimony and substantial record evidence. See e.g., pp. 5-6 supra and 10-11 supra.
|25||See U.S. v. Naftalin, 441 U.S. 768 (1979).|
|26||17 C.F.R. § 240.15c2-12. See Release Adopting Exchange Act Rule 15c2-12, 54 FR 28799, 28811 n.84 (July 10, 1989). See also County of Nevada, Securities Act Rel. No. 7535 (May 5, 1998), 67 SEC Docket 256 (settlement to cease-and-desist order finding violations of Sections 17(a)(2) and (a)(3) in sale of municipal bonds); Maricopa County, Securities Act Rel. No. 7354 (Oct. 3, 1996), 62 SEC Docket 2834 (settlement to cease-and-desist order finding violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule l0b-5 thereunder); County of Orange, California, Exchange Act Rel. No. 36761 (Jan. 24, 1996), 61 SEC Docket 487 (public issuers are primarily liable for the content of their disclosure documents and are subject to proscriptions under the antifraud provisions); and County of Nevada, Initial Decision Rel. No. 153 (Oct. 29, 1999), 70 SEC Docket 3303 (municipal bonds subject to Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule l0b-5 thereunder).|
|27||See Statement of the Commission Regarding Disclosure Obligations of Municipal Securities Issuers and Others, Securities Act Rel. No. 7049, 59 FR 12748 (March 17, 1994) (municipal issuer that releases information that is reasonably expected to reach investors and the trading markets is subject to the antifraud provisions).|
|28||In contrast, in its 1995 CAFR (issued after the sale of the subject three bond issues), Miami admitted that it had initiated Operation Right Size because a net deficiency of $26 million "became apparent in February 1995 and the City immediately began the process of correcting the deficiency through several actions including workforce reductions, cost reductions and operating efficiencies."|
|29||See pp.11-12 supra.|
|30||See, e.g., Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988) (in order to be material, "there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available") (quoting TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)).|
|31||"Municipal Securities Disclosure," Exchange Act Rel. No. 34961 (Nov. 10, 1994), 57 SEC Docket 2993, 2993-94.|
|32||Miami's argument would not be a defense to the City's affirmatively misrepresenting in the three bond sales that there had been no material adverse change in Miami's financial condition since the prior fiscal year, and that its budget was balanced.|
|33||See Maricopa County, 62 SEC Docket at 2836.|
|34||The law judge found that Miami's failure to disclose in the Official Statements that S & P had downgraded the City's general obligation bonds from A+ to A was a material omission. Miami argues that the Order Instituting Proceedings did not allege this violation. We do not reach the question of whether Miami's failure to disclose the downgrade constituted a material omission.|
|35||See Aaron v. S.E.C., 446 U.S. 680, 695 (1980); Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976); Steadman v. S.E.C., 603 F.2d 1126, 1132 (5th Cir. 1979), aff'd, 450 U.S. 91 (1981). Scienter need not be found to establish a violation of Section 17(a)(2) or (3) of the Securities Act. Aaron v. SEC, 446 U.S. at 697; SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 193 (1963); Steadman, 603 F.2d at 1134.|
|36||Herman & MacLean v. Huddleston, 459 U.S. 375, 390 n.30 (1983); Pagel, Inc. v. SEC, 803 F.2d 942, 946 (8th Cir. 1986); In re Meyer Blinder, 50 S.E.C. 1215, 1230 (1992).|
|37||Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976).|
|38||See Howard v. Everex Systems, Inc., 228 F. 3d 1057, 1063 (9th Cir 2000). The Ninth Circuit defined recklessness as: "an extreme departure from the standards of ordinary care  which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it." Id.|
|39||See Release Adopting Exchange Act Rule 15c2-12, 54 FR at 28812 and n.89 ("The presence of credit enhancements generally would not be a substitute for material disclosure concerning the primary obligor on municipal bonds.").|
|40||Courts have held that, in order to successfully assert a reliance-on-professionals defense, an issuer must demonstrate that it: (1) made complete disclosure to its counsel or accountant; (2) requested the professional's advice as to the legality of the contemplated action; (3) received advice that the conduct was legal; and (4) relied in good faith on that advice. See SEC v. Goldfield Deep Mines, 758 F.2d 459, 467 (9th Cir. 1985) (accountant and counsel). See also, SEC v. Caserta, 75 F. Supp.2d 79, 95 (E.D.N.Y. 1999) (accountants).|
|41||See nn.26 and 27 supra.|
|42||See Kahler Corp., 55 SEC Docket 24, 36 n.8 (Sept. 17, 1993) (settlement) (Unqualified opinion from independent auditors did not relieve issuer liability because "financial statements are management's responsibility.").|
|43||In re Citisource, Inc. Sec. Lit., 694 F. Supp. 1069, 1072-75 (S.D.N.Y. 1988) (municipality can be held liable under Section 10(b) of the Exchange Act); In reWashington Public Power Supply Syst. Sec. Lit., 673 F. Supp. 411 (W.D. Wash. 1987), aff'd, 823 F.2d 1349 (9th Cir. 1987) (issuers of municipal securities can be held liable under Section 10(b) of the Exchange Act and Rule l0b-5 thereunder); In re Washington Public Power Supply System Sec. Lit, 650 F. Supp. 1346 (W.D. Wash. 1986); New York City Municipal Sec., 507 F. Supp. 169, 184-85 (S.D.N.Y. 1980) (issuers of municipal securities must comply with antifraud provisions of the federal securities laws).|
|44||County of Orange, California, 61 SEC Docket at 501. See also County of Nevada, 67 SEC Docket at 259.|
|45|| Miami's financial advisers expressly disavowed responsibility for any of the financial information contained in the Official Statements. A disclaimer in the Official Statements stated that:
K. Parekh testified that, although it was "unusual" to include such a disclaimer, he did so because he "did not have any comfort as to the accuracy of any of the information that I was receiving from the City."
In his investigative testimony, Griffith Pritcher, bond counsel, denied any role in Miami's financial disclosures. Pritcher testified that: "[my legal] opinion doesn't go to the financial aspect of it [the Official Statement] . . . ." The audit opinion letter declared that "no opinion is expressed as to . . . any financial, demographic, or statistical data set forth therein." Robert Moore, the analyst at AMBAC Insurance, noted during his investigative testimony that AMBAC relied on financial information provided by Miami in performing its credit analysis for the Pension Bonds. Moore further testified that he did not speak with anyone in connection with performing the credit analysis and relied solely on the Official Statements and the FY 1994 financial statements.
Paredes admits that he carried out certain "due diligence procedures" for Miami prior to each bond offering. However, Paredes testified that this "subsequent events analysis" was not extensive and consisted of obtaining assurances from Miami officials that there had been no changes that impacted City's FY1994 financials. Paredes noted that Miami provided Deloitte a letter confirming that "[n]o events have occurred subsequent to September 30, 1994 that have a material effect on the financial statements that should be disclosed." Paredes testified that he had no interaction with the City's financial advisers, underwriters, or bond counsel. Paredes further testified that Deloitte did not look at any interim financial information and did not make any inquiries regarding Miami's cash flow. The City sued Deloitte claiming that each and every financial statement from 1989 through 1995, including the financial statement used to sell the three bond issues in 1995, was false and misleading.
We do not reach the issue of whether these bond professionals fulfilled their responsibilities with respect to these offerings.
|46||See U.S. v. Erickson, 601 F.2d 296, 305 (7th Cir. 1979) (criminal case); See U.S. v. Colasurdo, 453 F.2d 585, 594 (2nd Cir. 1971). See also Mishkin v. Peat, Marwick, Mitchell & Co., 744 F. Supp. 531, 538 (S.D.N.Y. 1990) (management is responsible for entity's financial statements).|
|47||The Order Instituting Proceedings charged only that the CAFR violated Exchange Act Section 10(b) and Rule 10b-5 thereunder.|
|48||Exchange Act Section 21C(a) authorizes the Commission to order persons to cease and desist from committing securities laws violations or future securities law violations if it finds that "any person is violating, has violated, or is about to violate any provision" of the Exchange Act. 15 U.S.C. § 78u-3 (a).|
|49||KPMG Peat Marwick LLP, Exchange Act Rel. No. 43862 (Jan. 19, 2001), 74 SEC Docket 384, 436, motion for reconsideration denied, Exchange Act Rel. No.44050 (Mar. 9, 2001), 74 SEC Docket 1351, petition denied, 289 F.3d 109 (D.C. Cir. 2002).|
|50||74 SEC Docket at 430.|
|51||Id. at 436.|
|52||Id. at n.148.|
|53||We have considered all of the arguments and contentions made by the parties. We reject or accept these arguments and contentions to the extent that they are inconsistent or in accord with the views expressed in this opinion.|